Are your income properties a business, an investment, or both? I suspect most property owners would say they are both. That’s how I feel about mine. They certainly qualify as a business, but the primary reason I bought them was as an investment for the future.
Why does this matter? Because unless you own income property strictly as a business, you should be concerned with maximizing the investment quotient of your properties. How can this be done? There are several answers to that question, but one in particular is of interest to me in this article.
Off the top of my head, I can think of these ways to maximize your investment in your properties: 1) keep them well-maintained; 2) keep them rented to good tenants who pay regularly; 3) do what you can to lower expenses.
In addition to these and other “nuts and bolts” ways to maximize your investment, the investor should consider whether his equity is being well-utilized. Let’s define the term “investment” for purposes of this article as “the difference between a property’s value and the debt on that property.” Using this definition, “investment” is another word for “equity.” (There are two articles about increasing one’s return on equity in my blog postings: Ways to Increase Your Return on Equity and Return on Equity, in case you would like to read more about my opinion on this subject.)
Here’s an important thing to keep in mind that many overlook: As time passes, the value of your property increases (in a normal market!) and the amount of your debt decreases. Obviously, this means that your equity in the property rises. While the income from the property may also rise (usually the expenses rise, too), typically when net income is compared to equity, return on equity decreases over time.
What can be done about this phenomenon? After all, we all like that high percentage of return on equity that we got when we first bought that property, right? The answer is that you have to release some or all of that equity to work for you in another way. Refinancing the property can release a fair amount of the equity in your property, but not all of it. Usually a lender will require that the investor maintain 20% or so of his equity in the property during a refinance. Sometimes that’s okay. Another alternative to release equity is to sell the property and reinvest in a more expensive property. The problem with this is that a significant portion of your equity is going to go to the Internal Revenue Service in capital gain taxes and depreciation recapture, and to your state if state capital gain taxes apply.
The solution to releasing your equity to go to work for you elsewhere is found in Section 1031 of the Internal Revenue Code, which allows you to sell your property, defer all of your capital gain taxes and depreciation recapture, and put your equity to work in new property that will generate a higher rate of return.
If you have questions about exchanging, please let us know. We handle all types of exchanges. Experience The Power of Tax-Deferred Exchanges!
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Please consider IOWA EQUITY EXCHANGE as your source for answers to your questions about Section 1031 like-kind tax-deferred exchanges. Contact us at your convenience for prompt, accurate information. Please think of us for your next exchange.
Ken Tharp
Providing Qualified Intermediary services for Section 1031 tax deferred exchanges all over the United States. Headquartered in Iowa, our services are available in Missouri, Kansas, Nebraska, Colorado, North Dakota, South Dakota, Minnesota, Wisconsin, Illinois, and all other states.
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Copyright © 2008 By Ken Tharp, All Rights Reserved. * Are Your Income Properties a Business, an Investment, or Both? * Contact Ken Tharp for information on Section 1031 tax-deferred exchanges anywhere in the United States.
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