What is an investment property?
Investment property is property that is acquired with the intention of generating a return on the investment through either rental income, future resale of the property, or both. The property can be held by an individual investor, a group of investors or a corporation.
Investment property can be a long-term venture or a short-term investment. With the latter, investors will often operate flipping, in which real estate is bought, converted or renovated and then sold at a profit within a short period of time.
Investment property can also be used to describe other assets that an investor purchases for the purposes of future appreciation, such as art, stocks, land, or other collectibles.
Understand investment properties
Investment property is property that is not used as a primary residence. They generate some form of income – dividends, interest, rents, or even royalties – that is outside the normal business of the property owner. And the way in which an investment property is used has a major impact on its value.
Investment properties generate income and are not a primary residence.
Investors sometimes conduct studies to determine the best and most profitable uses of a property. This is often referred to as the highest and best use of the property. For example, if an investment property is designated for both commercial and residential use, the investor weighs the pros and cons of both until they determine which has the highest return potential. You then use the property that way.
An investment property is often referred to as a second home. But the two don’t necessarily mean the same thing. For example, a family can buy a vacation home or other vacation property for their own use, or someone with a primary residence in the city can buy a second property in the country as a getaway for the weekend. In these cases, the second property is for personal use – not income property.
Types of investment properties
Residential: Rental apartments are a popular way for investors to supplement their income. An investor who purchases a residential property and rents it to tenants can collect monthly rents. These can be single-family houses, condominiums, apartments, townhouses, or other types of residential buildings.
Advertising: Investment properties do not always have to be residential properties. Some investors – especially corporations – buy commercial properties that are specifically used for business purposes. Maintenance and improvements to these properties may be higher, but these costs can be offset by higher returns. This is because the rental agreements for these properties often require higher rents. These buildings can be condominiums or retail stores.
Mixed use: A mixed-use property can be used commercially and residential at the same time. For example, a building on the ground floor may have a retail store front, such as a grocery store, bar, or restaurant, while the top of the structure houses residential units.
The central theses
- Investment property is acquired with the intention of generating a return through rental income, future resale of the property, or both.
- Real estate can be a short or long term investment opportunity.
- Investment properties are not first or second homes, which makes financing difficult for investors.
- The sale of an investment property is notifiable and can lead to capital gains that can have tax implications for investors.
Financing of investment properties
While borrowers securing a home loan have access to a range of financing options, including FHA loans, VA loans, and conventional loans, obtaining financing for an investment property can be more difficult.
Insurers do not offer mortgage insurance for investment properties, so borrowers must have at least a 20% discount to secure bank financing for investment properties.
Banks also insist on good credit and relatively low mortgage lending before granting a borrower a mortgage on investment property. Some lenders also require that the borrower have sufficient savings to cover spending on the investment property for at least six months to ensure that the mortgage and other obligations are up to date.
When an investor collects rent from investment property, the Internal Revenue Service (IRS) prompts them to report the rent as income, but the agency also allows them to deduct relevant expenses from that amount. For example, if a landlord collects $ 100,000 in rent over the course of a year but pays $ 20,000 for repairs, lawn maintenance, and related expenses, they report the difference of $ 80,000 as self-employment income.
If a person sells investment property at a price higher than the original purchase price, they have a capital gain that must be reported to the IRS. For 2021 and 2022, the capital gains tax rates for most assets held for more than a year are either 0%, 15%, or 20%.
In contrast, if a taxpayer sells his primary residence, he is only required to report capital gains tax on a home sale of more than $ 250,000 if he is filing individually and $ 500,000 if he is married and filing an application together. The gain on the sale of an investment property is the selling price less the purchase price less significant improvements.
To illustrate, imagine an investor buys a property for $ 100,000 and spends $ 20,000 installing new plumbing. A few years later, they sell the property for $ 200,000. After deducting your initial investments and capital repairs, your profit is $ 80,000.