Rental Profits Vs. Stocks
Rental properties and stock investments both offer the potential for a mix of profit through appreciation and cash flow. They also offer the ability to own investments with real underlying value -- a house or a share of a real company with tangible assets. However, they're treated differently for tax purposes and they also offer different mixes of returns.
Rates of Return
Stocks and rentals both offer wildly varying rates of return. The stock market has historically returned around 9.31 percent per year based on the performance of the Standard & Poor's 500 stock index between 1928 and 2012, with the worst year showing a 43.84 percent decline and the best year showing a 49.98 percent increase. Your return on a rental property comes from your rent, less expenses and mortgage payment, divided by your down payment. While some rentals are actually cash-flow negative in high cost parts of the country, returns in the low- to mid-teens are also not at all out of reach.
Cash Flow and Taxes
Real estate profits and stock income both are taxed as regular income, so you'll pay essentially the same taxes on them that you pay on your paycheck. However, rental profits enjoy some extra tax shelter. You're allowed to depreciate your building, which means that you can write off a portion of its cost every year as an expense, even if you haven't actually spent the money. While you can write off investment expenses for both stocks and rental properties, rental property expenses are claimed on Schedule E, where they aren't subject to limits or to being canceled out by the alternative minimum tax.
Taxes and Trading
The other source of profit from both rentals and stock ownership is selling for more than you paid. Profits from both are subject to capital gains taxes. However, if you sell rental real estate and use the proceeds to buy more investment real estate, you can defer paying your taxes on the transaction. You're allowed to do this even if you don't hold the real estate in an IRA, 401(k) or other tax-advantaged account. Stock trades, on the other hand, are taxable whether or not you actually pull any cash out of them unless you trade them in a tax-advantaged account.
Both stocks and rental properties can be leveraged. However, rental property loans are usually safer than stock leverage. When the stock market goes down, the value of your collateral drops and your broker can require you to pay back some or all of your loan through a margin call. Real estate leverage, on the other hand, usually doesn't get reassessed. As long as you're paying on it, the loan should stay in place. Furthermore, 60 percent or higher leverage is readily available on real estate, and with creative financing you can sometimes get over 80 percent.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.