Tax-free profits in real estate is just one of many reasons why real estate is my favorite asset class to build long-term wealth.
As someone who experienced more than nine years of the early retirement movement, I've noticed a growing trend to forsake owning for renting. Commonly cited reasons are cost, flexibility to move and potentially higher returns elsewhere. Goodness forbid owning a house as a startup founder. Egad!
While all these reasons for renting are completely valid, if you are renting and hardly ever travel, aren't investing your disposable income, aren't running a lean startup, or staying at the same job for years, you're actually negating all the benefits of renting. You might as well own!
Being neutral the property market by owning a primary residence allows you to sidestep inflation's never ending beating. Most of your costs are fixed, and if you ever decide to rent out your property, you'll begin to capture the benefits of inflation.
Don't Underestimate Tax-Free Profits In Real Estate
Most of us don't count on Social Security to be there for us in retirement. Expecting the government to take care of us, when it can't even take care of its own finances, is a dangerous thing.
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We also realize that if Social Security is there for us, then we might all be millionaires by the time we start collecting. Just in case we fail at becoming completely self-sufficient, Social Security is a powerful security blanket.
For investors in general, it is difficult to envision a $500,000 tax-free profit on your investment. However, if you own and then sell your primary residence, you can. Especially if you're married and live in higher cost areas like New York City, San Francisco, Los Angeles, San Diego, Seattle and even Denver. If you live in less costly areas, you can still envision the chance for a meaningful tax-free return upon the sale of your home.
But just like Social Security, even though we don't count on having $500,000 in tax-free profits (for couples) sometime in the distant future, it's nice to know that we have such optionality if the possibility ever arises.
Demonstrating The Power Of Tax-Free Real Estate Profits
There's no other asset class I'm aware of that allows for $250,000 (single) / $500,000 (married) tax-free profits upon sale. Let's visualize how much gross profit you need to make at various tax rates in order to clear $250,000 and $500,000.
As you can see from the chart, the higher your tax rate, the more beneficial it is to own real estate as an investment. If you have a Federal tax rate of 28% or higher with itemized deductions beyond the standard deduction level, then you've got another reason to own.
Given that time tends to make asset owners wealthier, those who plan to hold their primary residence for longer than the median seven years will likely find this chart even more compelling.
Renting Is Fine, But Owning Is Better
The best time to buy real estate is when you can afford to do so. Follow my 30/30/3 rule for home buying to buy responsibly. Inflation is too strong of a force to go against. When you rent, you are short the real estate market. That's not good over the long term.
We can debate about the actual financial costs / benefits of renting vs. owning until the cows come home. However, because there's so much at stake, each side will always think they're right. Thus, I'd rather discuss the perception that renting provides more freedom than owning.
Unless you're a digital nomad, most people live in one area for years with only two to six weeks of vacation a year. If you're one of these people, then the perceived benefit of having more freedom is negated.
If you're an owner, it's not like you can't travel for months on end either. I traveled for six weeks a year my last three years of work between 2010 – 2012, and I've traveled for 10 weeks a year between 2013 – 2015 so far.
As for expenses, your mortgage payment is automated and you can easily pay your property taxes online. If you are a landlord, you can hire a property manager for half a month's rent to manage all the go-betweens.
You can utilize Airbnb or find a subletter through Craigslist to cover your costs or make some money while you are away. There are even companies like Handy who'll clean your house or fix whatever is broken through their mobile app. Thank goodness for the internet!
The Return On Rent
Let's also be clear. The return on rent is always negative 100 percent. You will never get a return on your rent money, only a place to live.
Rent or own, your life will be what you make of it. If for some reason you can't get neutral the property market by owning your primary residence, then be disciplined enough to save and invest all the money that would have been invested in a property.
Explore real estate crowdsourcing opportunities. If you don't have the downpayment to buy a property, don't want to deal with the hassle of managing real estate, or don't want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today.
Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you're looking for strictly investing income returns.
Sign up and take a look at all the residential and commercial investment opportunities around the country Fundrise has to offer. It's free to look.
Shop around for a mortgage: Check the latest mortgage rates online through Credible. They’ve got one of the largest networks of lenders that compete for your business. Credible will provide free, no-obligation quotes from great lenders.
Your goal should be to get as many written offers as possible and then use the offers as leverage to get the lowest interest rate possible. Interest rates have finally started to tick higher post election.