I guess my follow up question here, is am I making a mistake by converting this condo with 40k in equity into a rental property, thus opening myself up to taxation on that 40k when the property is eventually sold (not planing on selling it anytime soon)
If you place into rental use, assuming no more appreciation (conservative), your tax liability when you sell (ignoring depreciation recapture) would be $6,000.
Lets assume you rent for five years. Would your after tax cash flow for those five years be greater than the $6,000 you would have to pay in capital gains?
The biggest thing to consider is time value of money. How much more is $40,000 now vs the after tax cash flow for five years, plus $34,000 after tax when you sell?
Can you use that $40,000 as a down payment on two properties, and grow your earnings faster?
Well, I will answer your last question first. I originally did plan on taking out a HE loan to use as a down payment. The problem I ran into was that the new HE loan messed with my D/E ratio messing up my mortgage pre-qual, so I have put it off until i find a home I wish to purchase. This is still an option.
Let me ask a question regarding this though. If I transfer this condo to a single member LLC, then try to take out a home equity loan on the property, am I at an increased risk of triggering the DOS clause?
Secondly, I anticipate being able to charge approximatly $1,000/mo for rent on my condo. Over a 5 year span, that is $60,000.
The mortgage payments on the property (including taxes & fees which are in escrow and Association fees) is about 700/mo. or about $42,000 over 5 years.
That leaves me with 18,000 net income, minus expendatures. I have no idea what an appropriate thumbrule is for this, but lets assume I spend $10,000 over 5 years on Maintenance/Repairs/Vacancy/Advertizing, etc...
That leaves me with $8,000 income over 5 years, pre-taxed or approx 6000 after tax.
Where am I going with this? I'm not really sure. My math is probably drastically wrong. (This is my first experience with rental property). Can you point me in a direction (Book, webpage, etc.), where I might be able to better understand the math/tax aspects of owning rental property.
Quote:
On 2004-12-28 15:56, pagnotar wrote:
Well, I will answer your last question first. I originally did plan on taking out a HE loan to use as a down payment. The problem I ran into was that the new HE loan messed with my D/E ratio messing up my mortgage pre-qual, so I have put it off until i find a home I wish to purchase. This is still an option.
Let me ask a question regarding this though. If I transfer this condo to a single member LLC, then try to take out a home equity loan on the property, am I at an increased risk of triggering the DOS clause?
Secondly, I anticipate being able to charge approximatly $1,000/mo for rent on my condo. Over a 5 year span, that is $60,000.
The mortgage payments on the property (including taxes & fees which are in escrow and Association fees) is about 700/mo. or about $42,000 over 5 years.
That leaves me with 18,000 net income, minus expendatures. I have no idea what an appropriate thumbrule is for this, but lets assume I spend $10,000 over 5 years on Maintenance/Repairs/Vacancy/Advertizing, etc...
That leaves me with $8,000 income over 5 years, pre-taxed or approx 6000 after tax.
Where am I going with this? I'm not really sure. My math is probably drastically wrong. (This is my first experience with rental property). Can you point me in a direction (Book, webpage, etc.), where I might be able to better understand the math/tax aspects of owning rental property.
Thanks for your help so far! It is appreciated
I would take out the heloc, and then transfer to an LLC. It is easier to obtain financing in your personal name than it is in the name of an LLC. There are many threads here regarding the DOS clause. I'm of the opinion (and in my experience) that they're not going to pull the DOS clause if you maintain a current status.
Keep in mind that your mortgage payments are not entirely deductible. Only the interest portion (and insurance and taxes if you're escrowing) are deductible. The principal portion is not. So that would reduce your expenses you're estimating. I always estimate for people (roughly) 30% for federal taxes. I'm not sure what the state taxes are where you live.
Off the top of my head, read the Rich Dad Poor Dad Series. They don't delve in to deep, but will touch base on the basics.
Keep reading all the posts here, and the books I mentioned. Others may have suggestions on books that help them.
You want to turn your primary residence into a rental property. You also say that you have owned and occupied the property for three years. If you are only worried about income taxes, you can have your cake and eat it too.
Use the condo as a rental for two years, then sell. Report the rental income/expenses on Schedule E and take your depreciation expense on a $70K basis. During your two years of rental use, I bet you show a net loss on paper that will reduce the tax liability on your other ordinary income.
The depreciation expense has been called a phantom expense because it only appears on paper but does not take any money out of your pocket. When the depreciation expense is included in the taxable rental income calculations, it is possible to have a tax loss yet still have positive cash flow.
When you sell the property after two years of rental use, your sale profits are tax free (actually tax free if you sell anytime before the third anniversay of converting to a rental). During the two year period of rental use, maybe the property will appreciate another $10K.
Now, if you collect a positive cash flow during your period of rental use, get the tax benefit of a tax loss from rental operations, get two more years of appreciation increasing the value of your property, AND get to keep all your sale profit tax free, would you go for it?
Buy a new primary residence and convert your former primary residence into a rental for two years. Sell the rental after two years, and convert your primary residence into a rental. Use the tax free sale proceeds to purchase a new primary residence.
Do it again, every two years. [ Edited by NewKidinTown2 on Date 12/28/2004 ]
I am a living testiment of a loss on paper and $185/mo in my pocket. And before I moved, I took out most of the equity for a downpayment on another primary. It is great. I unfortunetly waited more that two years to sell so I have to do the 1031 thing. But, in the last year, the value went up another $60K and now I can buy two rentals and now I will have my primary and two rentals. It works.
Quote: I unfortunetly waited more that two years to sell so I have to do the 1031 thing. dontaskwhy,
Remember that the two year rules say that you must have owned and occupied your primary residence for two of the last FIVE years prior to the sale to qualify for a capital gains exclusion on the sale profits.
There is no restriction on what you do with your property during the (up to) three years it may take you to sell it -- you can even use your property as a rental. As long as you sell within three years of vacating the property, you can still satisfy the two of last five year tests to exclude capital gains.
Use the property as a rental for three years or more, and you no longer have a primary residence. You have an investment property.
Quote:
On 2004-12-28 17:02, NewKidinTown2 wrote:
pagnotar,
You want to turn your primary residence into a rental property. You also say that you have owned and occupied the property for three years. If you are only worried about income taxes, you can have your cake and eat it too.
Use the condo as a rental for two years, then sell. Report the rental income/expenses on Schedule E and take your depreciation expense on a $70K basis. During your two years of rental use, I bet you show a net loss on paper that will reduce the tax liability on your other ordinary income.
The depreciation expense has been called a phantom expense because it only appears on paper but does not take any money out of your pocket. When the depreciation expense is included in the taxable rental income calculations, it is possible to have a tax loss yet still have positive cash flow.
When you sell the property after two years of rental use, your sale profits are tax free (actually tax free if you sell anytime before the third anniversay of converting to a rental). During the two year period of rental use, maybe the property will appreciate another $10K.
Now, if you collect a positive cash flow during your period of rental use, get the tax benefit of a tax loss from rental operations, get two more years of appreciation increasing the value of your property, AND get to keep all your sale profit tax free, would you go for it?
Buy a new primary residence and convert your former primary residence into a rental for two years. Sell the rental after two years, and convert your primary residence into a rental. Use the tax free sale proceeds to purchase a new primary residence.
Do it again, every two years.
<font size=-1>[ Edited by NewKidinTown2 on Date 12/28/2004 ]</font>
This is one of the greatest changes in the tax law and I have been executing this plan so far and appreciate your post. I'll add a twist that is my current decision point...in California appreciation is so significant that it is tempting to continue owning the property and not sell it. Yeah I know the exclusion is up to $500k if married, but long-term CG is 15% of the $500k (=$75k). In other words, if the property continues to appreciate significantly more than $75k I could save in taxes then it might pay to keep it... continue drawing equity out of it and acquiring more property that way. What are your thoughts?
Another suggested addition to the plan you outlined is to find a tenant who is interested in eventually buying. They tend to care for the property better. Then after 1, 2, or <3 years sell to them without broker's fees. This is not to be confused with the oft abused lease options. Personally I like to keep MY options open...
You use the cost of the condo less any amount attriubuted to the cost of the land.
Okay, so you are saying to use the 70k (minus land) as my depreciation basis. Does this change if this property is transfered to a single member LLC?
The basis for the LLC would be the basis that was in the hands of the member.
Okay, i think i got it. Thanks.
I guess my follow up question here, is am I making a mistake by converting this condo with 40k in equity into a rental property, thus opening myself up to taxation on that 40k when the property is eventually sold (not planing on selling it anytime soon)
Your current gain (untaxable) would be $40,000.
If you place into rental use, assuming no more appreciation (conservative), your tax liability when you sell (ignoring depreciation recapture) would be $6,000.
Lets assume you rent for five years. Would your after tax cash flow for those five years be greater than the $6,000 you would have to pay in capital gains?
The biggest thing to consider is time value of money. How much more is $40,000 now vs the after tax cash flow for five years, plus $34,000 after tax when you sell?
Can you use that $40,000 as a down payment on two properties, and grow your earnings faster?
Well, I will answer your last question first. I originally did plan on taking out a HE loan to use as a down payment. The problem I ran into was that the new HE loan messed with my D/E ratio messing up my mortgage pre-qual, so I have put it off until i find a home I wish to purchase. This is still an option.
Let me ask a question regarding this though. If I transfer this condo to a single member LLC, then try to take out a home equity loan on the property, am I at an increased risk of triggering the DOS clause?
Secondly, I anticipate being able to charge approximatly $1,000/mo for rent on my condo. Over a 5 year span, that is $60,000.
The mortgage payments on the property (including taxes & fees which are in escrow and Association fees) is about 700/mo. or about $42,000 over 5 years.
That leaves me with 18,000 net income, minus expendatures. I have no idea what an appropriate thumbrule is for this, but lets assume I spend $10,000 over 5 years on Maintenance/Repairs/Vacancy/Advertizing, etc...
That leaves me with $8,000 income over 5 years, pre-taxed or approx 6000 after tax.
Where am I going with this? I'm not really sure. My math is probably drastically wrong. (This is my first experience with rental property). Can you point me in a direction (Book, webpage, etc.), where I might be able to better understand the math/tax aspects of owning rental property.
Thanks for your help so far! It is appreciated
Quote:
On 2004-12-28 15:56, pagnotar wrote:
Well, I will answer your last question first. I originally did plan on taking out a HE loan to use as a down payment. The problem I ran into was that the new HE loan messed with my D/E ratio messing up my mortgage pre-qual, so I have put it off until i find a home I wish to purchase. This is still an option.
Let me ask a question regarding this though. If I transfer this condo to a single member LLC, then try to take out a home equity loan on the property, am I at an increased risk of triggering the DOS clause?
Secondly, I anticipate being able to charge approximatly $1,000/mo for rent on my condo. Over a 5 year span, that is $60,000.
The mortgage payments on the property (including taxes & fees which are in escrow and Association fees) is about 700/mo. or about $42,000 over 5 years.
That leaves me with 18,000 net income, minus expendatures. I have no idea what an appropriate thumbrule is for this, but lets assume I spend $10,000 over 5 years on Maintenance/Repairs/Vacancy/Advertizing, etc...
That leaves me with $8,000 income over 5 years, pre-taxed or approx 6000 after tax.
Where am I going with this? I'm not really sure. My math is probably drastically wrong. (This is my first experience with rental property). Can you point me in a direction (Book, webpage, etc.), where I might be able to better understand the math/tax aspects of owning rental property.
Thanks for your help so far! It is appreciated
I would take out the heloc, and then transfer to an LLC. It is easier to obtain financing in your personal name than it is in the name of an LLC. There are many threads here regarding the DOS clause. I'm of the opinion (and in my experience) that they're not going to pull the DOS clause if you maintain a current status.
Keep in mind that your mortgage payments are not entirely deductible. Only the interest portion (and insurance and taxes if you're escrowing) are deductible. The principal portion is not. So that would reduce your expenses you're estimating. I always estimate for people (roughly) 30% for federal taxes. I'm not sure what the state taxes are where you live.
Off the top of my head, read the Rich Dad Poor Dad Series. They don't delve in to deep, but will touch base on the basics.
Keep reading all the posts here, and the books I mentioned. Others may have suggestions on books that help them.
Good luck
pagnotar,
You want to turn your primary residence into a rental property. You also say that you have owned and occupied the property for three years. If you are only worried about income taxes, you can have your cake and eat it too.
Use the condo as a rental for two years, then sell. Report the rental income/expenses on Schedule E and take your depreciation expense on a $70K basis. During your two years of rental use, I bet you show a net loss on paper that will reduce the tax liability on your other ordinary income.
The depreciation expense has been called a phantom expense because it only appears on paper but does not take any money out of your pocket. When the depreciation expense is included in the taxable rental income calculations, it is possible to have a tax loss yet still have positive cash flow.
When you sell the property after two years of rental use, your sale profits are tax free (actually tax free if you sell anytime before the third anniversay of converting to a rental). During the two year period of rental use, maybe the property will appreciate another $10K.
Now, if you collect a positive cash flow during your period of rental use, get the tax benefit of a tax loss from rental operations, get two more years of appreciation increasing the value of your property, AND get to keep all your sale profit tax free, would you go for it?
Buy a new primary residence and convert your former primary residence into a rental for two years. Sell the rental after two years, and convert your primary residence into a rental. Use the tax free sale proceeds to purchase a new primary residence.
Do it again, every two years. [ Edited by NewKidinTown2 on Date 12/28/2004 ]
I am a living testiment of a loss on paper and $185/mo in my pocket. And before I moved, I took out most of the equity for a downpayment on another primary. It is great. I unfortunetly waited more that two years to sell so I have to do the 1031 thing. But, in the last year, the value went up another $60K and now I can buy two rentals and now I will have my primary and two rentals. It works.
This is all VERY good information! Thank all of you. I am sure I will have more questions as I go forward, and I wont hesitate to ask.
Thanks again
Quote: I unfortunetly waited more that two years to sell so I have to do the 1031 thing. dontaskwhy,
Remember that the two year rules say that you must have owned and occupied your primary residence for two of the last FIVE years prior to the sale to qualify for a capital gains exclusion on the sale profits.
There is no restriction on what you do with your property during the (up to) three years it may take you to sell it -- you can even use your property as a rental. As long as you sell within three years of vacating the property, you can still satisfy the two of last five year tests to exclude capital gains.
Use the property as a rental for three years or more, and you no longer have a primary residence. You have an investment property.
Quote:
On 2004-12-28 17:02, NewKidinTown2 wrote:
pagnotar,
You want to turn your primary residence into a rental property. You also say that you have owned and occupied the property for three years. If you are only worried about income taxes, you can have your cake and eat it too.
Use the condo as a rental for two years, then sell. Report the rental income/expenses on Schedule E and take your depreciation expense on a $70K basis. During your two years of rental use, I bet you show a net loss on paper that will reduce the tax liability on your other ordinary income.
The depreciation expense has been called a phantom expense because it only appears on paper but does not take any money out of your pocket. When the depreciation expense is included in the taxable rental income calculations, it is possible to have a tax loss yet still have positive cash flow.
When you sell the property after two years of rental use, your sale profits are tax free (actually tax free if you sell anytime before the third anniversay of converting to a rental). During the two year period of rental use, maybe the property will appreciate another $10K.
Now, if you collect a positive cash flow during your period of rental use, get the tax benefit of a tax loss from rental operations, get two more years of appreciation increasing the value of your property, AND get to keep all your sale profit tax free, would you go for it?
Buy a new primary residence and convert your former primary residence into a rental for two years. Sell the rental after two years, and convert your primary residence into a rental. Use the tax free sale proceeds to purchase a new primary residence.
Do it again, every two years.
<font size=-1>[ Edited by NewKidinTown2 on Date 12/28/2004 ]</font>
This is one of the greatest changes in the tax law and I have been executing this plan so far and appreciate your post. I'll add a twist that is my current decision point...in California appreciation is so significant that it is tempting to continue owning the property and not sell it. Yeah I know the exclusion is up to $500k if married, but long-term CG is 15% of the $500k (=$75k). In other words, if the property continues to appreciate significantly more than $75k I could save in taxes then it might pay to keep it... continue drawing equity out of it and acquiring more property that way. What are your thoughts?
Another suggested addition to the plan you outlined is to find a tenant who is interested in eventually buying. They tend to care for the property better. Then after 1, 2, or <3 years sell to them without broker's fees. This is not to be confused with the oft abused lease options. Personally I like to keep MY options open...