Investment in Real Estate Requires Careful Planning and Consultation by Laurie Jennings

Posted on January 30, 2014 by Laurie Jennings Arcia

As the economy improves, once cautious investors are eyeing real estate as a viable income-producing vehicle. According to the National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index, total returns on commercial real estate investment have been strong for the past three consecutive years. Additionally, residential construction, specifically in the high-demand multi-family sector, is experiencing a renaissance of its own as evident by the array of construction cranes popping up in major cities. While the threat of rising interest rates may weigh heavily on investor’s minds, the relatively high returns and fair degree of interest-rate and inflation protection of real estate investment may outweigh this potential risk.

Before delving head first into the real estate market, first-time investors should consider the following issues and meet with their professional advisors to help maximize returns while minimizing risks and liabilities.

Know Your Strategy

When putting money toward any new venture, investors should first examine why the investment makes sense for them. They should identify their short- and long-term goals and map out a plan that will help them achieve their intended objectives. For example, investors should ask themselves what type of property they plan to purchase, how long they intend to hold the property, what income they expect the property to generate, how they expect to earn that income and, lastly, what, if any, is their exit strategy. Answering these questions will set realistic expectations and help to determine the next steps investors can take to get started in real estate investments.

Establish the Appropriate Structure to Maximize Your Goals and Limit Liabilities

There is no one-size-fits-all structure for holding investment property. Rather, the preferred form of ownership will depend on a variety of factors, including the investor’s personal circumstances, his or her goals and a careful analysis of the legal liabilities and tax consequences of each entity. For example, limited liability companies (LLCs) allow investors to limit the risk to their capital investments and have profits and losses generated by the real estate to pass through their personal tax returns. However, when shares of LLCs are held in investors’ names, those assets become unprotected from creditors during bankruptcy and other legal proceedings. On the other hand, holding real estate in a trust or through a Single Member Limited Liability Company (SMLLC) can offer greater asset protection. Holding real estate in a trust has the added ability to distribute income generated by the real estate to beneficiaries, including family member.

Implement Beneficial Tax, Accounting and Estate Planning Strategies

There are several tax strategies available to help real estate investors increase depreciation deductions, minimize tax liabilities, maximize cash flow and, oftentimes, yield faster returns on their initial investment. Things to consider include reliance on either the cash or accrual basis of accounting, capitalizing on deductions, positively positioning gains and how investors will pass property onto future generations.

For example, the IRS allows investors to depreciate the structural components of a physical building(s) over a 27.5-year period for residential properties and 39 years for commercial real estate. However, with a cost-segregation study, investors may identify additional assets associated with the purchase, construction, repair and renovation of the property for which they may accelerate depreciation deductions over a much shorter timeframe (typically five to seven years).

Investors may realize additional deductions when they make energy-efficient improvement to the interior lighting systems; heating, ventilating, and air-conditioning systems; hot water systems; or building envelope of their properties that result in a 50 percent or more reduction in energy and power costs.

For high-income earners, there are strategies to help minimize their exposure to the new 3.8 percent tax on Net Investment Income, when they take the time to group together various investment activities in order to qualify their participation in those activities as material rather than passive. Similarly, investors with profitable rentals who spend more than 50 percent of their time and more than 750 hours working in that entity throughout the year may qualify as “real estate professionals” who may exclude rental income from the net investment income tax.

Build a Solid Team

Investment in real estate is not an endeavor for which individuals should embark lightly. It requires several skill sets and the expertise of a team of professionals who can work together to minimize risks and equip investors with an arsenal of tools and strategies that maximize their goals. This supporting staff may include realtors, real estate attorneys, mortgage brokers, insurance agents, bookkeepers, property managers, contractors and accountants – all of whom have experience with investment properties and can leverage opportunities and identify potential problems before they occur.

Berkowitz Pollack Brant has extensive real estate tax, estate planning and advisory services both domestically and abroad.

About the Author: Laurie Jennings CPA is senior manager of the Tax Services practice of Berkowitz Pollack Brant. For more information, call (305) 379-7000 or e-mail