Is This A Good Idea?
We own two rental properties. Our goal has always been to pay off the mortgages as soon as possible and then use the rental income as income for my husband's early retirement. Seems simple enough...except we'll have to pay higher taxes on that income without the mortgage interest to claim as an expense.
So we've been reconsidering (I think this might be what everyone keeps calling "leveraging"
. Now we're thinking we should NEVER pay off our mortgages. Instead, we should do a continuous loop of cash-out refinances once we build equity. At first, we'd use the cash to buy new properties that are good bargains and can be re-financed (with cash out) in a short amount of time.
Eventually, we'll use the cash as our income and we'll golf the rest of our lives away (in between finding tenants and fixing toilets!).
This seems to make much more sense from a tax standpoint - why pay off a mortgage and lose such a big deduction?
ANY input would be greatly appreciated. I understand there's still risk and work involved, but this seems a bit too good to be true.
D.Fouch
I have done many calculations on this and with today's interest rates, leveraging is uniformly the better strategy ( i.e. it produces the best results all the way down to zero appreciation).
You should try a few experiments with an Excel spread sheet and convince yourself. If you are not that familiar with spread sheets, your interest in formulating strategy is a great opportunity to motivate your learning.
The other factor with leveraging is managing risk properly. You don't want to be in a position where a large balloon payment is due in two years and you are relying on appreciation to cover your balloon. Again, spread sheets are very helpful.
Regards,
Ed
It all has to do with your risk tolerance.
what if your market crashes and rents fall by 30%? Will you be able to make your payments???
Maximum Leverage, Variable interest rates, and refinancing make sense while times are good, but you could loose your entire investment portfolio if you're in this position when your local market takes a dip.
You want tax savings, cash flow, cash, as well as security, right???
Consider this. Let's say you have a 100K property (for easy math). About the time you get 60% equity, you're not going to be paying as much interest, and hence less of a deduction. Do a 1031 exchange and use that 60K for a 40% down payment on a property that is 150K. You're in a secure position, you get a bigger property with more cash flow and you continue to get high interest deductions and depreciation. Pull out some extra cash every time you sell if you want to. Facing retirement, I believe that is a much wiser approach.
1031 exchange? Please explain...
A 1031 exchange is a tax deferred exchange where a property can be sold and another acquired without paying immediate capital gains tax on the sale of the first.
There are rules and conditions for a qualifying 1031 exchange and there are many web sites that discuss them. Do a google search on "1031 exchange" and you will find plenty of reading material.
Quote:Our goal has always been to pay off the mortgages as soon as possible and then use the rental income as income for my husband's early retirement. Seems simple enough...except we'll have to pay higher taxes on that income without the mortgage interest to claim as an expense.Your approach seems to be to replace W-2 income with rental cash flow so your husband can retire. If your husband is retired, you are just replacing salary income with rental income, so your total tax bill should be no higher than it is now.
. Now we're thinking we should NEVER pay off our mortgages.Your stated goal is to have enough cash flow to meet your lifestyle requirements. How many free and clear properties are needed to do this? After you have your cash flow needs met, then you might consider acquiring additional leveraged properties.
Quote:So we've been reconsidering (I think this might be what everyone keeps calling "leveraging"
If you decide to keep everything leveraged, how many properties will you need in your portfolio to meet your lifesytle needs in retirement? You can estimate this by looking at your cash flow after debt service. Let's assume that your two properties, if free and clear, provide enough cash flow to meet your retirement income need. Divide your current cash flow into your current debt service. Round up to the next higher whole number. This is the number of leveraged properties you need to generate the same income as your two properties free and clear.
Quote:This seems to make much more sense from a tax standpoint - why pay off a mortgage and lose such a big deduction?A strategy based upon a tax deduction is somewhat shortsighted. Remember, you only get an expense for interest payments after you have paid the mortgage interest. If you look at your lifestyle income needs, paying taxes on the amount of cash flow that just meets your need is independent of whether you have a mortgage or not.
For example, let's say that your two free and clear properties generate $1000 monthly cash flow. Let's say that you need eight leveraged properties to generate the same $1000 monthly cash flow. The income tax paid on your $1000 monthly cash flow is the same in both instances.
Now that I have demonstrated that it does not matter whether you have a mortgage expense deduction or not, the only remaining tax advantage to owning eight leveraged properties as opposed to two free and clear properties is the potential depreciation expense deduction. Your depreciation expense for eight properties will be larger than the expense for two properties (assuming all properties are equal). This larger depreciation expense might give you a large enough net passive loss to reduce your tax liability enough to make it worthwhile. However, I suspect that your net rental cash flow can be largely offset by the standard deduction and your standard exemptions -- making a large net passive loss unusable.
In summary, tax considerations should not ever be the sole reason driving your investments. Tax considerations have a place in your investment approach. Tax considerations should come in third after Cash Flow and Future Appreciation are taken into account.[ Edited by DaveT on Date 02/10/2004 ]