Real estate investing has always been a popular way to increase wealth and generate passive income. However, when investing in real estate, many people need to realize the power of leverage. Leverage allows investors to amplify their returns and get more bang for their buck. Now, let’s discuss how real estate pays you back, how to maximize your returns with leverage, and how to offset capital gains taxes using real estate investments.
How Real Estate Pays You Back
Before we dive into the power of leverage, let’s talk about the four ways real estate pays you back: appreciation, depreciation, principal paydown, and cash flow. Appreciation occurs when the value of your property increases over time, while depreciation allows you to write off the declining value of your property on your taxes. Principal paydown happens when you make your mortgage payments, and cash flow is the money left over after you pay all the expenses associated with owning the property. By utilizing leverage, you can increase these four forms of returns exponentially.
What Leverage Looks Like
What does this look like in practice? Let’s say you have $100,000 to invest in real estate. Without leverage, you can purchase a $100,000 property and potentially earn a 5% return per year. However, with leverage, you can use that $100,000 as a down payment to purchase a $500,000 property. Assuming a 20% down payment and a 5% interest rate, you’ll have a mortgage payment of approximately $2,048 per month. If you rent out the property for $3,200 per month, you’ll have a monthly cash flow of $1,152. This means that your cash-on-cash return is now 13.8% per year!
Risks Involved
While leverage can increase your returns dramatically, it’s essential to consider the risks involved. If the value of your property decreases, your losses will also be amplified. Additionally, leveraging can lead to increased debt, which can be detrimental if you’re unable to make your mortgage payments. It’s important to do your due diligence and invest in properties with strong rental demand and appreciation potential.
Tax Benefits of Real Estate
Tax time is just around the corner, and for many real estate investors, this can be a stressful time. However, did you know that you can utilize real estate investments to offset your capital gains taxes? By investing in a 1031 exchange, you can defer your capital gains taxes by trading your relinquished property for a like-kind property. This means that you can essentially roll over your profits and avoid paying taxes until you sell the new property. Another way to offset capital gains taxes is by investing in a qualified opportunity zone fund. These funds invest in designated areas that are in need of economic development, and investors can receive significant tax benefits for investing in these areas.
The power of leverage in real estate investing cannot be overstated. By utilizing leverage, investors can increase their returns exponentially and generate significant passive income. However, it’s important to consider the risks involved and invest in properties that have strong rental demand and appreciation potential. Additionally, real estate investments can be used to offset capital gains taxes, allowing investors to keep more money in their pockets. We hope we provided valuable insights on how to maximize your returns with leverage and use real estate investments to minimize your tax liabilities.
