Rental properties have the fantastic advantage of earning passive income. This means you can get money without having to ‘work’ in the traditional sense. Of course, it’s not free money, as you still have to put in time and effort at the start, but once your investment is established, it can provide an excellent return.
By going one step further and automating your rental property management, you’ll be even closer to financial freedom and reducing your reliance on ‘active’ work.
The Promise of Passive Income in Real Estate
Rental properties can generate passive income and increase your equity. They can help you earn a consistent stream of revenue without actively working for it.
But what exactly is passive income?
According to the IRS, this is defined as regular earnings from a source other than an employer. It refers to the money you earn without your active participation, or ongoing effort.
Rental properties are the perfect example, although there are exceptions. The IRS does not recognize rental income from a real estate professional as passive, nor does it count as passive if you rent the space out but still conduct business there. Finally, leasing land also doesn’t count. To truly be considered passive income, your rental property must be used or occupied.
In addition to the potential for earning passive income, rental properties also offer several tax benefits.
However, despite the upsides, there are a number of challenges associated with managing a property.
Benefits of Passive Income
There are numerous benefits to earning passive income. These include:
- A steady cash flow. Rental payments provide a steady, predictable income stream. And because they tend to increase over time, you will likely have a positive cash flow projection as long as you have tenants.
- Your property appreciates over time. Property is one kind of asset that increases in value over time. This means it’s also a possible hedge against inflation.
- Tax benefits. As mentioned above, there are a number of tax breaks available for landlords, to help you maximize your investment.
- Portfolio diversification. Property doesn’t follow the same market trends as other assets like stocks or bonds. So investing in property can help you reduce the overall risk of your investment portfolio and minimize any losses during a downturn in markets.
Despite the benefits, there are costs associated with automation or property management services. And the more your chosen platform or service does for you, the more expensive it is likely to be. As such, it’s important to assess whether the benefits you’ll receive will outweigh the expense.
Challenges of Active Property Management
Hands-on property management requires a lot of time and effort. After all, there are many aspects to consider.
Maintenance and repairs
One of the biggest headaches for many owners of rental properties is conducting maintenance and repairs. This is particularly true if you have tenants who are heavy handed with the property and it seems like as soon as you’ve fixed something, another repair crops up.
One way to stay on top of this is to create a maintenance schedule. This means you’ll need to conduct regular inspections of your property. It also requires having a relationship with a trusted contractor, so that when problems arrive, they can be addressed quickly and effectively.
Handling tenants
Whether you need to find new tenants, or address complaints or concerns, dealing with renters can be difficult. While a thorough screening process can help you weed out any bad apples, you also need to create a good experience for your tenants, to ensure they renew their leases.
And of course, this includes rent collection. Dealing with late payments or tenants who don’t abide by the lease agreement can cause more than just frustration – it may also literally cost you. If you need to get lawyers involved, or have tenants who disappear without paying, it’ll affect your bottom line.
Admin and financial management
Any job comes with paperwork, but with rental properties, there’s so much to consider. From keeping your books in order to managing leases, there’s a lot of documentation involved.
This means you’ll need to be organized, and keep accurate records of all financial transactions, tenant communication, and contracts.
Regulations and legal obligations
Laws change frequently. It’s important to keep up with any changes to legislation that may affect you, or your tax liability. This includes fair housing laws, zoning and building regulations, and tax laws.
In addition to the above challenges being time-consuming (as well as expensive), spending too much time in active property management might disqualify you from classifying revenue as passive. In fact, the IRS has a number of tests to determine whether rental property income is active or passive, and this includes spending at least 50% of your time on real estate professional work, in which you participate actively.
So it’s vital to minimize the amount of time you spend on managing your rental property. And one way to do this is through automation.
Automating Rental Property Management
It’s possible to automate many aspects of rental property management. The benefits include increased efficiency with fewer errors, the ability to easily track multiple properties, and reminders for tasks that need to be done. That way, you can save time and keep organized.
As an added bonus, automating certain tasks can help you reduce your active involvement to ensure your revenue is classified as passive by the IRS.
Streamlining operations
Automating processes can help streamline property management and improve your bottom line.
For example, you could automate rent collection. That will allow you to easily receive, track, and allocate payments for your rental property, along with all the relevant documentation. This lowers the risk of late or missed payments, improves your cash flow management, and helps relieve the heavy admin burden of managing your rental property.
The same is true for expense management, especially for maintenance costs. Property management software allows you to easily handle maintenance requests. Tenants can log requests digitally, helping you to prioritize tasks and track their progress.
Automation can also help improve communication and relationships with your tenants, through messaging systems and automated notifications.
With the right automation systems in place, it’s possible to save so much time and effort. For instance, you can also automate your accounting processes to make financial reporting so much easier.
Property Management Services
An alternative to automation is to enlist professional property management services. Here, professionals act as middlemen between you and your tenant to help you with the day-to-day responsibilities and complexities associated with property management.
With their expertise, they can take on the tasks that would otherwise cause you stress or take up too much time, like tenant screening, processing applications, collecting rent and handling late payments, coordinating maintenance, and communicating with your tenants.
Some services can also help you with financial management and legal compliance.
By handling these tasks, property managers can reduce your workload while ensuring your property is managed effectively, to help you make the most of your passive income.
Achieving True Passive Income
Not all rental properties are created equal. With a few strategic decisions, you can ensure that you maximize potential passive income.
The first consideration is where you buy. Properties in desirable locations can fetch higher rents, and will feature better tenant demand. The ideal location should have a strong economy and good infrastructure. An added bonus is if it is close to public transport, schools, shopping, or entertainment areas.
Another important factor is the property type. For example, apartments or multi-unit properties usually have a greater potential for cash flow, but they might also have higher turnover rates.
The condition of your property is also crucial. Well-maintained properties are usually more appealing to renters, but does mean you’ll need to ensure they stay that way through proactive maintenance and repairs.
However, no matter how sound your investment, market conditions might change. It’s important to adapt to any possible changes with effective financial management. At Fusion CPA, our team has years of experience in accounting and tax for rental properties. We can help you manage your bookkeeping and finances to ensure that you get the most out of your investment.
For help navigating the intricacies of passive income from your rental property, schedule a Discovery Call with one of our CPAs.
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