Author Topic: Landlords, are you a business?  (Read 13509 times)

brooklynguy

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Re: Landlords, are you a business?
« Reply #50 on: November 11, 2014, 11:45:37 AM »
Thanks for the work you put into this, Cheddar!

Even though I recognize that you did not take ACA subsidies into account, my first observation is that the second married couple (the one w/ a $1019 refund) is almost perfectly positioned to get maximum ACA subsidies, while the first married couple (w/ a $4546 refund) is below the threshold to receive any ACA subsidies.  Because ACA subsidies are potentially one of the (if not the single) biggest ticket items out there as far as tax optimization, I would prioritize seeking those tax credits over the EITC (assuming Medicaid or an alternative health insurance arrangement (or no health insurance arrangement) is not an option (or not a desired option)).  Of course, this assumes that you're willing to plan around the ACA as it exists today even though there's a relatively good chance it could change in the near-term future.

My biggest takeaway from this is that there are too many competing incentives to try to make this scheme work.  You have to be aware of all of them, account for all of them, thread the needle juuuuust right between all of them, and then make sure your individual circumstances don't change (and hope the tax laws don't change) in a way that defeats the purpose.

On the other hand, the same could be said about almost any tax planning strategy.

Cheddar Stacker

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Re: Landlords, are you a business?
« Reply #51 on: November 11, 2014, 12:11:50 PM »
You're welcome. Hopefully someone will get something out of it. I know I learned a bit.

ACA subsidies just have too many variables at this point to consider it for a long-term plan IMO. If you know the exact rules of your specific state for the current year, you will have to apply it on an individual basis. I have honestly never, ever looked into them since they haven't effected me or my client based yet. Nearly everything I know about them I've learned from this forum. Our client base is not conducive to ACA and EITC, they make too much money in general.

johnhenry

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Re: Landlords, are you a business?
« Reply #52 on: November 11, 2014, 12:43:12 PM »
Thanks, Cheddar!!  That's awesome.  Do you have this in spreadsheet form? 

I agree with Brooklyn.  Even with all the info in front of you, this is hard to analyze.

One other point is that this doesn't factor in depreciation for the rental business or the business generating earned income.

So.... if a rental business is generating net of $20K, the 50% rule says their annual gross is $40K.  The 1% rule says their monthly gross of 40K/12=3333 should be resulting from property worth $333,333.  If 80% of that value is structure and 20% land, (we'll ignore closing costs and rehab) and say the cost basis for depreciation is $266,666.  Of that, 1/27.5 or $9696 is depreciated annually.  Net 20K, pay tax on 10K, defer tax the other 10K.  Defer not just for 27.5 years, but until you sell.

So if you assume those variables:
a) gross rent is 1% of purchase price
b) net income is half of gross income
c) 80% of purchase price is in structure (and for simplicity ignore closing costs and rehab, which will increase amount depreciated)
d) it's residential and depreciated over 27.5 years

It follows that depreciation will allow you to defer nearly half (almost exactly half) of your net.  Which means in Cheddar's example, only $10K would make it to the "business income" line.

It is true that the alternative side gig that generates $20K net may also have some depreciation to claim.  But it's hard to imagine a business that with $40K gross and $20K net generating $10K per year in depreciation, even with schedules of less than 27.5 years for equipment.

Cheddar Stacker

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Re: Landlords, are you a business?
« Reply #53 on: November 11, 2014, 01:01:13 PM »
The spreadsheet is attached, but it's not a working document, it's just a picture of the data taken from a formal tax software, so it's really just a cleaner version of the table I posted. Might not be very helpful, but it's a bit easier to read at least.

I get what you're saying with all the depreciation stuff, and that taxable income does not equal cash flow. That was just too big a variable for me to play with for this exercise. Also, if you're looking at rental properties either as LLC or C-Corp it's fairly irrelevant since it all comes down to the wage you would pay. If you're looking at Rentals (Sch E) vs. (Sch C) active flips, or consulting, or a property management company or whatever, then I see your point. The depreciation creates a lot of tax deferral so the cash flow should exceed the taxable profit. However, you didn't consider debt service so your "half" really only applies if there is no mortgage since a big chunk of the mortgage will be principle that's not included in the 50% rule.

A lot to take in. I can't imagine what a newbie reading this might be thinking. If you don't understand what we're talking about, circle back later after learning all the rest of this. This is not for the novice investor.

johnhenry

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Re: Landlords, are you a business?
« Reply #54 on: November 11, 2014, 03:21:43 PM »
However, you didn't consider debt service so your "half" really only applies if there is no mortgage since a big chunk of the mortgage will be principle that's not included in the 50% rule.

You are right.... I jumped the gun on that.  I messed up that example.  I do(did originally) have mortgages on all my holdings, but I've found that it's possible to meet the 50% mark even when factoring interest expenses, not just operating expenses.  But most of mine are closer to 2% than 1%, which makes that possible.  Although most folks do use it to estimate expenses, not including debt service.... so I definitely mis-used it my example.

With that said, you are exactly right, the main point I was making is the power of income deferral when depreciation is factored.

I think the mistake in my example actually understated the case I was trying to make.  If the interest portion of the debt service was factored in, then the net income would be lower, but the depreciation claimed would become a higher percentage of the income.