Yes, owners have a legal recourse against bad tenants, but these issues are often not resolved quickly bringing a great deal of stress and aggravation. Clients will need a lawyer and the lawyer needs to get paid. Some of these issues linger for a long time.
Guess what? Neither the mortgage company, insurance company nor the tax man care. They want their money and they want it on time. Ahh, the joys of ownership.
Even if the tenants pay fully and promptly, it is common for a property to go unrented for some time after tenants move out and before a new tenant moves in. How many months can the client go without rent before an underperforming property stops being a decent investment and becomes a real problem?
If clients truly have the temperament to be a landlord, few have a good grasp on the financial aspects of a rental. It is a lot more complex than just collecting enough rent to cover the mortgage. Most would be rental owners have heard there are “tax breaks” but they don’t actually know how things like depreciation and recapture work. They should work with a good tax person which is another often overlooked expense.
About half the time, clients are looking to tap their retirement funds to buy the property, either through distributions or because they heard they can buy real estate with their IRA money.
It is interesting to me to see how often people underestimate the taxes due from a retirement plan distribution. They forget that if the entire distribution would be taxed in the 25 percent bracket, to net $1,000, they need to pull $1,333. Oddly, it is also common for people to fail to see the taxes as an added expense that affects the net return on the would-be real estate venture.
While, you are permitted to buy some types of real estate with IRA money, it is far from a simple transaction.
You cannot use a traditional mortgage. The property must be strictly an investment property. No personal use is permitted. In fact, neither the client nor anyone in the client’s family can transact with the property. An outside party will need to be hired to manage or maintain it. More expenses.
All maintenance, taxes, insurance and other expenses must be paid out of the IRA, so cash will need to be available in the IRA. Run out of IRA cash and you may have a problem. Remember, we are talking about an IRA so the rules regarding contributions and rollovers apply. Plus, owning a property in an IRA makes the misunderstood tax breaks previously mentioned a mute issue. And lets not forget the rules regarding distributions.
Owning property in an IRA can make fulfilling required minimum distributions challenging. If you have other IRAs, RMDs can be taken from those accounts, but what value is used to calculate the RMD for the IRA that holds the property? The custodian must report a value to the IRS as of each 12/31 resulting in yet another expense.