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Real Estate as Investment Property

There are many ways to invest in real estate. You can invest in unimproved land, in land with buildings, or land with other income-producing attributes, such as minerals or leases for recreation use. You can be a direct investor or you can be part of an investment group such as a limited partnership (LP) or real estate investment trust (REIT). You can be an active investor or a passive investor. Irrespective of how you invest, you should be aware of features of real estate used as housing and for commercial purposes.

Real estate investors let others use their property in consideration for payment. Rent is a payment made for the use of someone else's property. Rental terms are often set down in a written document called a lease. A lease is a legal document that specifies all the terms, conditions, duration, and payments for use of property. A lease gives the owner (the landlord) and renter (the tenant) certain specific rights and specifies obligations of both parties. These rights and obligations are enforceable by law.

Rent is considered income to the real estate investor and is subject to income tax. However, the investor may deduct all expenses for the upkeep, maintenance, management, and advertising of the property. Expenses also include interest payments and taxes. Capital invested in the property, including capital improvements, can be depreciated (deducted in proportion to the expected "useful life" of the property). The useful life is deemed to be how long the property will last before it must be replaced. Buildings, appliances, and other appurtenances eventually wear out and need to be replaced. The expected life of most property to be depreciated can be found in Internal Revenue Service (IRS) depreciation tables. For example, a building has an expected useful life of 33 years before it needs to be replaced, whereas a refrigerator may have a useful life of 7 years. There are a variety of depreciation formulas one can use, and the IRS prescribes which you can use to take the maximum deduction. Land has an infinite useful life and cannot be depreciated; however, minerals and other natural resources that produce income can be depleted. An investor can take a depletion deduction prescribed by the IRS for income-producing resources on their land.

The advantage to real estate investing is that it produces income that is sheltered from taxes by expenses and depreciation (or depletion).

The advantage to real estate investing is that it produces income that is sheltered from taxes by expenses and depreciation (or depletion). Furthermore, the long-term value of real estate tends to increase over time if well managed. One also has flexibility in managing real estate to generate income, capital gains, or a combination of both. Real estate investment "losses" may also be used to offset taxes on other income. Because depreciation and depletion deductions are not actually paid in cash, as would be a mortgage interest payment, they tend to offset actual cash income—sheltering it from taxes.

Real estate designated as housing is called residential real estate. If the owner lives on the property, it is referred to as "owner occupied"; otherwise it is rental property or vacant. Investment real estate may include single-family homes, duplex homes, condominiums, and cooperatives. If the owner does not live in the home, he or she may rent or lease the property to others who pay the owner for use of the property. Real estate used for trade or business, such as a shop, store, office, or factory, is called commercial real estate. Raw land, or undeveloped land, is real estate without any buildings or other useful structures. Undeveloped land is leased for recreation, camping, hunting, etc., or for its natural resources, such as minerals, oil, and natural gas.