How to incorporate income-generating real estate into a financial plan

Real estate investors struggle to find financial planners who can fit their real estate holdings into their plan.

And that’s because most financial planners use out-of-the-box software that supports traditional investment accounts like IRAs, 401(k), and taxable accounts, but not the unique aspects of real estate investments, according to Dana Anspach, President and Founder. reasonable money.

“Off-the-shelf software packages do a great job of handling basic investment types,” Anspach said in a video interview. “But when you get into real estate, everything changes.”

Like traditional investments, real estate investments appreciate. But owners of income-producing real estate must also consider net cash flow after expenses, depreciation, amortization and taxes in their investment. “Many rental real estate assets have positive cash flows, but negative or neutral taxes, Anspach said. “And that’s not an easy thing to model using most financial planning software packages.”

In his practice, Anspach worked with his client who owns an income-generating property to create a spreadsheet that would take into account the unique factors associated with real estate investments and merge that data into a financial plan.

In addition, Anspach considered other unique factors, including whether the owner of the rental property qualifies as a “real estate professional”. If someone qualifies as a professional, they can offset the losses with other types of income. “But there are a series of qualifications that must be met to obtain real estate professional status,” she said.

In addition, it took into account the potential tax rate arbitrage from the depreciation that owners of rental properties can use. “When you sell the property, you get the depreciated amount back and it’s taxed at a rate of 25%,” she said. If you’ve been at a 40% plus tax rate along the way, paying a 25% gains tax is relatively nice.”

“It’s a lot to take in,” she said. “And since most of the tools available to planners don’t include this feature, it can be difficult.”

There is also risk management associated with owning a rental property.

One of the ways real estate investors manage the risk of natural disasters or unreliable and unpredictable cash flows is to create an emergency fund for each property. Another is to only spend money one year in arrears. And another is to build their portfolio until it provides them with double the cash flow they would need to live on. “That way they can get through a year where cash flow is cut in half,” Anspach said.

“Overall, the concepts we apply to financial planning and investing apply to real estate,” she said. “There’s no free lunch. Real estate offers returns that can exceed what you might get in an equity index fund over time, but the level of risk can be much higher.”

Ultimately, Anspach said, it takes a lot longer to come up with real estate financial plans because there are so many more factors to factor in. “But now we can see how all of these factors interact and how to combine them to achieve that basic level of reliable and predictable income that most people want as they approach their retirement years,” he said. she stated.

For those who want to own an income property, Anspach recommends The book on advanced tax strategies, cracking the code for savvy real estate investorsby Amanda Han and Matthew MacFarland.