Why would one want to invest in real estate? All realtors will tell you: appreciation, cash flow and depreciation. Undoubtedly, over time, real properties will again rise in value. Even with the pounding that prices have taken, over the past 10 years (as August 2010), residential properties, on average (Case Shiller/SP 10 City data), outperformed the S&P 500 +47.3% for real estate, -30.9% for stocks! If you are saving for retirement, doesn’t it make sense to diversify using investment properties?

If you have though of “downsizing” at or prior to retirement, consider the purchase of your retirement home now. After a professional adviser “crunches” the numbers, you might be amazed to see that buying a second home that can be rented can very well fit into your budget. In addition to rental income that you could receive, rental real estate also benefits from depreciation. This is a phantom expense that can turn a situation that is profitable from a cash flow perspective into a loss for tax purposes.

If you file jointly and your Adjusted Gross Income (AGI) is $100,000 or less, you may be able to write off up to $25,000 of your real estate losses against your income. That’s a $6,250 reduction in taxes for those in the 25% tax bracket.

When you are ready to downsize, there could be great news for you. Unless current tax laws change, you may be able to sell your current residence and receive a tax exemption on up to $500,000 on the capital gains you realize. With that money, you can probably have enough to pay off the existing mortgage on the rental and move in to it. You might even have enough extra to provide you with extra income for the rest of your life.

One of the keys to success in the real estate market is understanding how the tax laws work in your favor. With proper planning, your cash flows can be managed and taxes reduced, making your purchases affordable.

Always be sure to check with your professional tax adviser before entering into complex investment transactions and tax laws are continually changing.