Author Topic: The (tax) problem with investing in Rental Property  (Read 5786 times)

MooseOutFront

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The (tax) problem with investing in Rental Property
« on: April 09, 2014, 08:52:05 AM »
For an aspiring early retiree who is maxing tax advantaged space and intends to live off of a Roth conversion ladder in the earliest stages of early retirement, rental property income has some drawbacks.

Rental property income is taxed as ordinary income (less FICA).  You do get to tame the number down via expenses, depreciation, and the mortgage interest deduction, but whatever is left will fill your tax free space first, just like a pension.  For example, I could rent my house for $24,000 per year.  After operating expenses and depreciation, I'm left with $8,000 in taxable income.  Which is cool and all.

My family of 4 has tax free space up to $28,200, and I do intend to receive self employment income in ER which, considering the double FICA issue, makes my concerns with rental property pretty irrelevant now that I have it all typed out. :)

I suppose the consideration to make is that if you have multiple rentals, you'll always be filling up your lowest tax space with that income and your only real option to maximize lowest tax rollovers would be to sell the properties to get rid of that "ordinary income."  If you're working some to supplement your retirement income then you'll have more flexibility to pick and choose your rollovers in low income years.

arebelspy

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Re: The (tax) problem with investing in Rental Property
« Reply #1 on: April 09, 2014, 08:58:28 AM »
This seems similar to me to the complaining about paying lots of taxes because you're making lots of money.

Yes, you can't do rollovers as well as if you weren't making as much money. Yes, capital gains is much better tax-wise than rentals (which are more like dividends - ordinary income). But the amount of income it generates more than makes up for this.

In other words, you do pay more taxes, but you also end up with more spending (after tax) money.  That's A-Okay with me.

If you want it sheltered, own the rental in your self directed IRA (Roth or Traditional).

Then access it through a rollover.
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MooseOutFront

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Re: The (tax) problem with investing in Rental Property
« Reply #2 on: April 09, 2014, 09:11:54 AM »
I need to look more into the possibility of owning rentals in a Roth or traditional IRA.  My thought on this post is more of a planning stream of consciousness.  I don't yet own any rentals, but certainly want to in early retirement.  I'm not certain the returns are there to justify the extra effort when compared to just investing in stocks or REITS, but I really like the diversification away from just rolling 100% equities.

Rental income is certainly treated more nicely than self employment income.  But still, for somebody like me in the 15% bracket who has to make the Roth vs 401k vs Taxable decision on about $20k per year of my savings, when I choose to do rollovers and what income streams will be filling my lowest tax brackets at that time are important planning considerations.  Maybe I wait to buy rentals until a few years in to heavy Roth rollovers.

arebelspy

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Re: The (tax) problem with investing in Rental Property
« Reply #3 on: April 09, 2014, 09:20:05 AM »
I need to look more into the possibility of owning rentals in a Roth or traditional IRA.  My thought on this post is more of a planning stream of consciousness.  I don't yet own any rentals, but certainly want to in early retirement.  I'm not certain the returns are there to justify the extra effort when compared to just investing in stocks or REITS, but I really like the diversification away from just rolling 100% equities.

Rental income is certainly treated more nicely than self employment income.  But still, for somebody like me in the 15% bracket who has to make the Roth vs 401k vs Taxable decision on about $20k per year of my savings, when I choose to do rollovers and what income streams will be filling my lowest tax brackets at that time are important planning considerations.  Maybe I wait to buy rentals until a few years in to heavy Roth rollovers.

Definitely have your first few years set up, or just use the rentals to fund those years.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

totoro

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Re: The (tax) problem with investing in Rental Property
« Reply #4 on: April 09, 2014, 09:31:25 AM »
In Canada you can borrow against the equity in a rental property for investment purposes and the interest is tax deductible.  This can allow you to increase your tax deductible interest and invest the equity in income-producing assets that have better tax treatment like dividends.

In addition, you can plan to live in the primary residence and all appreciation gains are tax exempt. 

arebelspy

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Re: The (tax) problem with investing in Rental Property
« Reply #5 on: April 09, 2014, 10:38:22 AM »
In Canada you can borrow against the equity in a rental property for investment purposes and the interest is tax deductible.  This can allow you to increase your tax deductible interest and invest the equity in income-producing assets that have better tax treatment like dividends.

In addition, you can plan to live in the primary residence and all appreciation gains are tax exempt.

And cash out refis are non-taxable events.  Cashing out equity once every 20 years x 20 properties = lots of annual tax free cash.

THERE'S a topic we haven't discussed much yet that would blow some people's minds.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

matchewed

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Re: The (tax) problem with investing in Rental Property
« Reply #6 on: April 09, 2014, 10:45:28 AM »
In Canada you can borrow against the equity in a rental property for investment purposes and the interest is tax deductible.  This can allow you to increase your tax deductible interest and invest the equity in income-producing assets that have better tax treatment like dividends.

In addition, you can plan to live in the primary residence and all appreciation gains are tax exempt.

And cash out refis are non-taxable events.  Cashing out equity once every 20 years x 20 properties = lots of annual tax free cash.

THERE'S a topic we haven't discussed much yet that would blow some people's minds.

Oooooh didn't know that one.

"O Canada!
Our home and native land!
True patriot love in all thy sons command.
With glowing hearts we see thee rise,"

Nah never mind it's too cold there, and I'm a wussy complainypants when it comes to the cold.

arebelspy

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Re: The (tax) problem with investing in Rental Property
« Reply #7 on: April 09, 2014, 10:54:13 AM »
Oh, that's in the US - I don't know about Canada, but I'd bet it's the same - you're taking a loan out, in their view, so of course you wouldn't pay taxes on it...
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

matchewed

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Re: The (tax) problem with investing in Rental Property
« Reply #8 on: April 09, 2014, 10:55:33 AM »
Ah gotcha. One of these days I swear I'll get to reading that Real Estate and Landlording section. It's small right? Like a few threads or something? ;)

arebelspy

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Re: The (tax) problem with investing in Rental Property
« Reply #9 on: April 09, 2014, 11:14:39 AM »
Ah gotcha. One of these days I swear I'll get to reading that Real Estate and Landlording section. It's small right? Like a few threads or something? ;)

Yup, less than half as many threads as this section, Investor Alley!  :)
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

totoro

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Re: The (tax) problem with investing in Rental Property
« Reply #10 on: April 09, 2014, 11:18:38 AM »
In Canada you can borrow against the equity in a rental property for investment purposes and the interest is tax deductible.  This can allow you to increase your tax deductible interest and invest the equity in income-producing assets that have better tax treatment like dividends.

In addition, you can plan to live in the primary residence and all appreciation gains are tax exempt.

And cash out refis are non-taxable events.  Cashing out equity once every 20 years x 20 properties = lots of annual tax free cash.

THERE'S a topic we haven't discussed much yet that would blow some people's minds.

Oooooh didn't know that one.

"O Canada!
Our home and native land!
True patriot love in all thy sons command.
With glowing hearts we see thee rise,"

Nah never mind it's too cold there, and I'm a wussy complainypants when it comes to the cold.

Not cold at all where I live (classified as a Mediterranean climate in fact).  But, yah, I was in Nova Scotia last week and there was a "spring ice storm" that shut down the world for three days.

marty998

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Re: The (tax) problem with investing in Rental Property
« Reply #11 on: April 09, 2014, 04:22:54 PM »
In Canada you can borrow against the equity in a rental property for investment purposes and the interest is tax deductible.  This can allow you to increase your tax deductible interest and invest the equity in income-producing assets that have better tax treatment like dividends.

In addition, you can plan to live in the primary residence and all appreciation gains are tax exempt.

And cash out refis are non-taxable events.  Cashing out equity once every 20 years x 20 properties = lots of annual tax free cash.

THERE'S a topic we haven't discussed much yet that would blow some people's minds.

Oooh yes the whole living off equity thing. Works a treat, if your properties are the right type that keeps appreciating, you can just keep pulling buckets of cash out without ever selling and incurring capital gains tax.

arebelspy

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Re: The (tax) problem with investing in Rental Property
« Reply #12 on: April 09, 2014, 04:50:59 PM »
Marty you've complained multiple times about how we here in the states don't count appreciation in our real estate calculations (and mentioned how you do get appreciation in your market) and now you're scoffing when I throw out a strategy that utilizes it?  :P

(Unless I'm misreading that "if your properties are the type.." Which sounds sarcastic but may not be)
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

sdp

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Re: The (tax) problem with investing in Rental Property
« Reply #13 on: April 09, 2014, 06:48:48 PM »
Be VERY careful with cash-out refi's.  If the cash-out is not used for the rentals you own (say you buy your own house, a boat, a car, a trip to moon...) then the IRS will not allow you to use the cash-out balance and interest on it as a deduction.  If you do, and they find out, expect to pay some serious penalties and be audited every year you file a schedule E until the day you die...
The IRS will look at a Cash-Out refi as a reduction in cost basis which will effect your depreciation on your schedule E and will also effect the capital gains if/when you sell the property.  and, of course, they will not let you use the interest deduction for the entire portion of the loan....

Be careful!

arebelspy

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Re: The (tax) problem with investing in Rental Property
« Reply #14 on: April 09, 2014, 08:01:01 PM »
Correct.  However you can use it to purchase more rentals and then deduct it, or you can not worry about the interest deduction, depending on your age, strategy, etc.  (And only the portion that you took out over the previous amount isn't deductible, the rest still is).
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

tdccarpenter

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Re: The (tax) problem with investing in Rental Property
« Reply #15 on: April 10, 2014, 06:45:48 AM »
I do taxes annually for several partnerships, s corps and individuals that own a lot of rentals.  With the combination of, "expectation of capital appreciation", home office deduction, standard milage, depreciation, 1031 exchanges, etc you should not have to pay much tax (if any) on your properties if you keep good records and plan your moves in advance.

totoro

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Re: The (tax) problem with investing in Rental Property
« Reply #16 on: April 10, 2014, 08:18:11 AM »
I don't claim depreciation - capital cost allowance in Canada.  I don't because I still have high interest deductions because of high mortgage amounts and I'm not making a huge net in the end.  Depending on taxable income, it may not make sense to claim depreciation for a building due to the recapture upon disposition.

http://www.taxtips.ca/glossary/recapture.htm

tdccarpenter

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Re: The (tax) problem with investing in Rental Property
« Reply #17 on: April 10, 2014, 11:05:00 AM »
totoro: I'm not familiar with the Canadian tax law, but stateside, there are several factors to take into account regarding depreciation.  Other factors to consider are:

passive loss rules
willingness of a client to do a 1031 exchange
how long the client intends to hold the property
other expenses related to the property
other income the client has

In effect, it serves as a tax defferal tool.  Knowing your total income picture helps a ton.

totoro

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Re: The (tax) problem with investing in Rental Property
« Reply #18 on: April 10, 2014, 11:10:24 AM »
tdcarpenter - yes we have many of the same rules except the 1031 exchange.  I will probably take the CCA in a couple of years but right now I can manage taxable income through the use of dividends instead of income from my business. 

The risky/expensive thing about the CCA is the recapture on sale, at least in Canada.  You need to plan the year that occurs and make sure the benefits outweigh the end result.  I'm not a tax expert - this is my accountant's advice but it seems to be true when I look at the rules.