Second Home Investment — Learn How a Second Home can be a Sound IRA Investment Strategy
The second home investment when configured within the OUTSIDE® structure probably offers the widest range of benefits for the broadest demographic of personal real estate investors.
Intrinsic Value
The primary purpose for a second home investment should be the enjoyment of the property itself. The purchase of a second home investment is a lifestyle choice. It serves a purpose for, and fills a need or desire of, the investor and perhaps the investor’s extended family as well. It is impossible to place a dollar figure on the intrinsic value of occupancy and enjoyment of a home. However, this element of the return on investment should definitely be weighed heavily when comparing to traded assets, the more widely understood investment choice for an IRA.
How Do You Calculate Return on Investment for a Second Home?
Secondary to the emotional investment of hearth and home is the business finance consideration of the second home investment. What type of return on investment can the combined second home investment and IRA in SAFE HARBOR® hope to produce? One of the key aspects of the OUTSIDE® structure to remember, which makes it unique from other forms of IRA investing, is that the investor will own two assets concurrently - the second home and the IRA. It is the projected earnings of the IRA combined with the anticipated capital appreciation of the second home that must be calculated in order to consider the hard numbers that can be gained from a second home investment configured within the OUTSIDE® structure. The diversification of the concurrent investments offers the investor a greater potential return while at the same time providing broader protection.
Capital Appreciation
Let’s first examine the potential capital appreciation of the second home investment. Because the OUTSIDE® structure requires the investor to use leverage the actual cash investment in the second home is a mere fraction of the total value of the second home investment. Therefore the returns are measured based on what is termed the “cash-on cash” return on invested capital or investment. This method of investing leverages up the percentage of your return. For example, using gross figures for simplicity: A $100,000 property is purchased with $20,000 down, the balance is financed by a traditional mortgage. The property is then sold for a $15,000 gain. A return of $15,000 on a $20,000 investment results in a 75% return on investment, (ROI). (This calculation is not taking into consideration the cost or duration of the financing). Market conditions can vary widely in different geographic regions and historically housing has experienced periods of escalated appreciation, flat conditions and some periods of value adjustment. Over the long term however, statistics show a nationwide average of an annual 5% appreciation for residential real estate.
SAFE HARBOR® Earnings
Now let’s look at the IRA side of the second home investment. To comply with the OUTSIDE®structure the IRA must be SAFE HARBOR® directed. The SAFE HARBOR® account offers several different earnings opportunities, all with the necessary requirement of protection from loss of capital. Fixed indexed account opportunities provide unlimited upside earnings potential, however, for the purpose of comparisons in arriving at a second home investment decision a conservative 5% annual return should be used.
Tax Benefits
Taxes are an element to be considered in every investment decision. Those investors familiar with Self Directed or Trustee Directed IRA real estate termed by Uranga & Associates, the INSIDE method, understand the approach of a tax deferred investment. All expenses related to the investment must be paid for from IRA monies and all income related to the investment must return to the IRA. Income tax at the highest rate within the investor’s income tax bracket is paid when the IRA is eventually distributed. For many investors, in today’s tax environment, approximately 40% of the value of their IRA will eventually go to the IRS. Where a second home investment is structured by the OUTSIDE® method in a SAFE HARBOR® directed plan, income tax liability on the IRA is satisfied at the time it is utilized for the second home investment by applying tax offsets applicable to this type of real estate. This significant difference between the two methods is where the OUTSIDE® method can offer the investor additional savings and therefore a higher ROI.
