Tax Cart Before The Horse?
Maybe I have put my tax cart before the horse. For the last couple years I have had to write a tax check to Uncle Sam. In an effort to avoid that, I bought a single family home that I will be renting. I have a few realtor friends who have told me that this is a great tax move. The PITI payments on the house are about $800. I will start out charging $600 rent (that is about what the market here will bear). I know I can deduct expenses on the house, but can I also deduct the $200 loss each month? This is a long term purchase. When I retire, I may sell it or my current house to generate retirement funds. I am hoping that with expenses, depreciation, appreciation and income loss I can quit paying Uncle Sam and instead move the money to equity.
AM I am idiot?
Hello Pasvorto,
This is my take: "Give to Caesar that which is Caesar's". One does not have to be a fool in going about giving their share. As to purchasing a rental property and having a $200 negative cash flow, I would not do that. It is always better to have a positive cash flow. I would think there are many places to park your extra cash and not be in as high a tax bracket. Person on this board are here to creatively purchase deal using as little of their own money as possible. Most are here to create wealth from their ability to find and close the deals.
But who am I to question your plan, good luck.
You can only dedect the Interest, Taxes, and Insurance portions of the PITI payment. You can never deduct amortization of the principal because it is not an expense. It is just a transfer of one asset, cash, to pay off a liability, the mortgage, which increases your equity. However, you can also deduct depreciation (a non-cash expense) on top of the interest, tax, and ins. This is a benefit because although it reduces your basis used to figure capital gains when you sell, you pay a depreciation recapture tax which is a lower rate than the cap gain rate up the the amount of the original basis. It is also lower than the regular income tax rate paid on rental profits. So you have the dual benefits of defering taxes and paying them later at a lower rate. You can also deduct maintenance and certain other expenses relating to renting the property - advertising, possibly milage...
What term of loan do you have? Is it 30 years? If you have a negative $200 cash flow before maintenance and vacancies are considered, you will probably never make any money unless you expect both the rents and the value of the property to appreciate substantially. It is not very difficult in my area to find a property that will be immediately cash flow positive if you use a 30 year loan. If you are using a very short term loan such as 10 years, then you are paying off your principal very rapidly and you are not paying nearly as much of that $800 in interest as I had assumed. If this is the case, then disregard what I just said.
As a general rule you will need your cash expenses (interest, taxes, insurance, maintenance, ads, mgmt fees --- basically everything but depreciation and pricipal) to be lower than your rents or you will lose money. What you probably want to do is to break even or make a net profit before figuring depreciation, but report a loss after depreciation so you can deduct that loss against your other income to reduce your taxes.
To quote yourself "Am I an idiot"? Ummm, on the surface my answer would be yes. Even you should be able to see the flaw in your logic. Just take it to the next level, if you keep buying property like that you can eventually get yourself to paying no taxes because you won't be making ANY income at all, of course you won't be able to pay your electric bill either so you won' t be able to see this answer to your post.
Paying taxes means you are making money. You are not a victim of paying too much in taxes, but simply poor tax planning.
I love paying taxes it means I am making money. The secret to maximizing deductions to reduce your taxes is moving the money going out of your pocket into devices that are tax deductable, but only moving that money into a tax deductable device if you have no choice but to move the money in the first place.
What I'm trying to say is that if you have to make monthly payments on something anyways, it is better to make montly payments that are tax deductable.
Example: You buy a car with a loan through GMAC. $300 a month. no decuctions.
Better: You buy a car with a HELOC $300 a month payment that is tax deductable.
Stupid: You buy a car $300 a month just to take $300 a month out of your income.
Don't buy into a bad investment to lose money just to pay less taxes.
Just get your tax planning done better.
If you have $5000 a month after taxes each month and you end up paying $10,000 in additional taxes at the end of the year, and this bothers you, then you probably really should adjust something so that you are only recieving $4200 a month and that $800 a month is going to the IRS each month.
I guess whre I got this idea (aside form the realtor friends) was from an accountant. I had him look at my return last year and said there was nothing he could do to reduce my tax burden. "However", he said,"if you owned a business or some rental property then we have more options." I can't see myself owning a business, so I opted for plan B. I am hoping to increase the rent annually until it covers the mortgage payment withing a few years.
The reason your accountant suggested real estate is mostly because of the depreciation deduction. Try to structure a deal where you have break even or positive cash flow, and then the depreciation will create a paper loss on you tax return to help reduce you tax burden.
Other methods of reducing your taxes:
I assume you own your home, but if you rent, buy a house. Mortgage interest is tax deductable, rent payments are not.
Tax credits are great. If you don't have a degree, go to college. Or send your spouse or kids to college. With the Hope tax credit you get a dollar for dollar reduction in taxes on the first $1000 and 50 cents on the dollar reduction for the next $1000 paid in tuition - this works for the first 2 years of college. There are other tax credits for tuition as well.
If you are planning to have (more) kids someday that will reduce your taxes substantially.
If you make under $25K? single/$50K married in AGI, you can get a savers credit for dollars put in a 401K or IRA. This is the govt giving you money back just for saving your own money.
If you are investing/saving outside of a retirement account and paying taxes on stock gains or interest income - put that money in a ROTH IRA, up to $3K per year. You can always get the original contribution back out without a penalty. Gains can't be withdrawn without a penalty until 59.5 but are then totally tax free.
The reason your accountant suggested real estate is mostly because of the depreciation deduction. Try to structure a deal where you have break even or positive cash flow, and then the depreciation will create a paper loss on you tax return to help reduce you tax burden.
== fair enough
I assume you own your home, but if you rent, buy a house. Mortgage interest is tax deductable, rent payments are not.
== I do own my own home
Tax credits are great. If you don't have a degree, go to college. Or send your spouse or kids to college. With the Hope tax credit you get a dollar for dollar reduction in taxes on the first $1000 and 50 cents on the dollar reduction for the next $1000 paid in tuition - this works for the first 2 years of college. There are other tax credits for tuition as well.
If you are planning to have (more) kids someday that will reduce your taxes substantially.
== Got a degree. Kids grown and gone.
If you make under $25K? single/$50K married in AGI, you can get a savers credit for dollars put in a 401K or IRA. This is the govt giving you money back just for saving your own money.
== make over $50k
== 401K maxed out
If you are investing/saving outside of a retirement account and paying taxes on stock gains or interest income - put that money in a ROTH IRA, up to $3K per year. You can always get the original contribution back out without a penalty. Gains can't be withdrawn without a penalty until 59.5 but are then totally tax free.
== self-directed IRA
== Consumer debt under a home equity loan to reduce tax burden.
As you can see, my tax option are few.
Quote:However, you can also deduct depreciation (a non-cash expense) on top of the interest, tax, and ins. This is a benefit because although it reduces your basis used to figure capital gains when you sell, you pay a depreciation recapture tax which is a lower rate than the cap gain rate up the the amount of the original basis. It is also lower than the regular income tax rate paid on rental profits. bbriscoe,
Some of your information is a bit out of date -- at least since the tax code changes in 1997.
Depreciation recapture tax rate is 25%, even if your marginal tax bracket is lower. The maximum long term capital gains tax rate today is only 15%.
The regular income tax rate paid on your rental income is your marginal tax rate. Depending upon your taxable income, you may find yourself in a 10%, 15%, 25%, 28%, or 33% tax bracket.
In the future, take advise only from those qualified in that particular discipline...seek out investors in your locale to mentor you...likely there's a wealthy old sage nearby who can show you the ropes, verify your analysis...after a number of years I still benefit from the perspective of "old pros" around my area...they usually say things like, "buy that one and don't look back" or "how will you ever make money with that?" No negative cash flow deals, and payoff that consumer debt, even if it's secured by a home-equity loan...effectively, you still have dysfunctional debt that you've converted from unsecured to secured debt...discipline with leverage is just as critical as discipline with your cash...experience and history of making good deals will reduce your tax liability and increase your cash flow as well as your balance sheet...good luck.