4 Things to Know About a Home Investment

The U.S. housing market faced a slump in 2018 partly because would-be buyers had to contend with a combination of rising prices and surging interest rates. Yet with the Federal Reserve suggesting it will ease up on future rate hikes and homebuilders poised to shift from luxury construction to more mass affluent homes, the housing market could begin to perk up again.

That could prompt more speculative buying from large firms or individuals looking to snatch up a second — or even third — property to leverage as an investment. For most, though, the motivation is much simpler: They are looking for a place to live, build equity, create memories and perhaps one day sell for a profit.

Homeowner Hassles

No matter what’s driving you or whether you can afford one home or multiple homes, beware of the unanticipated financial costs, time commitments and overall stress that can come from dealing with repairs and legal obligations. In this regard, a house is fundamentally different than the typical investment.

[See: How to Invest in Real Estate Without Buying Property.]

Most investments do not require you to scrutinize insurance policies in hopes of protecting against the potential for natural disasters or man-made accidents. Nor do most investments come with the very real possibility that disagreements you have with other people living on the premises can derail your ability to sell it for a profit.

For instance, you may want to sell a home even though your spouse wants to stay. That debate may postpone a sale that could have occurred during a favorable real estate market. Or if a storm damages the home and your insurer refuses to cover the cost of the repairs, financial woes related to the fixes may push your sale back into a time frame when the market has worsened.

Single Home

Both your life circumstances and larger macroeconomic issues may restrict your ability to choose the precise timing and location of your home purchase. Ideally, however, you’d be able to pull the trigger when property prices and mortgage rates are somewhat depressed, in an area with reasonable property taxes that is also poised to see an influx of new business, jobs and upwardly mobile residents in the coming years.

The problem is that these collective dynamics are the exception, not the norm. Sure, we could point to markets like Seattle or Brooklyn, which have seen home prices more than quadruple over the last three decades. But for every Seattle and Brooklyn, there are other areas whose outlook has flatlined or become grimmer, even as they once looked promising.

[See: 8 Great Tips to Shield Your Portfolio From Volatility.]

Also consider that we don’t have control over the process. Sometimes, in fact, the process controls you. Think about anyone who was forced to sell their home in the wake of the financial crisis, whether it was due to job loss, a transfer or an offer they couldn’t refuse. The lesson: As with any investment, there’s risk involved and it’s impossible to forecast what will happen.

Multiple Homes

If you can afford to buy a second or third home, there’s also a series of risks, including finding reliable tenants if you chose to become a landlord or fending off vandalism and burglaries if it’s a vacation home. These situations can lead to financial losses instead of income. Also take note of the tax implications to renting out your properties.

Rental-based depreciation deductions allow you to reduce your annual tax obligations for 27.5 years, from the time the property you own is ready and available to produce rental income. When you sell that rental property, you will have to pay taxes on the gain that reflect the lower cost basis as a result of the annual depreciation. Don’t plan on getting around it — the Internal Revenue Service requires that lower cost basis whether or not you actually deducted each year.

There’s also “passive activity limits” to beware of. Renting out property you own usually qualifies as passive income unless you (or your spouse, if filing taxes jointly) participated as a real estate professional for the property or certain other rare exceptions apply, as defined by IRS Publication 925. If your activities count as passive, you cannot use deductions or losses stemming from renting out the property to offset active income such as salary from a job.

Portfolio Piece

As you decide about using your home or homes as an investment, remember that real estate is an asset class that fits inside your larger portfolio, and that your investment portfolio fits inside your overall financial plan. Choosing when to buy and sell a home should complement your long-term strategy for wealth creation and preservation, with an eye toward tax consequences.

[See: 10 Ways to Maximize Your Retirement Investments.]

A home can influence everything from your retirement plan to your estate plan. That makes it a rather unique investment.

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4 Things to Know About a Home Investment originally appeared on usnews.com

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