Over the last 50 years, home prices in the U.S. have increased by a little more than 5% annually. This means that the $200,000 home you buy today could be worth more $864,000 in 30 years. No wonder real estate is considered such an effective way to build wealth.
But few actually take full advantage of the opportunity at hand. Based on the National Association of Realtors report, the average homeowner only sells their house every 10 years. They are allowed tax-free capital gains every two years. Instead of expanding their real estate holdings and experiencing that 5% growth, they settle for the standard single-home approach, thinking more is too complex and time-consuming.
But making your first million in real estate is possible as a real estate entrepreneur and simpler than you think, provided you follow the proven roadmap laid down by countless real estate investors before you.
It’s all about expanding your real estate portfolio. The larger it is, the more that 5% growth will be worth. To do this, start by buying smart, living within your means, making the right upgrades, generating income and then rolling those profits into additional properties.
The best part is this can all be a side hustle while continuing your career. By common estimation, it takes about six years to go through the complete process. If that entrepreneurial spirit is put to work, here’s what the path to a million looks like.
Get your start in real estate with a fixer-upper
For new real estate investors, nothing is as impactful as your first house. When you buy a fixer upper as your own home, work on it yourself and then sell it or rent it out after two years. With this, you’re able to add real value to the property. It doesn’t cost you much more than your normal mortgage payment.
You’re going to take out a loan for this purchase. You’ll want to find something that’s available at a below market price and it is something you can put some sweat equity into. That can include everything from new landscaping to interior improvements, to a new roof or siding. Modern features are in demand, too, like a new HVAC system as well as energy-efficient upgrades to make the property more livable for the next owner.
Move on to the next one
After two years or so, you sell it and collect the proceeds from your investment and hard work. Maybe you bought the house for $200,000, made some simple improvements to the property, and were able to sell it for $300,000. That’s $100,000 in capital gains that you’re able to pocket tax-free. The next step in the process is to take that $100,000 and split it — $50,000 toward the down payment on another house, which you’ll live in, fix up and sell, and $50,000 to buy a rental property.
Do it all over again
Once again, you’re fixing up the house you’re living in but, by this point, you have a rental property that’s providing you with additional income. And after two years or so, once you’re done fixing up your second home, you sell it and do it all over again, buying more rental units. You move into one and fix it up and over the next two years can now start borrowing against the equity in the previous rentals to buy more.
From that point on, you’re using the equity you’ve built up in your properties to fund your purchases, which you’re fixing up and adding to your rental portfolio, increasing your income every step of the way. Best of all, the value of your real estate portfolio is now larger and growing, so you’re building your overall wealth as you go through this process.
If you keep going along on this path, by the end of six years you should have lived in three different homes that you’ve fixed up and sold, have a portfolio of 10 rentals and have a net worth of close to a million dollars between the net asset value of your properties and the cash coming in from the sale of your homes, not to mention the monthly cash flow.
A tax-advantaged way to grow wealth
The beauty of this approach is that you’re building up larger and larger value in each home that you buy along the way. But, rather than having only a single home, you now have many rentals growing in value, which you’re able to use the equity or sale proceeds from each one to buy more.
The first tax benefit of this strategy is the primary-residence exemption. It allows as much as $500,000 of capital gains every two years. With this though, you have to live in the house for the two years. Selling every two years and turning that tax-free gain into more real-estate allows you to use that actual cash gain to invest in new properties.
The recent tax changes mean a limit exists on what you can claim for your primary mortgage and property taxes. Those limits don’t apply on rental properties, however. This means most of your loans should be on your rental properties, not your primary residence. After a few years of following this formula, that should be a very achievable goal. It should enable you to buy your own home entirely with cash.
The hardest part of this process is admitting to yourself that for the next six years, you’re not going to try to keep up with the Joneses when it comes to your primary residence. Instead, you’ll be buying in “rental” neighborhoods, living in older properties and doing it all entirely within your means.
Call Williams & Kunkel CPA today in Flower Mound at 972-446-1040 to have a chat and find out how you can save money on your taxes as a real estate professional.