Most people who have built wealth - and investment advisors - will recommend that real estate should be a large portion of your investment mix. For a lot of wealthy folks, real estate may make up the largest portion of their investments.
Why do the wealthy invest in real estate? Some believe that real estate is a safe investment over time. Many like that it is tangible. Some savvy investors will point out that they can use leverage to get into a property, and the property can provide more than one source of return on investment.
Most investments require that you have all of the cash up front. Think about buying stocks, bonds, CD's and so on. If you want to be able to purchase a $500,000 investment, you will likely need $500,000.
That is not necessarily the case with real estate. With a minimum of 25-30% down a person could potentially buy a $500,000 property. You could rent the property and potentially cover your expenses and make a profit. Later you could sell that property and use the proceeds to buy one or more additional properties. Historically, real estate prices have increased 4-6% a year, so your return on investment results from the increase in value during the holding period in addition to the potential cash flow with an investment property.
Most investors that are growing wealth with real estate use leverage to get started and take advantage of 1031 exchanges to keep all of their money working for them, deferring any capital gains and building wealth for future generations.** Capital gains taxes can range from a minimum of 15% to over 30% on the sale of an investment property.
Savvy investors have figured out how to invest in properties for positive cash flow, buy and hold for long term passive income and create a legacy with their real estate and build generational wealth using strategic 1031 exchanges. They know that their heirs will benefit from what is called the "stepped up basis" when they inherit a property.
How does the stepped up basis benefit your heirs? Let's say someone owns a property that they bought years ago for $100,000. That used to be a lot of money, right? And let's say that property is worth $1,000,000 today. If they sold it without doing a 1031 exchange, they would likely have to pay 15-30+% capital gains tax on all the gain.
However, if the heirs inherit the property, they get what's called a stepped-up basis. They inherit the property with a tax basis of $1,000,000. So, if the heirs turned around and sold it for $1,000,000, there would be no capital gains. Some investors have chosen to exchange larger investment properties for several smaller properties so that individual heirs can inherit properties that meet their individual needs and the investor can avoid future conflicts among family members.
If you are an investor who is over 60 year old, you owe it to yourself to learn how you can build wealth for your family and have your heirs avoid paying capital gains tax when they benefit from the stepped up basis.
**This is not tax advice - please consult with your tax professional.
Published in West Maui Neighbors magazine - August 2018