What Is an Investment Property?
Let me tell you directly: investment properties are real estate assets you buy to generate returns, either through rental income, future resale, or both. You might hold them as an individual, in a group, or through a corporation, and they can be long-term holdings or short-term flips where you renovate and sell quickly for profit. While we often think of them as real estate, the term can also apply to things like art, securities, or collectibles bought for appreciation.
Key Takeaways
- Investment properties are real estate assets acquired to generate returns through rental income, future resale, or both.
- These properties can be classified into residential, commercial, or mixed-use categories, each offering different income potential and investment strategies.
- Financing investment properties is more challenging than primary residences, requiring at least a 20% down payment and strong credit.
- Investors must report rental income to the IRS but can also deduct relevant expenses, and selling an investment property may result in a taxable capital gain.
How Investment Properties Operate and Generate Income
Understand this: investment properties aren't your primary residence. They generate income like dividends, interest, rents, or royalties, separate from your regular business. The way you use the property directly impacts its value.
You should study to find the most profitable use, which we call the property's highest and best use. For instance, if it's zoned for both commercial and residential, weigh the pros and cons to see which gives the highest return, then proceed that way.
People often call an investment property a second home, but they're not the same. A family might buy a cottage for personal use, or you could get a weekend retreat in the country—that's personal, not for income.
Various Types of Investment Properties Explained
Let's break down the types. Residential properties are popular for supplementing income; you buy a home and rent it out for monthly rents. These include single-family homes, condos, apartments, townhomes, or similar structures.
Commercial properties aren't always residential. Investors, especially corporations, buy them for business use. Maintenance and improvements cost more, but higher rents offset that—think commercially-owned apartments or retail spaces.
Mixed-use properties serve both commercial and residential purposes at once. For example, a building with a store like a convenience shop or restaurant on the ground floor and apartments above.
How to Finance Your Investment Properties
Financing is tougher for investment properties than for your primary home. You won't get options like FHA or VA loans easily.
Insurers skip mortgage insurance here, so you need at least 20% down to get bank financing.
Banks demand good credit, low loan-to-value ratios, and enough savings for six months of expenses on the property to ensure you keep up with payments.
Navigating Tax Implications for Investment Properties
If you collect rent, the IRS requires you to report it as income, but you can subtract expenses. Say you get $100,000 in rent but spend $20,000 on repairs and maintenance—you report $80,000 as self-employment income.
Selling for more than you paid means a capital gain, taxable at 0%, 15%, or 20% for assets held over a year in 2021 and 2022.
Unlike primary residences, where you exclude up to $250,000 (or $500,000 joint) in gains, investment properties tax the full gain: selling price minus purchase price minus major improvements. For example, buy for $100,000, spend $20,000 on plumbing, sell for $200,000—your gain is $80,000.
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