real estate investing for high income earner?

[Brendan Prendergast]

hello all.  first post here.  I am interested in getting into the real estate investing world and have a few introductory questions.  Unlike many of you, I have no interest in doing this full time (at least not until I'm retired); however, I think real estate investing could be a fun, challenging, and more fulfilling way to make money than the stock market.  My day job pays well and I typically find myself in the 33% bracket.  

1.  what are the tax considerations for a relatively high incoming earning real estate investor?  It appears that rental incomes and/or proceeds from a flip would be taxed as ordinary income.  By contrast, stock market returns, if held for a year, yield a much lower LTCG rate of 15%.  What am I missing here (obviously I'm not an accountant!)

2.  I am debt adverse.  Much of what I read here and in several books I've picked up on the subject indicates that the way to make real money is to gain leverage by borrowing money from banks.  I just spent years paying off student loans.  Another mortgage is not really what I want.  I already have a mortgage and take the mortgage interest tax deduction with it (don't think I can do that twice?).  I was thinking of investing the cash I would otherwise put into stocks/bonds into a rental property or rehab/flip.  I'm not counting on monthly cash flows from this to pay my bills or feed my family.  

3. Many investors seem to focus on SFH in the $50-150k range. I imagine there is a lot of competition in that price range from all of you more savvy investors =). Does anyone out there go for a more "high end" rental?

4. If I decide to rehab/flip, I would do this as a team with my brother in law. what have folks done as far as structuring the business? ie, LLC, partnership, me as sole proprietor and him as employee? maybe too complex a question...

5. why should I go thru all the trouble of researching and purchasing properties when i can sit on my butt and purchase shares of a REIT?

Lots of questions; thanks in advance for your responses!

[Ned Carey]

@Brendan Prendergast  real estate investing is a big benefit to high net worth / high income earners. 

• You get depreciation which can reduce your taxes (subject to limitations)
• Rental Income is Not taxed as regular income as stated above. It is passive income which is not subject to social security/ self employment tax.
• Capital gains can be deferred through 1031 exchanges as mentioned.
• If you have substantial retirement funds you can invest tax free.

The above benefits are for buy and hold rentals not rehab and flip. There are no real tax benefits for Rehab and flip. Rentals do not have to be Single Family Homes, they can be apartment buildings or other commercial properties like shopping centers or office buildings.

Borrowing for personal items is bad. Borrowing for investing increases your risk but also increases your return. If you can borrow at 4% and invest that money at 8%, doesn't it make sense to borrow?

You can reduce your risk by reducing your loan to value ratio. If you borrow 80% loan to value (LTV) you have modest risk on a good deal. But if you only borrow 50% LTV that is a pretty safe situation. A Measure of risk in called "Debt Coverage Ratio". The higher the number the more income (profit) you have to cover the debt. Banks will lend at about a 1.25 DCR but if you only borrow at a 1.6-2.0 DCR you risk is minimal, but you have increased you return on your investment.

Rehab and flip is an active business that provide chunks of cash. Rental properties provide cash flow and wealth accumulation over time.

One thing to consider is being a lender on real estate. You can invest relatively safely with significantly better returns than most fixed income investments. Hard money lenders can earn 15% or more on their money.