Investing in real estate is one of the most popular and effective ways to build wealth and generate income streams. Two common ways to make money in real estate are through capital gains and rental income. While both can be lucrative, they are fundamentally different and require different strategies and approaches.
What are capital gains?
Capital gains are the profits made from selling a property for more than its purchase price. For example, if you buy a property for $200,000 and sell it for $300,000, you have a capital gain of $100,000. Capital gains are taxed at a lower rate than ordinary income, making them an attractive option for investors. The tax rate on capital gains depends on the length of time you hold the property. If you hold the property for more than a year, you are eligible for long-term capital gains tax rates, which can be as low as 0% or as high as 20%.
What is rental income?
Rental income, on the other hand, refers to the income generated from renting out a property. This can be a single-family home, a multi-unit apartment building, or a commercial property. Rental income can provide a consistent and predictable stream of cash flow, making it an attractive option for investors who want a steady source of income. However, rental income is taxed at ordinary income rates, which can be as high as 37%, depending on your tax bracket.
Capital gains vs. rental income
So, which is better: capital gains or rental income? The answer depends on your investment goals and your risk tolerance. Capital gains are typically associated with higher risk and higher returns. Flipping, for example, is a popular strategy for generating capital gains. Flipping involves buying a property, renovating it, and selling it for a profit. While flipping can be highly lucrative, it also comes with risks. If the market turns, or if the renovation costs are higher than expected, you could end up losing money.
Rental income, on the other hand, is typically associated with lower risk and lower returns. Investing in rental properties requires a longer-term strategy and a focus on cash flow. The goal is to buy a property that generates enough rental income to cover expenses and provide a positive cash flow. While rental income may not generate the same level of profits as capital gains, it can provide a steady stream of income over the long term.
Direct effort
Another factor to consider when choosing between capital gains and rental income is the level of involvement required. Flipping requires a significant amount of work and expertise. You need to know how to find the right property, how to estimate renovation costs, and how to market the property for sale. Rental income, on the other hand, requires ongoing management and maintenance. You need to find tenants, collect rent, handle repairs, and keep up with needed maintenance. While both strategies require work, rental income is typically more direct and requires more ongoing management.