Author Topic: Income Taxes and Real Estate Investment  (Read 1987 times)

Jakerado

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Income Taxes and Real Estate Investment
« on: February 29, 2016, 10:58:38 AM »
Apologies for starting a 2nd topic while my other one is still on the front page here, but...

How do you count income tax on rental properties when comparing them vs a stock-appreciation(ie: index fund) based portfolio? Let's say you have an income tax rate of ~30%, and, since you're getting paid instead of deferring realized gains until the tax rate drops, you end up having to actually pay the 30% after expenses are taken out.

Do you discount the returns of a rental property by 30%? Stick it into an LLC to hold on to the money until your personal tax rate falls(so, discount by less than 30%)? Something else? Let's assume the money is not needed until FIRE, so the tax rate after FIRE is reduced to roughly the same, but until FIRE you're only making 70% of what you should be...which means an index fund would grow faster?

iamlindoro

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Re: Income Taxes and Real Estate Investment
« Reply #1 on: February 29, 2016, 11:35:23 AM »
I compare average long term market returns to Cash on Cash return.  No discounting or biasing one way or another.

Assuming you did a good analysis on the property, the preferential tax treatment of real estate, depreciation in particular, makes it an awesome investment vehicle.  Since my goal is early retirement ASAP, I care about the cash flow I'll have at that time-- I wouldn't ding it just because I might be on the hook for some more tax between now and day one of FIRE.  Besides, taxes just mean I made money.  I don't plan to pay them at all in FIRE.

not_a_trex

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Re: Income Taxes and Real Estate Investment
« Reply #2 on: February 29, 2016, 11:47:31 AM »
The profits are considered income. You fill out a Schedule E form to calculate this. It is calculated for that tax year, and I don't think you can hide it by just sticking it in an LLC.

I wouldn't compare just the tax rates of stock earnings (I'm assuming long term capital gains, here) vs the income taxed earnings from real estate, since it's so much more complicated than that. What is the return on investment for each opportunity? After leveraging with a mortgage and then getting a tax deduction for paying off said mortgage, after deducting property taxes and insurance and repairs and all the other things, is your "profit" withdrawal less than the depreciation deduction? There's a good chance that while, at least on paper, you did not make a "profit", you were still able to put money in your bank account at the end of the month.

Jakerado

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Re: Income Taxes and Real Estate Investment
« Reply #3 on: February 29, 2016, 12:36:30 PM »
The profits are considered income. You fill out a Schedule E form to calculate this. It is calculated for that tax year, and I don't think you can hide it by just sticking it in an LLC.

I wouldn't compare just the tax rates of stock earnings (I'm assuming long term capital gains, here) vs the income taxed earnings from real estate, since it's so much more complicated than that. What is the return on investment for each opportunity? After leveraging with a mortgage and then getting a tax deduction for paying off said mortgage, after deducting property taxes and insurance and repairs and all the other things, is your "profit" withdrawal less than the depreciation deduction? There's a good chance that while, at least on paper, you did not make a "profit", you were still able to put money in your bank account at the end of the month.

I was considering leaving the money in the LLC/c-Corp until your personal tax rates were more favorable...effectively deferring the personal income tax. I'm not a tax accountant so I don't know how realistic that is, and it was just a thought, I'm sure there are far more variables to consider before going down that road. Good point on depreciation.


Here's an example of what I was thinking, with made up numbers to make it easier:
Down payment: 10,000
Yearly profit: $1140 (95/mo profit after expenses)*0.7=+$798 after tax

Investing: 10,000 at 8% return: 10,800

So, after one year with avg stock market gains your portfolio is worth 10,800. With the house it would be worth $11,40 before tax or $10,798 after, $2 less than the index fund. Of course the numbers are made up, but unless I'm missing something it seems like your personal income tax rate should be a factor when comparing the return from real estate to other options.


jwright

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Re: Income Taxes and Real Estate Investment
« Reply #4 on: February 29, 2016, 12:46:45 PM »
You have to include the earnings from a rental (or business) into income regardless of whether you personally take possession of it.  If the cash remains in the LLC bank account, you still pay the tax. 


Jakerado

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Re: Income Taxes and Real Estate Investment
« Reply #5 on: February 29, 2016, 12:58:56 PM »
You have to include the earnings from a rental (or business) into income regardless of whether you personally take possession of it.  If the cash remains in the LLC bank account, you still pay the tax.

Oops, right, and after a cursory search the only way to actually hide the income is to make a c-corp and eat a 15% income tax +15% holding tax for up to 50k income...only worth it at significantly higher personal tax rates, at which point you'd probably have a tax accountant figuring out the best structure for you.