Landlords: simple example on why people may not be making any money.

[K-ice]

Brief, rent is $1800 and expenses are $1600 but the landlord is still in the hole at the end of the year.

Expenses:
Mortgage $1000 (let’s assume 50% interest 50% principal, this changes every month but this is a simple example)
Property tax, insurance, other expenses $600 (assume everything to do with the building is covered here)
TOTAL $1,600

RENT $1,800

OK so it looks good, you are making $200 per month and covering the mortgage. 
Happy, happy!

Now it’s the end of the year and income tax time.

Income Tax (monthly values listed)
Gross income $1,800
Deduct mortgage interest $500
Deduct expenses $600
Net Income = $700 per month

 (But wait, I was only really putting $200 in my pocket. I can’t get the $500 that went towards the mortgage principal back.)
Assume the Tax rate is 40% so $280 is due each month in personal income taxes. (More likely this will hit you as $3,360 owing at the end of the year. GULP!  Sad, Sad!)

So in reality, this rental is costing you $80 per month.  That is not a lot but the landlord is still not making anything. To go from thinking you make $200 to a -$80 sucks!

What am I missing?

There would be capital cost allowance on the building depreciation (kinda beyond simple to consider that)….

As is, is this a good simple example to help wannabe landlords?

How many of you go one step further and make sure your rental is still profitable after paying income tax?

[Drifterrider]

Brief, rent is $1800 and expenses are $1600 but the landlord is still in the hole at the end of the year.

Expenses:
Mortgage $1000 (let’s assume 50% interest 50% principal, this changes every month but this is a simple example)
Property tax, insurance, other expenses $600 (assume everything to do with the building is covered here)
TOTAL $1,600

RENT $1,800

OK so it looks good, you are making $200 per month and covering the mortgage. 
Happy, happy!

Now it’s the end of the year and income tax time.

Income Tax (monthly values listed)
Gross income $1,800
Deduct mortgage interest $500
Deduct expenses $600
Net Income = $700 per month

 (But wait, I was only really putting $200 in my pocket. I can’t get the $500 that went towards the mortgage principal back.)
Assume the Tax rate is 40% so $280 is due each month in personal income taxes. (More likely this will hit you as $3,360 owing at the end of the year. GULP!  Sad, Sad!)

So in reality, this rental is costing you $80 per month.  That is not a lot but the landlord is still not making anything. To go from thinking you make $200 to a -$80 sucks!

What am I missing?

There would be capital cost allowance on the building depreciation (kinda beyond simple to consider that)….

As is, is this a good simple example to help wannabe landlords?

How many of you go one step further and make sure your rental is still profitable after paying income tax?

At one place you say expenses are $1,600 and another $600.  Can't be both.

Taxable income is what is left over AFTER expenses.  Unless your tax rates hits 100%, there will always be a profit (assuming your expenses are less than your revenue).
Your mortgage interest is deducted as an expense as is your principle, property taxes and insurance.  Also, if you can deduct for depreciation, THAT is also an expense (albeit a non-cash expense).

So you could actually break even in terms of dollars and still benefit from the depreciation (but in the US not for too many years.  The IRS will, at some point, tell you you are not running a business but having a "hobby" and disallow further deductions.

So using your numbers:

Revenue  $1,800
Expenses ( 1,600)
NET              200

X tax rate (40%) = $120 profit.

[K-ice]

At one place you say expenses are $1,600 and another $600.  Can't be both.

...

Your mortgage interest is deducted as an expense as is your principle, property taxes and insurance.

To clarify the total out of pocket is $1600. This includes the mortgage $1000 ($500 interest + $500 principal) and other expenses $600.

Maybe it is different in Canada, but we can't deduct the mortgage principal as a tax reducing expense.  So be prepared to pay tax on it.

I'm not sure how it works in the US, but that would be awesome, if I threw extra payments at my principal and actually got a tax break!

[bacchi]

Mortgage principal is not tax deductible in the US either.

Depreciation (in the US) is based on a 27.5 year schedule, generally. Assuming a $100,000 cost basis, that's $3600/yr.

700 * 12 = 8400
- 3600 = $4800 income to taxes

40% of that is 1920, which is covered by the 2400 profit.

[AlexK]

While I agree the numbers you presented for rent and expenses are not great, the situation is not as bad as you propose. Rent will increase every year but the mortgage payment will not. The property value will trend upward. After 15 or 30 years of small returns you are left with a paid-for property.

It is laughable though when I see a MLS listing where the listing agent says "cash flow positive!" when the rent only slightly exceeds the mortgage payment. To get me interested the rent would need to be 2X the mortgage payment! There are no properties in my area that are attractive rentals at this time so not only will I not be buying, but I will start selling rentals soon with proceeds buying stocks.

[The_Dude]

Your example has to include depreciation.  You can't talk income taxes in a "simple" example and ignore one of the biggest impacts to taxes which is depreciation.

In the US, you are both required and assumed to have taken depreciation expense on your rental property.  You don't get to choose taking depreciation expense.  Only depreciation on the building is applicable, not the land.

Also, all of the depreciation you take on a rental property reduces your tax basis in that property when you go to sell and increases your capital gains at the time of sale.  For folks that make too much money to deduct passive losses on rental property this is when you would be able to recapture the disallowed losses too.

[psyclotr0n]

For folks that make too much money to deduct passive losses on rental property this is when you would be able to recapture the disallowed losses too.

Would you mind explaining what passive losses are and how you can recapture? Still a noob on this. What are the income limits for deducting passive losses?

[K-ice]

Your example has to include depreciation.  You can't talk income taxes in a "simple" example and ignore one of the biggest impacts to taxes which is depreciation.

Ok. True. That is how you can break even. In Canada you can claim upto 4% per year. But you don't need to use it all up.

With $100K building value that would be $4000 in the first year.

So $8400 - 4000 = 4400 taxable income.

40% of that is $1760 which is covered by the $2400 profit.

[powskier]

If people are not making money it is because they purchased at a price that was too high or in a location where rents were not high enough.

[Drifterrider]

At one place you say expenses are $1,600 and another $600.  Can't be both.

...

Your mortgage interest is deducted as an expense as is your principle, property taxes and insurance.

To clarify the total out of pocket is $1600. This includes the mortgage $1000 ($500 interest + $500 principal) and other expenses $600.

Maybe it is different in Canada, but we can't deduct the mortgage principal as a tax reducing expense.  So be prepared to pay tax on it.

I'm not sure how it works in the US, but that would be awesome, if I threw extra payments at my principal and actually got a tax break!

spell check works but word check doesn't:)

You take depreciation as a way of offsetting your capital cost.

[Bearded Man]

Your example has to include depreciation.  You can't talk income taxes in a "simple" example and ignore one of the biggest impacts to taxes which is depreciation.

In the US, you are both required and assumed to have taken depreciation expense on your rental property.  You don't get to choose taking depreciation expense.  Only depreciation on the building is applicable, not the land.

Also, all of the depreciation you take on a rental property reduces your tax basis in that property when you go to sell and increases your capital gains at the time of sale.  For folks that make too much money to deduct passive losses on rental property this is when you would be able to recapture the disallowed losses too.

Wait, are you saying that if you make too much money (150K+) to deduct losses, you get to deduct them on your taxes when you sell? Sounds like a great strategy to eliminate your tax penalty for selling, no?

[The_Dude]

For folks that make too much money to deduct passive losses on rental property this is when you would be able to recapture the disallowed losses too.

Would you mind explaining what passive losses are and how you can recapture? Still a noob on this. What are the income limits for deducting passive losses?

Wait, are you saying that if you make too much money (150K+) to deduct losses, you get to deduct them on your taxes when you sell? Sounds like a great strategy to eliminate your tax penalty for selling, no?

Sorry for the late replies but here is a simple intro article I found when I just googled this topic that may help you.

https://www.biggerpockets.com/renewsblog/2014/07/31/four-depreciation-tax-mistakes-investors-need-avoid/

psycolotron, as Bearded man indicated in his reply the passive loss limit was $150k when my wife and I crossed it.  Not sure if it has changed in the last few years.  So if your over the $150K limit you can't deduct any passive net loss your real estate investment has against your ordinary income.  It is then rolled forward each year.  You can apply this unused loss against either future years in which your passive investments earn a profit.  This can happen either from the sale of the property but also from years in which the property income generates a profit. 

Bearded Man, as far as a strategy it isn't one I would recommend.  The disallowed passive loss is not adjusted for inflation.  Generally speaking a deduction today is worth more than one in the future.  Yes tax rates play a role and you can find exceptions to that rule.  I know for me a $1,000 deduction against ordinary income is much better for me than $1,000 deduction 10 or 20 years from now.

[MaikoTsumi]

Your example has to include depreciation.  You can't talk income taxes in a "simple" example and ignore one of the biggest impacts to taxes which is depreciation.

In the US, you are both required and assumed to have taken depreciation expense on your rental property.  You don't get to choose taking depreciation expense.  Only depreciation on the building is applicable, not the land.

Also, all of the depreciation you take on a rental property reduces your tax basis in that property when you go to sell and increases your capital gains at the time of sale.  For folks that make too much money to deduct passive losses on rental property this is when you would be able to recapture the disallowed losses too.

Wait, are you saying that if you make too much money (150K+) to deduct losses, you get to deduct them on your taxes when you sell? Sounds like a great strategy to eliminate your tax penalty for selling, no?

What is really happening is, you get taxed based on the deductions you should have made, whether you actually make them or not.  If you don't keep track of your passive losses, first, you missed out on the current year deduction due to income, second, you're taxed anyway as if you did make those deductions.