THE PURPOSE OF THIS ARTICLE is to give a friendly whack upside the head to people who own rental property You probably made a good investment when you first bought the property. But have you owned it too long? 
Depending on how long you’ve held your property, it might not be a good investment anymore. I didn’t say not a good property; I said not a good investment. Read on to find a simple way to determine if your property is still measuring up. You may be in for a surprise!

First, lets quickly review the four financial benefits of owning investment real estate:

1. CASH FLOW: After you pay all expenses and loan payments, cashflow is the money left over.

2. PRINCIPAL REDUCTION: The loan is paid down with money collected from tenants.

3. INCOME TAX SAVINGS: IRS rules allow property owners to take depreciation deductions, which shelter the cash flow and principal reduction. Any leftover depreciation creates a paper loss, which, in many cases, can be used to shelter other income- such as salary from your job.

4. APPRECIATION: Over time, theproperty increases in value.These four benefits are powerful! You earn tax-sheltered cash flow, your tenantsbuy you the building, you get to tell the IRS you’re losing money, and all-the-while, the property goes up invalue. What a country!
So why am I challenging you toreconsider whether your property is still a good investment? Simple! Your “return on equity” is probably low -and getting lower by the year! Let me show you an example. Don’t get all tangled up in the numbers. Just concentrate on the big picture and how it applies to you.

Return on Equity Drops from 18 to 7 Percent
Assume you bought a rental house 16 years agofor $70,000. You invested $10,000 and borrowed the rest. Your goal is to retire in another15 years and use the rental house to provide retirement income. (A great plan!)
So, how good was your investment 16 years ago? Let’s total your benefits. Assume the cash flow, principal reduction and tax savings added up to$1,800 that first year. You were earning 18 percent ($1,800 divided by $10,000) on your investment. Not bad. Plus the rental house was appreciating. You’re an investment genius!

Fast-forward 16 years to the present.
Let’s assume the following: Your yearly cash flow hasincreased to $5,000 and the principal reduction is $2,000; a total of $7,000 – just from the first two benefits! In addition, let’s assume the net value of your rental house has appreciated over the years so it’s now worth $120,000 and your loan has been paid down to $40,000. However, because you’ve owned the property solong, the depreciation deductions (assumethey’re $3,000) are no longer enough to shelterthe $7,000 of cash flow and principal reduction.That leaves $4,000 of unsheltered (taxable)income. Instead of saving tax, you have to pay tax. If you’re in a 35-percent bracket, (combined federal and state), you pay $1,400 tax. So, your benefits from the rental house now look like this: $5,000 cash flow, plus $2,000 principal reduction, minus $1,400 tax paid. A total of$5,600.

This is all summarized on the “Return on Equity Worksheet” on the next page. (The blanks in the right column are for you to use on your ownproperty.)

It’s no wonder you consider yourself an investmentgenius if you measure the $5,600 againstyour original $10,000 investment: that’s a 56percent return. But that’s where most people gowrong!

Your Original Investment Has Nothing to Do with Today’s Rate of Return!

Your investment is not the amount you originally invested years ago. You’ve got way more than$10,000 “tied up” today! Your investment is the amount you could get out of the property if you sold it today. That’s called your “net equity.” Over the past 16 years, your property has increased in value and your mortgage has been paid down. The current difference between theproperty’s net value (after selling expenses) andyour mortgage balance is $80,000. In other words, if you sold the property today, you couldwalk away with $80,000.

However, if you keep the property, in effect you’re re-investing the $80,000 into the property. Now, how does your investment look? Not so good. You’re earning $5,600 in benefits on an $80,000 investment – that’s only 7 percent! What if a REALTOR® called you up and said, “I’ve got a great real estate investment for you. You’ll earn a measly 7 percent.” You’d hangup on them! Well, you already own it! If you wouldn’t buy a property like that, why would you continue to own it?

What if you did this instead? Use your $80,000equity as the down payment on a different property- one that produces 18 percent again? With that down payment you could probablyafford a $400,000 rental property. Once you’ve owned that property for a few years, your equity will have grown again (and your rate of return fallen), so you repeat the process. The goal is to maintain the highest possible rate of return, which will make a huge difference in your future wealth. 

You’ll maximize your wealth by wisely moving your equity from your current property to another as soon as your rate of return would be greater in the next property.
Just for fun, take out your calculator and figurehow much money you’d have in 15 years if youleave the $80,000 invested at 7 percent. Thencalculate what $80,000 invested at 18 percentgrows to in 15 years. I could give you the answerbut you might not believe me – check for yourself… it’s gigantic!

Three Ways to Move Your Equity

Here’s a key point. If you decide it’s time to “move your equity,” be sure to explore all your options.

There are three common ways to move equity:

1. SELL: You could sell your current propertyand buy another. The problem with selling isyou have to pay capital gains tax.

2. REFINANCE: You could refinance your currentproperty and use the loan proceeds to buyanother property. The problem with refinancingis you’re probably not able to borrow the entire$80,000 equity.

3. EXCHANGE: The third, and best, way tomove your equity is to exchange. Exchanging allows you to move your entire $80,000 netequity to another property without paying tax. It’s wealth building’s most powerful tool. So, what does this all mean? Well, if you own rental property, congratulations. Your investment brilliance shines brightly. However, the longer you own that property your glow begins to fade. The wise thing to do is re-evaluate your propertyevery year. In essence, make the decision to “rebuy” the property. As soon as the rate of return on your equity could be higher in another property, it’s time to take action.

HERE IS A COPY OF TOM LUNDSTEDT’S ARTICLE

This material is designed to provide information about the subject matter covered. The accuracy of the information is not guaranteed. This material issold or offered with the understanding that the author is not engaged in rendering legal, accounting or other professional services. If legal advice or otherexpert assistance is required, the services of a competent professional should be sought.

A SHORT, MIDDLE-AGED WOMAN wearing red glasses came up tome after one of my real estate seminars. She seemed shy and hesitant, but she’d listened intently and taken lots of notes during the class. She told me her name was Norma and proceeded to ask me several good questions about real estate investing. She happened to mention she had $200,000 in her retirement account.When I congratulated her, she said, “Don’t be impressed. I had $300,000 a few years ago!”

Her retirement account, like many others, had suffered as a result of investment choices. Norma went onto tell me she wished she had bought real estate instead of “investing in an IRA.” She was amazed when I told her she could have her cake and eat it too- or rather, have her IRA and real estate too! Let me explain.First and foremost: A retirement account (traditional IRA, Roth IRA,SIMPLE IRA, SEP, Keogh, 401k, etc.) is not an investment! It’s simply a special account that holds your investments. It can hold many types of investments, such as mutual funds, stocks, bonds, and … drum roll,please: real estate!

Picture a truck with the words “MY RETIREMENT ACCOUNT” painted on the doors. In the back of the truck,you load whichever allowable investments you choose. As you picture this, ask yourself, “Is my retirement truck on the way to becoming a big, heavy duty monster truck, or will I end up with a little, wimpy mini pickup?” When I told Norma her retirement account could own real estate she said, “But I asked the company that administers my account if my IRA could own real estate, and they said ‘no,’”Whoa! Instead of merely saying “no,”the person with whom she talked should have added three important words: “not with us.”

TEST YOUR INVESTMENT I.Q.
Use Your IRA to Invest in Real Estate Let’s get this straight: retirement accounts can own real estate The problem is that most companies that hold retirement accounts aren’t geared up to handle real estate. Therefore, they have no incentive to inform their customers that real estate is an alternative investment choice. That’s the main reason for the misconception that real estate can’t beheld in a retirement account.Let’s get this straight: Retirement accounts can own real estate. In a minute, we’ll get to the basic ins and outs of real estate IRAs.

But first some advice:

This article is designed to be a launching pad for readers to begin their exploration of real estate IRAs. It’s a complicated subject and everyones situation is unique, so be sure to talk with your competent advisors before you take any action.

OK, here we go.

First, establish a self-directed retirement account with a company/custodian that specializes in realestate lRAs. This is a relatively easy process and can be done by either establishing a new accountor rolling over the assets of an existing account.(Be sure there are no surrender charges for rolling over an existing account.) Once you’re the proud owner of a self-directed IRA with a custodian that can handle real estate,what’s next? There are specific rules as to what you can and cannot do with your real estate IRA.

Some Things You Can Do

1. Your real estate IRA can buy and sell many types of real estate including raw land, rental properties, condos, fixer-uppers, commercial properties, lakeshore, etc. Keep in mind it’s the self-directed real estate IRA that buys, owns and sells the property. Not you personally. You don’t withdraw the money from the IRA to buy the property – the custodian buys the property in the name of your self directed real estate IRA.

2. The property can be rented but the rental income is paid into your IRA, not to you.

3. All the expenses of renting and operating the property must flow in and out of your self directed real estate IRA. Be sure your self-directed real estate IRA has enough liquid reserve funds to cover operating expenses, improvements, etc.

4. It is possible to finance a property that is owned by your IRA. But the financing must be”non-recourse.” That means the property, not the IRA account, is the sole security for the loan.Most traditional lenders won’t provide nonrecourse financing. However, seller financing or private loans are possibilities. Let me emphasize again: Get good professional advice before taking any action.

5. Your real estate IRA can buy a partial interest in a property. This is useful if your IRA doesn’t have enough money to buy 100 percent of the property. It could be a partner and own a fractional interest.

Some Things You Cannot Do

1. Your real estate IRA cannot buy a property that you, your spouse or certain family members already own. Likewise, your real estate IRA cannot sell a property it owns to you, your spouse or certain family members.

2. You, your spouse or certain family members cannot have any personal use of the property owned by your real estate IRA.

3. Your IRA cannot lease the property to your business. Your business cannot use or occupy any part of the property.

Is a Real Estate IRA Right for You?

So, now you know you can use your retirement account to buy real estate. But the bigger issue is should you use your retirement account to buy real estate? The answer is, it depends on the type of real estate and your unique situation.You already know your real estate IRA cannot own property that is used by you, certain family members or your business. Therefore, primary residences, second homes and vacation homes are not candidates. In addition, a rental property that produces tax shelter from depreciation deductions would probably not be a good fit because the tax shelter would go to waste in your retirement account. Other types of real estate, such as raw land,fixer-uppers, and non-leveraged rental properties,are perfect candidates. The profit from these investments would be taxed if you owned the property personally. However, if your real estate IRA buys, owns and sells the property, the profit would compound in your IRA tax-deferred (or tax-free if it’s a Roth IRA)! Keep in mind, there is a limit on how much you can contribute each year to your retirement account. But there’s no limit on how much the account can earn! Hubba hubba!Last But Not Least

1. Before your IRA buys any property, you’ve got to understand how real estate works. There’s a lot to it. Make a commitment to learn how to analyze a property before you buy it, including operating expenses and management considerations. Study the financial benefits such as cashflow, depreciation and appreciation. Learn howto determine cap rates, cash on cash and other rates of return. And so on. The more you know,the better your chance of success.

2. Remember that real estate IRAs are a specialty and not every retirement account administrator/custodian is geared up to handle them. In the “Further Resources” box I’ve included several real estate IRA custodians (as well as some other resources) to get you started. Bear in mind, there are other custodians and you need to find one that’s right for you. Check out their web sites or call them.

3. If you’re in the real estate profession, I hope you can see the huge potential of real estate IRAs. Think of the millions of dollars that are sitting in the retirement accounts of your potential clients. Get out there and help them take advantage of a great opportunity!

Finally, if the choices you’ve made so far for your retirement account aren’t taking you where you want to go, find a new vehicle. Real estate opportunities are everywhere for those savvy enough to recognize them and motivated enough to take action. Whatever Happened to Norma? Sometimes I wonder if anyone ever acts on the information they receive in my seminars. can only hope. But if I let my imagination run wild … It’s 20 years from now and I’m driving down the interstate when a huge, shining, beautiful 18-wheeler semi truck pulls along side me. The driver gives a friendly toot on the air horn, waves and smiles. I can’t believe my eyes – it’s a little old lady wearing bright red glasses and as the truck passes I see huge lettering running from front to back: “NORMA’S REAL ESTATE IRA!” What a country!

PDF OF ARTICLE

Further Resources
Entrust 1-800-392-9653
www.entrustadmin.com

Lincoln Trust 1-800-825-2501
www.lincoIntrust.com

Sterling Trust 1-800-955-3434
www.sterling-trust.com

On the Internet, enter “real estate IRA” on a search engine such as Google. Another good resource is the book, IRA Wealth, by Patrick W Rice with Jennifer Dirks

For more information on buying, owning and selling investment real estate, visit the “Products” section at www.tomlundstedt.com

This material is designed to provide information about the subject matter covered. The accuracy of the information is not guaranteed. This material is sold or offered with the understanding that the author is not engaged in rendering legal, accounting or other professional services. If legal advice or other expert assistance is required, the services of a competent professional should be sought.