Flipping houses can be one of the most lucrative ways to invest in real estate for those who are able to buy properties for less than their market value and resell them for a profit. On the other hand, investors who buy real estate for income can potentially build an empire of rental properties that generate enough monthly cash flow to cover all of their living expenses and more. Both methods of real estate investing -- flipping and rental income -- can effectively build wealth. However, each also has its own pitfalls.
Profits come fast when investors flip houses, and the return can often be very large compared with the amount of money you put into the project. An investor with a good understanding of what properties are worth in a particular area could buy cheap, renovate the house and potentially make a profit of tens of thousands of dollars within weeks or months. Income from rental property investing, however, involves taking a long-term perspective. Your profits on rental houses will add up over time from the monthly rent payments you receive, and the equity you build as you pay down the mortgage debt.
The rewards of flipping houses or buying rental properties can go beyond monetary gain. Neighbors in a particular community will rejoice when an investor buys an old, run-down house and renovates it to mint condition because it causes their property values to go up as well. Investors who buy houses to rent for income often receive personal pride and satisfaction in providing quality housing for families to live in and create memories. Meanwhile, the renters are slowly paying off the mortgage on the house over time with their monthly rent payments.
Quite a few real estate investors have lost the shirts off their backs trying to make money flipping houses, sometimes due to events that were out of their control. Property values will take a plunge when either the local or national economy suffers. A house could lose value because of bad neighbors or a terrible event taking place nearby. The renovation costs on a house could go sky high after discovering it has a bad foundation, mold inside the walls, termites or some other problem that makes it unsellable. Rental income real estate can be a cash cow, but sometimes the cow gets sick and requires maintenance repairs that can be expensive. You might get bad tenants who do not pay or vandalize their apartments or rental homes. You also could end up paying the mortgage and expenses from your own bank account if you don't collect enough rent to cover the bills.
You could face undesirable tax consequences in the house-flipping business. If you get to a point at which you are generating enough profits to live on, the IRS will classify you as a dealer and begin to tax your profits at your ordinary income tax rate rather than the lower capital gains rate, which is 15 percent for most taxpayers. You also will have to pay taxes on the gain during the current tax year, rather than defer taxes indefinitely by executing 1031 exchanges. There are more tax advantages available for investors who aim to build an empire of rental income properties. Those benefits include tax write-offs for mortgage interest, repairs and maintenance expenses, property taxes and property depreciation. The tax breaks you receive for rental income property add up to bigger profits on your bottom line.
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