Using Real Estate To Build Wealth

Here are three ways your home can increase your net worth

the exact amount of mortgage loan you can afford.

Take Myrtle and Reginald Campbell. They wanted to trade up from the 1,475-square-foot, four-bedroom home they bought in San Antonio, Texas, for $72,000, to a larger home that they decided to build themselves. Their new 1,959-square-foot, three-bedroom home cost $174,000, including land and construction, more than twice what their first house cost them, but they didn’t skip a beat.

Myrtle, 43, an insurance claims representative, and Reginald, 43, a courier for Overnight Transportation, sold their smaller home for $88,000 last September, $16,000 over the original cost of the home. They used the proceeds from the sale to pay the $10,000 deposit plus closing costs on their new home in Schertz, Texas. The Campbells’ great credit scores and household income of $90,000 allowed them to finance $166,000 of the $174,000 purchase price at an interest rate of 5.99%. The $1,300 mortgage payment is comfortably affordable for a couple with their income level.

“We always wanted a bigger house,” says Reginald. But the size of the home is not the only benefit the Campbells enjoy. “I knew that taxes were cheaper being outside of Bexar County [the home of San Antonio]. Insurance is cheaper too. And I wanted my daughter to experience a new environment,” he says.

There are other ways to trade up. McDaniel says a more sophisticated swap of smaller and larger properties is done with a “Section 1031 exchange.” In this kind of exchange, the real estate owner can avoid tax liability from a property sale by purchasing another property within a six-month window using the escrowed proceeds from the first sale. Another way to trade up is through a trust deed exchange. For people who have paid their mortgages in full, they can exchange the smaller property for a lar
ger one, with the difference in the values of the two properties being liquidated through periodic payments per the terms of the trust deed.

By trading up, Flateau says, the real estate owner can take control of a larger asset, which has the potential to lead to greater wealth. He notes that going from co-ops and condos to two- or three-family homes is more typical in trade up transactions in places like New York than in other markets. He also says there are tax advantages to trading up, such as the exemption from capital gains tax on the proceeds of the sale of the smaller home.

So when is it best to trade up? “Generally when people have built up substantial equity in their property, then they could look at a second property or trade up,” says Flateau. But he cautions that risk factors, such as determining your financial ability to take on a larger mortgage and the operational risk of managing a larger property, should be weighed carefully before trading up.

TAX ADVANTAGES

Owning real estate can yield tax savings to the owner that can add to your wealth. “You can write off mortgage interest, real estate property taxes, and mortgage points that are treated as

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