Author Topic: real estate investing for High income earner?  (Read 7275 times)

PencilThinMustache

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real estate investing for High income earner?
« on: February 16, 2015, 07:24:57 AM »
I have been interested in investing in real estate, and have read a few books from this site's recommended list.  But before I plunge any further into really considering the move to real estate, a very important question:

As a high income earner, I am concerned that any income from the rental property (or profit from a flip) would be taxed at my marginal rate of 33% as "ordinary income."  This seems like a foolish way to "diversify" my investments when considering the long term capital gains rates of 15% from a stock portfolio. 



frugledoc

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Re: real estate investing for High income earner?
« Reply #1 on: February 17, 2015, 02:33:35 PM »
If you have a low income spouse buy real estate in their name.

Agree it's not a great investment for higher income tax payers.

jmusic

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Re: real estate investing for High income earner?
« Reply #2 on: February 17, 2015, 04:07:09 PM »
I'm certainly no expert, but doesn't depreciation typically offset rental income, resulting in a taxable "loss?"

sol

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Re: real estate investing for High income earner?
« Reply #3 on: February 17, 2015, 05:12:53 PM »
I'm certainly no expert, but doesn't depreciation typically offset rental income, resulting in a taxable "loss?"

Yes, this is the usual method of avoiding getting hosed on real estate.  Gross rents count as taxable income, but interest and maintenance and insurance are deductible and then you depreciate the building (but not he land value) and in most cases you come out about even.

A property with high cash flow is likely to be tax negative. Most common rentals around here turn a small profit after depreciation.
« Last Edit: February 17, 2015, 07:54:31 PM by sol »

clarkfan1979

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Re: real estate investing for High income earner?
« Reply #4 on: February 17, 2015, 06:41:55 PM »
Because of depreciation, you will most likely break even on your taxes. On a less technical side, don't be flashy around your tenants. If you show up in fancy car with fancy clothes, they might feel less obligated to pay the rent. I have never had a tenant like this, but I have met a few people over the years that think this way.

MrMoneyPinch

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Re: real estate investing for High income earner?
« Reply #5 on: February 18, 2015, 04:19:30 PM »
I'm certainly no expert, but doesn't depreciation typically offset rental income, resulting in a taxable "loss?"
It depends.  Depreciation is just a way to kick the can down the road to the time where you sell the property.

All depreciation taken during the whole time you possessed the property is ADDED to the sales proceeds for tax purposes.  So you get a tax bill on a big capital gain, and a tax bill on the depreciation (which is taxed at your marginal rate). 

Of course, you can plan on keeping the property forever, fully depreciating it, and then pass the tax bomb on to your estate. 

sol

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Re: real estate investing for High income earner?
« Reply #6 on: February 18, 2015, 05:01:35 PM »
Someone please correct me if I'm wrong, but I think the capital gains taxes can be avoided by selling while you're in the 15 percent bracket. And I think the depreciation recapture is taxed at 25 percent regardless of your tax bracket.

adamcollin

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Re: real estate investing for High income earner?
« Reply #7 on: February 18, 2015, 10:10:40 PM »
This is not as easy as it seems. There are many more considerations. I would suggest you to consult a CPA for more information.

mattgwt

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Re: real estate investing for High income earner?
« Reply #8 on: February 20, 2015, 12:32:17 PM »
I have been interested in investing in real estate, and have read a few books from this site's recommended list.  But before I plunge any further into really considering the move to real estate, a very important question:

As a high income earner, I am concerned that any income from the rental property (or profit from a flip) would be taxed at my marginal rate of 33% as "ordinary income."  This seems like a foolish way to "diversify" my investments when considering the long term capital gains rates of 15% from a stock portfolio.

Depreciation reduces your tax bill in the early years, but eventually fades away and then is recaptured to an extent when you dispose of the property. Buildings (but not land) are typically depreciated over 27.5 years, and the building is typically 25-50% the cost of the land, so depreciation lets you deduct 1.5-2% of the value per year. At net rent (after expenses) of 4-6% you will still owe some tax, but around a third will be effectively deferred.

Overall though you're right, on a strict long-term annualized return basis, the historical passive 4-7% real returns from stocks with gains taxed at 15%, and with much of the gain compounding tax-free until sold, are better than earning 2.5-3% after annual taxes (if you're in a high tax bracket), fees/expenses, and hassle. The main advantages to owning real estate are:

1) Similar to bonds, rental RE produces a fairly consistent reliable monthly income, independent to a degree of fluctuations in the underlying asset value (as long as you keep it rented). Even if stocks produce the assumed returns over the long run, they can go in the tank for years and years. Thus rental RE income is a useful way to cover routine expenses for people who do not have much other consistent income, e.g. retirees who have a weighty stock portfolio but don't work much, no pension, etc., not so useful for a high-income earner many years from retirement.

2) Real estate has some special features distinct from stocks, namely that you can use or live in it, and CG tax can be effectively deferred forever through section 1031 exchanges. So, you can invest in some property now and capture the appreciation and rental income (even if minor), then if in a few years you decide you want a vacation home, the rental can be exchanged tax-free for the vacation home. CG tax is only owed once you finally dispose of the property. Owning useful real property insulates you to a degree from extreme tail risk, e.g. if a meteor strikes and collapses global trade and the banking system, people will still need somewhere to live, etc.

3) Key assumptions regarding long-term stock returns are based on historical figures, and may not hold true going forward. The Japanese stock index is today worth less than half of what it was worth in 1990; 25-year returns were not just lower than expected, they've been deeply negative. Many European stock indices have gone nowhere in 15 years, with several 50% plunges thrown in for good measure. There are any number of plausible reasons why stock returns going forward might be at the lower end of historical experience, or even weaker. If so, a 3% net inflation-adjusted return from rental property would be independently attractive in its own right, even disregarding the other benefits.

4) Lastly, owning local rental properties is nice in that it plugs you into the local economy. You can form relationships with tenants, lawyers, accountants, property managers, contractors, real-estate agents, and so on. You never know when you might meet somebody who provides enduring long-term value as a business contact, or even as a friend.