Why Most Real Estate Investors are Doomed to Failure | Finance ...

Let me start by saying

that, sure, real estate can be a good investment. Real estate provides a hedge against inflation. And real estate often amounts to a forced saving plan. But most of the people who?ve jumped onto the real estate investment bandwagon over the last few years are going to fail. Here?s why:

Ignoring returns on investment

When you compare bank accounts, you know that 5% interest means more money in your pocket than 2% interest .

Similarly, you know that a mutual fund with a track record of 11% annual returns has made more money than a fund with a track record of 8% annual returns. Duh.

One picks investments and investment Evaluates performance by looking at the return on the investment. This rule is true for stocks, bonds, and everything else ? including real estate

Which means that investors who can not or do not know how to calculate the return on a real estate investment. ? and almost all amateur real estate investors fall into this category ? fly blind

To be fair, real estate return on investment calculations get tricky fast

First, consider how easy something.. like a bank CD. If you buy a bank CD for $ 100 and a year later receive $ 105 back, the return on investment calculations are pretty easy. Divide $ 5 by $ 100 and you get 5%. That?s the return on investment.

But what about a real estate investment that requires a $ 50,000 down payment and then monthly negative cash flows of $ 500 for 43 months. If you sell the property in year 44 and net $ 85,000 in cash, have you really made money with your real estate investment

You can not truly know Whether this imaginary real estate investment is a good deal unless . you compare its annual return to your other options

It turns out, by the way, that the imaginary real estate investment is a slightly better deal than the imaginary CD ? something you need a spreadsheet program like Microsoft Excel to deter mine. Programs like Microsoft Excel include rate of return calculation tools like the IRR function Which you can and should use to estimate returns on investments with complicated cash flows.

Ignoring Real Estate Tax Laws

Here?s another reason that real estate investors fail. Real estate investments dramatically complicate your income taxes. For example, the passive loss limitation rules mean that you can not use depreciation tax deductions Typically except in special circumstances until you sell the property.

Schedule E (which you use to report your real estate investing to the IRS) requires you to prepare profit and loss statements by real estate investment -. a bookkeeping requirement that pretty much forces you to use a full blown accounting system like QuickBooks

Finally, rampant misunderstandings about Section 121 of the Internal Revenue Code mean that while most people should not have pay taxes on the profit from selling their home, many pay taxes Thurs.

And do not even get me started on dealing with the unrelated business income tax you?ll pay if you use a self-directed IRAs for real estate. Or on the pitfalls of creating a daisy-chain of like-kind exchanges. Or about depreciation recapture if you segregate costs into real property and personal property components.

Here?s the reality sandwich

. For many small investors, real estate, Sun complicates your income taxes that you?re faced with two bad choices. Bad choice number one: Winging it on your tax return or relying on some infomercial, the real estate agent, or your brother-in-law for accounting and tax planning. (This approach means you?ll make all sorts of expensive tax accounting mistakes.)

Bad choice number two: Paying an experienced tax practitioner, perhaps a $ 1000 a year or more to make sure you do not foul This of course yourself up pretty much eats up the extra profits you hoped to get from real estate. Which means that while you will have the satisfaction of doing your tax accounting right, only your accountant and real estate agent make money. My advice to you? Learn how the real estate tax laws work and how to do real estate accounting before you start investing. Then, after you truly understand this stuff and do not start investing, do as much of your own accounting as you possibly can. I really do not think you?ve got any other good choice as a small real estate investor. Sorry. Summing up

As I said in the first paragraph of this little essay, real estate can be a good investment. But the investment is way trickier than most new investors realize. And in order to make a decent return, I think you must understand way more finance, tax and accounting than the typical real estate investor.

id=?article-resource?> Seattle CPA and Quicken for Dummies author Stephen L. Nelson says most new real estate investors will fail ? and his prediction has nothing to do with the popping of any real estate bubble. Nelson says something far more basic and endemic handicaps most new real estate investors ?

LLC formation and incorporation LLC expert Stephen L. Nelson CPA has written more than 150 books. Formerly adjunct to tax professor at Golden Gate University, Nelson taught the graduate tax class ? Choice of Entity:? LLC vs. S Corporation.?? A Seattle CPA, Nelson is also the author of the bestselling book QuickBooks for Dummies, Which has sold more than 500.000 copies. He also publishes and edits the popular web s corp site.

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