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Over the last weeks, we discussed some of the main ways of making money with real estate.
These four ways are:
The last of the four ways to have a return is due to the fact that in property investment you can claim expenses as a tax shelter. This is a rather exceptional feature among different investment alternatives.
That said, a country’s tax structure is something unique and tends to change significantly when new governments are elected. The US, for example, is known for its favorable tax benefits scheme for the property investor.
Spain on the other hand has cut since 2013 a lot of tax benefits for the real estate investor. But still, there is some tax shelter left worth mentioning.
As an owner of an investment property, you take in taxable rental income and payout tax-deductible operating expenses like insurance and repairs, leaving you with a Net Operating Income (NOI) on which you would expect to pay taxes. However, the tax code permits further deductions in some cases.
The first of these deductions is mortgage interest. In Spain, this deduction still is in place if you bought your Spanish property before the 1st of January 2013, and, if the property is intended as the purchase of the habitual residence.
Thus, mortgages on a non-regular home, whether a second residence or an investment property, can not be deducted.
The second source of tax shelter is what Jordi wrote about in last week‘s newsletter post; depreciation.
Even though the market value of the property is increasing over time, you can make the assumption that the buildings (but not the land) are in fact wearing out over time and becoming less valuable – and you can take a deduction for that presumed decline of the value of your asset.
The Spanish Treasury allows you to deduct annually as a company, a maximum of 2% of the purchase price, on which you will not pay taxes. This is as a company, not as an individual.
Therefore, you can find tax shelter:
less operating expenses
= NOI (Net Operating Income)
(less mortgage interest < 2013 bought habitual residence)
less depreciation (max. 2%)
= Taxable income
The foundation for the real estate investor is now in place. You understand now that an income property has the potential to provide you with as many as four different types of returns:
– cash flow = the money you have left after paying all your bills
– appreciation = the growth in equity caused by an increase in the property’s value
– loan amortization = the growth in equity caused by the gradual paydown of your mortgage
– tax shelter = a property’s ability to shield from taxation some of the rental income
Every concept and every calculation you do as an investor will bear some relationship to one or more of these four basic returns. You are ready now to get serious about real estate investing.