DEFINITION of ‘Investment Property’
Investment property is real estate property that has been purchased with the intention of earning a return on the investment, either through rental income, the future resale of the property or both. An investment property can be a long-term endeavor or an intended short-term investment such as in the case of flipping, where real estate is bought, remodeled or renovated, and sold at a profit.
BREAKING DOWN ‘Investment Property’
The way in which an investment property is used has a significant impact on its value. Investors sometimes conduct studies to determine the best, and most profitable, use of a property. This is often referred to as the property’s highest and best use.
For example, if an investment property is zoned for both commercial and residential use, the investor weighs the pros and cons of both options until he has ascertained which one has the potential for the highest rate of return, and then utilizes the property in that manner.
Difference Between Financing a Home and an Investment Property
While borrowers securing a loan for a primary residence have access to an array of financing options, including FHA Loans, VA Loans and conventional loans from a variety of banks, in most cases, it is more challenging to procure financing for an investment property than for a primary residence.
In particular, insurers do not provide mortgage insurance to investment properties, and as a result, borrowers need to have at least 20% down to secure bank financing for investment properties.
Additionally, to approve borrowers for a mortgage on an investment property, banks insist on good credit scores and relatively low loan-to-value ratios. Some lenders also require the borrower to have ample savings to cover six months’ worth of expenses on the investment property.
Reporting Earnings from Investment Properties
If an investor collects rent from an investment property, the Internal Revenue Service (IRS) requires him to report the rent as income, but the agency also allows him to subtract relevant expenses from this amount.
For example, if a landlord collects $100,000 in rent over the course of a year but pays $20,000 in repairs, lawn maintenance and related expenses, he reports the difference of $80,000 as self-employment income.
If an individual sells an investment property for more than he purchased the property, he has a capital gain and must report these earnings to the IRS. As of 2017, capital gains on assets that are held for at least one year are considered long-term gains and taxed at 15 percent, except for those who are married and have taxable income exceeding $450,000 or single and have income exceeding $400,000, in which cases the rate is 20 percent.
In contrast, if a taxpayer sells his primary residence, he only has to report capital gains in excess of $250,000 if he files individually and $500,000 if he is married filing jointly. The capital gain on an investment property is its selling price minus its purchase price minus any major improvements.
To illustrate, imagine an investor buys a property for $100,000 and spends $20,000 installing new plumbing. A few years later, he sells the property for $200,000. After subtracting his initial investment and capital repairs, his gain is $80,000.
Be sure to contact your CPA or Tax Advisor to confirm the details stated above as well as your particular financial position.
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