What Is It?
Many of our clients from Cummins Inc have been interested to know more about purchasing rental properties. Purchasing a rental property is one way of investing in real estate. Rental property is typically a multifamily dwelling that you purchase with the intention of renting out individual units. However, you might also purchase single-family homes as rental properties. Most real estate investments are growth-oriented, meaning that the return on your investment is based on how much your property increases in value from the time you purchase it until the time you sell it.
However, when you purchase a rental property, your focus will typically be on current income and cash flow. Although you may someday sell the property at a profit, the greater part of your return will likely come from rental income. It's important that the Cummins Inc employees who are looking into investing in rental property note that for this reason, rental property is typically a long-term investment.
What Are The Risks?
It's also important that these Cummins Inc clients are aware of the risks that come with it. Although rental property is not as speculative as some real estate investments, substantial risks are associated with investing in rental property. In particular, rental property investments are subject to market risk and liquidity risk. Your tenants could run into financial difficulties and become delinquent with their rent payments--or not pay them at all and require eviction proceedings.
Political or economic changes in the area could affect your occupancy rates and property values. Changes in tax laws could reduce or eliminate the favorable tax treatment of rental property. Changes in zoning laws could have a positive or negative impact, as could changes in traffic patterns. Should you find yourself with an unexpected cash need, you will probably not be able to quickly liquidate your rental property. Before considering getting into the rental property business, these Cummins Inc employees should evaluate their ability to deal with these risks.
Caution: We'd like our Cummins Inc clients to be aware that there are inherent risks associated with real estate investments and the real estate industry, each of which could have an adverse effect on the financial performance and value of a real estate investment. Some of these risks include a deterioration in national, regional, and local economies; tenant defaults; local real estate conditions, such as an oversupply of, or a reduction in demand for, rental space; property mismanagement; changes in operating costs and expenses, including increasing insurance costs, energy prices, real estate taxes, and the costs of compliance with laws, regulations, and government policies. Real estate investments may not be appropriate for all investors.
When Can It Be Used?
You Have the Knowledge and Attributes Required to Be Successful
In order to be successful with any type of real estate investment, it's essential that these Cummins Inc employees have (or be willing to work on acquiring) knowledge of the real estate business as a whole. Books and seminars are a good start. You might also want to talk to others who have made successful investments in the type of real estate you are considering--in this case, rental property. In particular, investing in rental property requires common sense, in that you must have the foresight to find the right location.
Finding good properties in up-and-coming neighborhoods takes more than just luck. It is a product of knowing an area and recognizing its trends. You must also be a good judge when it comes to choosing tenants and/or professional property managers. However, one of the most important factors is determination. You may not realize it if you are just starting out, but it takes a serious commitment to keep your rental property in top condition, so you can continue to attract quality tenants and increase your property value.
You Understand the Risks and Responsibilities Inherent to Real Estate Investing, and You Are Comfortable With Them
Like all real estate, rental property is a risky investment. Before considering this type of investment, these Cummins Inc employees must evaluate their ability to deal with the risks and responsibilities associated with rental property. In addition to measuring your risk tolerance, asking yourself some of the following questions may help you evaluate the appropriateness of this investment:
- Do I have the financial backing required to purchase investment property?
- If not, is my credit rating good enough to secure financing?
- Do I have the ability and the resources to use my own money if necessary to help the investment survive?
- Would my life's savings be in jeopardy if I needed cash to help pay bills for the investment property?
- If there were vacancies or delinquencies, would I have sufficient income to pay the expenses until the rental income returned to normal levels?
- Can I keep my current job or business and invest in real estate on a part-time basis?
- Would worrying about my rental property interfere with other aspects of my life?
- If I decide to go into this business and it fails, would I be all right financially? Emotionally?
Strengths
Rental Property May Receive Favorable Tax Treatment
Because rental property is considered business property, mortgage interest, property taxes, insurance, advertising, maintenance, and other expenses are typically tax deductible. These deductions can be used to offset some or all of your rental income.
Property depreciation is also deductible. However, remember that net rental income (income minus expenses) and net capital gains from the sale of rental property will be included when calculating whether your total investment income is subject to the 3.8% tax that applies to the investment income of individuals with an adjusted gross income (AGI) above $200,000 and couples filing a joint return with more than $250,000 AGI.
Rental Property Provides Both Current Income and The Potential for Capital Gains
As mentioned, most of the return on your rental property investment will be current income in the form of rent payments. However, rental property also has the potential for capital gains because there is a chance that you can eventually sell the property for more than your original purchase price. By contrast, other types of real estate investments (e.g., raw land) provide an opportunity for capital gains, but little current income.
Variety of Property Types and Locations Provides Flexibility
When you purchase rental property, you can choose from a wide variety of property types and locations. Your choices range from urban high-rises to small apartment buildings, to suburban duplexes and townhouses, to single-family homes in the country or at the seashore.
Tradeoffs
Like All Real Estate, Rental Property Can Be a Highly Speculative Investment
It is imperative that these Cummins Inc employees understand the risks they are undertaking when they invest in real estate. There is no guarantee you will realize a profit on a real estate investment. In fact, there is no guarantee your property will even retain its current value. What makes real estate investing so hazardous is that so many of the factors that determine the success or failure of a given real estate investment are outside of the investor's control.
Changes in the tax code could reduce or eliminate the tax advantages of real estate investing. Economic changes in an area (e.g., the failure of a major business or the closing of a military base) can adversely affect property values and put many of your tenants out of work, creating the possibility of delinquency. Financial markets can also affect the value of real estate investments as interest rates fluctuate. These are just a few of the many risks for our Cummins Inc clients to consider if they are thinking about investing in real estate.
Rental Property Requires Personal Involvement and Constant Management
Regardless of whether you choose to manage the property yourself or hire a property management professional, your involvement doesn't end with the purchase of rental property. You will need to interact with tenants and/or property managers throughout the life of the investment. These interactions can be rewarding, but they can also be highly stressful. Before investing in rental property, these Cummins Inc clients should consider whether they would be emotionally capable of firing a manager or evicting a tenant if the need arose.
For our Cummins Inc clients who are considering self-management of the property, consider whether you are willing to deal with tenants' complaints and problems, which may come at all hours of the day and night. These Cummins Inc employees should keep in mind, too, the numerous day-to-day tasks necessary to keep the rental property operating smoothly. In addition, there are many liability issues you probably haven't even considered, such as building security and codes, anti-discrimination laws, the possibility of lead and/or asbestos in the building, and ADA (Americans with Disabilities Act) accommodations, to name a few.
Investing In Rental Property Typically Requires a Large Outlay of Capital
Many investors do not even consider getting into real estate because of the relatively large sums of money necessary to acquire and maintain property. This capital requirement also contributes to real estate's poor liquidity. This disadvantage works in two ways: first, by making it difficult for you to enter the real estate game yourself, and second, by making it difficult to find a buyer who can get you out of the game when you're ready to quit. If you are not prepared to lay out a significant amount of money for an individual real estate investment (or you are not willing to secure the necessary financing), you might want to consider a different type of venture, such as a real estate investment trust (REIT) or a real estate partnership.
Political And Economic Changes In the Area Can Affect Occupancy and Property Values
Since the majority of your return from an investment in rental property comes from rental income, it is important to keep your occupancy rates as high as possible. Of course, many factors might make this more difficult. Political changes (e.g., a tax hike) can adversely affect the residents of a given community, making them less likely to upgrade to a nicer apartment or rental home.
Economic changes (e.g., a factory closing) can create high unemployment, making it difficult for your tenants to pay their rent. Rezoning, relocation of roads, and other unexpected events can also affect your property value and could be devastating when you eventually decide to sell the property. In fact, if property values decline enough, you may find yourself unable to sell the property at all.
Real Estate Is Not a Liquid Investment
Like all real estate, rental property is relatively difficult to sell in a hurry, and there is little certainty about the selling price you will receive if you do manage to find a quick buyer. Unlike the stock market and many other securities markets, there is no established national exchange for real estate trading. If you choose your property wisely and manage it well, you may have a steady stream of rental income, but you will probably not be able to sell the property quickly if an unexpected cash need arises. Other types of investments, such as stocks, bonds, and other short-term securities, should be included in a balanced portfolio to provide adequate liquidity.
How to Do It
Select the Rental Property You Want to Purchase
Selecting the appropriate rental property can be a daunting task. Many first-time real estate investors choose to start small, choosing a duplex or similar property as a starter. Although it is not the most glamorous type of property, a duplex provides many advantages over other types of rental property, especially if you are just getting into the landlord business. Duplexes are affordable--prices are typically comparable to single-family homes.
They also provide you with personal housing, should you decide to live on-site and manage the property yourself. You can rent out one side of the duplex and live in the other, using the tenant's rent to help make your mortgage payments. Other options for starting small include single-family homes, triple-deckers, and brownstones. If you are an experienced landlord, you might consider a large apartment building or complex. Although the following list is not exhaustive, some important things to consider when choosing property include:
- Number and size of units
- Fair market rents in the area
- Location of property
- Availability of parking
- Proximity to schools, shopping, public transportation, and other amenities
- Quality of local school system
- Commuting time to major business districts
- Crime levels in the area
- Police and fire protection in the area
- Amount of property taxes
- Costs for adequate insurance
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Arrange Financing for the Purchase (If Necessary)
If you are purchasing rental property, you will probably need a mortgage. Even if you have resources available to make the purchase, taking a mortgage is typically advantageous because the mortgage interest is usually tax deductible as a business expense. There are many different types of mortgages to suit your specific needs, although not all types of mortgages are available from all lenders, and many are not appropriate for investment property. These Cummins Inc employees should remember that choosing a mortgage can be a complex process, and making an inappropriate choice can have consequences later.
Decide on form of Ownership
How should you own your home? That depends. If you are purchasing property by yourself, your only real choice is sole ownership (unless you incorporate). However, if you are buying property with another person or persons (e.g., your spouse, your children, or a group of associates), you have several options with regard to form of ownership. You may choose to own the property as joint tenants, as tenants in common, or, if married, as tenants by the entirety. Each of these forms of ownership has certain advantages and disadvantages, depending on your situation.
Tip: It is also possible to form a business entity (e.g., partnership, limited liability company) to own property.
Arrange for Ongoing Management and Maintenance of Property
You might decide that you can handle management duties yourself, especially if your investment is limited to only a few units and the properties are located close together. For any of our Cummins Inc clients who choose to manage your property themselves, be sure you understand the magnitude of the task you are undertaking. Many would-be managers have found that their schedules cannot accommodate the time commitment. Some of the necessary duties include:
- Placing ads as rental units become available
- Interviewing prospective tenants
- Performing credit checks and contacting references on prospective tenants
- Sending and receiving correspondences
- Setting and collecting rents
- Following up on delinquent rent payments
- Keeping books and paying bills
- Cleaning common areas such as hallways and laundry rooms
- Making safety and maintenance inspections
- Mowing lawns/landscaping
- Shoveling and plowing snow
- Arranging for all repairs and maintenance
- Making improvements to the property as necessary
Professional management may be necessary if you don't have the time or inclination for these necessary activities, or if you own many properties in diverse locations. Professional managers may also be useful if you are uncertain about fair market rents in the area where you have purchased property. Hiring professional managers means you don't have to do as much to keep your rental property functioning, but it also requires you to give up a certain degree of control over the property, and the salaries of property managers will need to be paid.
Choose Your Tenants Carefully
Ultimately, the success of your rental property investment relies heavily on the quality of your tenants. Thus, finding and keeping good tenants is extremely important, so take your time. Make sure you screen all prospective tenants carefully. Get as much information as possible, including credit, employment, and personal history. Ask for references and contact them for more information.
If you discover undesirable information, you are not obligated to rent to that person. You are within your rights as a landlord to set rules regarding pets, smoking, noise, and so on, and you can reject any prospective tenant as long as your decision complies with fair housing laws and are based on legitimate business criteria. Making your rules known to prospective tenants at the outset (and including them in the rental agreement) can protect you in the long run. You can protect yourself further by requiring a security deposit and the first month's rent before signing the rental agreement, if local laws allow you to do so.
Tax Considerations
Rental Expenses (Including Mortgage Interest) Are Typically Tax Deductible
Income-producing real property, including rental property, is considered business property. As such, it receives certain favorable tax treatment in that your expenses are typically deductible. The general rules regarding deduction of rental expenses are as follows:
- All expenses (including mortgage interest, property taxes, insurance, utilities, advertising, maintenance, and so on) can be deducted against rental income received on the property
- If the total expenses are less than the gross rental income, the resulting profit is taxable income
- Rental activities are considered passive activities. Losses from passive activities that exceed income from passive activities are disallowed for the current year but may be deducted from passive activity income in future years. However, if you materially participate in those rental activities, you may deduct up to $25,000 of any excess passive losses against income from other sources. This $25,000 amount begins to phase out when your modified adjusted gross income (MAGI) exceeds $100,000 and is eliminated entirely for incomes exceeding $150,000. Rental expenses include a wide variety of items that you might not ordinarily consider. However, as long as they are truly used in the course of business, these items are perfectly legitimate deductions. The following are a few examples of items you might be able to deduct as business expenses:
- Tools and hardware
- Cleaning supplies and expenses
- Lawn equipment
- Office supplies
- Office machines (e.g., typewriters, fax machines, copiers)
- Computers and management software
- Postage
- Salaries
- Payroll taxes
- Books and subscriptions
- Seminars and meetings
- Legal fees
- Travel costs to and from the property
Rental Property Depreciation Is Also Deductible
Another tax benefit of rental property is the deductibility of depreciating assets. Rental property is assumed to decrease in value over a period of years, due to wear-and-tear and other factors. Although this is not necessarily the case, you are allowed to deduct depreciation as a way to recover this assumed loss of value. Rental houses and apartments placed in service after January 1, 1987, depreciate on a straight-line basis over 27.5 years (approximately 3.63 percent per year). Thus, if you purchase rental property this year for $275,000, your depreciation deduction would be $10,000 per year for the next 27.5 years.
Tip: We'd like our Fortune 50 clients to note that c ertain qualified property may be entitled to a special 30 percent first-year depreciation deduction (in addition to the normal first-year depreciation deduction).
Repairs And Improvements Are Not The Same In the Eyes of the IRS
It is important to understand all of the tax deductions associated with rental property. One subtle but important rule to know is that repairs and improvements are treated differently in the eyes of the IRS. Repairs keep your property in good working order but do not materially add to the value of the property or substantially prolong its life. Repairs are considered expenses and may be deducted like any other business expense. Improvements, on the other hand, add to the value of the property, prolong its useful life, or adapt it to new uses. Improvements are classified as capital investments and are thus recovered through depreciation.
Capital Gains Tax Liability May Result From The Sale of the Property
We'd like to remind our Cummins Inc clients that because your rental property is a capital asset, you may be required to pay capital gains tax when you sell it. In general terms, if you sell the property for more than you paid for it (or your basis in the property), you have realized a capital gain. If this gain cannot be offset by capital losses, you will have to pay capital gains tax on this amount. Capital gain income and loss can have a significant impact on your net return on your investment.
How does Cummins determine eligibility for participation in the Cummins Pension Plan, and what are the implications for employees who temporarily leave the workforce? This inquiry should delve into the specific criteria that define an eligible employee, such as citizenship requirements and exclusions, as well as the continuation of benefits and service credit during approved leaves or breaks in service at Cummins. It would also explore the complexities surrounding vesting and how service prior to a break is credited upon re-employment at Cummins.
Eligibility and Participation in the Cummins Pension Plan: Eligibility for the Cummins Pension Plan requires being an active employee, not participating in another Cummins defined benefit pension plan, and meeting certain citizenship or residency criteria. During approved leaves of absence, employees continue to accrue service credits, ensuring continuous growth in their pension benefits. Notably, vesting occurs after three years of service, securing the employee's entitlement to pension benefits upon leaving the company. The plan handles breaks in service by allowing reemployment within 12 months to count towards vesting and benefit calculations, safeguarding employee benefits against temporary disruptions in their career with Cummins.
What are the potential benefits and limitations of the forms of distribution available under the Cummins Pension Plan, and how should employees prepare for their pension benefit election? This question requires an analysis of various forms of distributions, such as lump sums versus annuities, highlighting the financial implications of each choice, particularly in relation to the IRS rules for 2024 regarding tax treatment. Employees should also consider how their family structure (e.g., marital status, dependents) may influence their decisions when electing a distribution method.
Distribution Forms and Tax Considerations: The Cummins Pension Plan offers various distribution forms, including lump sums and annuities, each with distinct tax implications under IRS rules for 2024. Employees must consider their family structure and tax status when choosing a distribution form, as these factors influence the tax treatment and financial outcome of their pension benefits. The plan provides clear guidelines on these options, ensuring employees can make informed decisions that align with their personal and financial circumstances.
In what ways do pay credits and interest credits accrue within the Cummins Pension Plan, and how can employees gauge their potential retirement benefits over time? This question will focus on the specifics of how pay credits are calculated based on an employee's compensation and service at Cummins, as well as the impact of interest credits on the total account balance and long-term retirement planning. It will also examine how employees can track these credits through the Cummins retirement resources.
Accrual of Pay and Interest Credits: The pension benefits at Cummins accrue through pay credits based on compensation and service, along with interest credits. Employees can monitor their accumulating benefits through the Cummins retirement resources, offering transparency and planning advantages. This structured accrual method supports employees in projecting their future pension benefits and making informed decisions about their retirement timing and financial needs.
How does Cummins ensure compliance with ERISA and other regulatory standards in the management of the Cummins Pension Plan, and what rights do employees have under these regulations? This query should explore Cummins' obligations as a fiduciary in managing employee benefits and highlight the key rights of plan participants. The discussion should include access to plan documents, the process for filing claims, and the significance of ERISA protections for employees retired from Cummins.
Regulatory Compliance and Employee Rights: Cummins diligently adheres to ERISA standards in managing the pension plan, emphasizing fiduciary responsibility and ensuring participants' rights are upheld. Employees have rights to access plan documents, participate in claims and appeals processes, and are protected under ERISA from any plan-related discrimination. This regulatory compliance not only secures the integrity of their pension benefits but also reinforces the legal framework protecting participant rights.
What role does the Pension Benefit Guaranty Corporation (PBGC) play in safeguarding the retirement benefits of Cummins employees, and how does this affect the perception of the plan's reliability? This question would examine the insurance coverage provided by the PBGC, what types of benefits are guaranteed, and under what circumstances benefits may not be fully covered. Employees might analyze how this federal insurance impacts their confidence in the plan, especially in light of changing economic conditions.
Role of the Pension Benefit Guaranty Corporation (PBGC): The PBGC insures the pension benefits under the Cummins Plan, providing a safety net that enhances the reliability of these benefits. Employees covered by the plan can gain confidence in the security of their pensions, knowing that even in the face of potential plan termination, the PBGC guarantees the core benefits, subject to certain legal limits and conditions.
How does the Cummins Pension Plan interface with employees' Social Security benefits, and what should retirees consider when planning for a sustainable retirement income? This inquiry will look at the coordination of benefits under the Cummins plan with Social Security, examining how pension income might influence Social Security calculations. It would require discussions on the timing of retirement elections and how they align with Social Security claims.
Interaction with Social Security Benefits: The Cummins Pension Plan is designed to integrate smoothly with Social Security benefits, offering provisions that help plan participants optimize their total retirement income. Understanding this interaction allows employees to strategically plan their retirement age and benefit commencement, maximizing their financial stability in later life.
What are the specific procedures and deadlines that Cummins employees should follow to successfully elect a distribution from the Cummins Pension Plan upon retirement? This question will necessitate a detailed look at the steps involved in initiating a benefit distribution, including the importance of spousal consent, the timing of application submissions, and any documentation that may be required. Understanding these processes can significantly affect the financial outcomes for retirees.
Procedures and Deadlines for Electing Pension Distribution: The Cummins Pension Plan outlines specific procedures and deadlines for electing a distribution upon retirement, emphasizing the importance of timely and informed decision-making. By understanding these processes, employees can avoid delays and ensure that they receive their pension benefits in the manner that best suits their post-retirement financial plans.
What are the implications of choosing to defer pension benefits and how does the Cummins Plan accommodate employees who opt not to start their benefits at the normal retirement date? This inquiry could address the potential financial consequences of deferring benefits, including eligibility requirements for such deferral and how it aligns with IRS regulations. Employees should critically evaluate their financial situations and retirement goals, weighing the allure of continued employment against starting their retirement benefits sooner.
Deferring Pension Benefits: Employees at Cummins have the option to defer their pension benefits beyond the normal retirement date, which can influence the financial value of their benefits. The plan provides guidelines on how deferral impacts benefit calculations and distributions, assisting employees in making decisions that align with their long-term financial goals.
How can Cummins employees designating beneficiaries ensure that their wishes are respected concerning death benefits, particularly in light of recent changes in the pension landscape? This question focuses on the options available to employees for designating beneficiaries, the process for updating these designations over time, and the specific forms that need to be completed to ensure compliance with the Cummins Pension Plan. It will also discuss the impact of state and federal laws on these designations.
Designating Beneficiaries and Ensuring Compliance: The plan stipulates clear processes for designating beneficiaries for pension benefits, ensuring that employees' wishes are respected and legally documented. This is crucial for planning and securing financial provisions for survivors, reflecting the plan's comprehensive approach to retirement benefits.
How can Cummins employees contact the Cummins Retirement Benefits Service Center to obtain more information about the Cummins Pension Plan and related retirement processes? This question emphasizes the various channels through which employees can reach out to the service center, the types of queries they can address regarding the Cummins Pension Plan, and the resources available online to assist with pension-related inquiries. Employees are encouraged to take advantage of these resources to make informed decisions regarding their retirement planning.
Accessing Information and Assistance: Cummins provides multiple channels for employees to access information and assistance regarding their pension plan, including online resources and a dedicated service center. This accessibility ensures that employees can obtain detailed information and personalized support, enabling them to navigate their pension benefits effectively.