About to invest in first property - Rental deduction question

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About to invest in first property - Rental deduction question

Account Closed
San Jose, CA · Member since 2019 · 64 posts · 26 votes

Hi All,

I'm narrowing my focus and strongly considering buying a condo in Maui as in investment. This will be my first investment property. Two part question.

I have two options for the mortgage - classify it as a 2nd home, or classify as an investment. The mortgage brokers said that the new mortgage rules allow me to classify it as a 2nd home and take advantage of lower interest rates, as long as I stay in the property 14 days a year. I can still rent it out.

In my analysis, I am assuming I can write off:

  • Building Depreciation (32% of purchase price over 27.5 years)
  • HOA
  • Utilities (cable/internet/water/electricity)
  • Property Manager
  • Mortgage Interest
  • Property taxes

If I take the lower interest rate associated with the 2nd mortgage loan, will I then lose all of the deductions associated with an investment property?

Also, just want to make sure I am understanding the impact of the deductions, using some assumptions:

  • Annual Gross Revenue: $50k
  • Annual Deductions from above: $48k
  • Annual Gross Profit, taxed at my marginal tax rate (~44.3%): $2k

So even if the property only cash flows $2k/year, I will still get additional cash flow from the $48k in deductions (I can change my withholdings or get a refund)

Annual savings from deductions - ($48k * marginal tax): $20,400

My total profit from this property for the year should be ~$22k, correct? I'm a bit confused because in a brief email exchange with my accountant, he said that I will not be eligible because it will be considered passive income and since I make over $150k, I can't deduct losses. I think he misunderstood my email so want to check here (maybe I need a new accountant?).

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  • Patrick Franta
    Realtor · Wailea, HI · Member since 2014 · 95 posts · 45 votes
    7y

    Aloha Jeremy,

    Congratulations on narrowing your search to one of the greatest places on earth!  These questions are definitely geared more towards an accountant but I will give you my insight.  Your assessment is pretty accurate in that all of your operating costs & interest on your debt servicing will be deductible from your gross revenue.  This is whether you buy it as a second home or investment property.  If you buy as second home you cannot use any of the rental revenue to qualify and you must stay in the property for at least 14 nights a year.  Also, when you plan to sell it you will not be able to 1031 the property unless it hold it as an investment property for 2 years.

    I'm not sure you should consider what you are saving in taxes on your deductions as income though? To me when you are analyzing any income property you should focus on what the NOI/Purchase Price is or your CAP rate. If you want to go deeper you can factor in the annual appreciation rate to determine your IRR. To me with the example you provided your net income would be $2K. Honestly, with most VR condos here on Maui if you are financing with 25 -30% down and can break even it is a good deal.

    A few thing to keep in mind:

    I highly recommend using a local lender on Maui when purchasing a VR here.  They know the product and the underwriters see these condos day in day out.  I have seen too many national lender end up not being able to close on these condos because the owner occupancy rates are too low, or that they operate as a condo-tel.  If you need any recommendations on lenders here I have a few great ones.  

    Second home and Investor loans have different down payment requirements, typically 25-30%.  Also some complexes here will require 30% minimum no matter how you purchase.

    There are a lot of different routes you can go with management.  My wife manages over 100 units here so I know how that breaks down very well.  For most investors a la cart style management seems to be the best option, this is where you manage the bookings and the management company handles all the turnover and maintenance for 10-15%. 

    I hope this helps.  If you have any additional questions I would be more than happy to help.  I have a pro forma p&l template I can run on any VR condos here for you.  Just let me know.  Mahalo.                   

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  • Account Closed
    OP
    San Jose, CA · Member since 2019 · 64 posts · 26 votes
    7y

    Thanks for the reply Patrick. Regarding taxes, how come you wouldn’t factor that into your analysis? Won’t you receive that money back at the end of the year through a tax refund, or couldn’t you change your tax withholding and get some of that money back throughout the year?

    I’ll shoot you a PM on the lender and pro forma. 

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  • Patrick Franta
    Realtor · Wailea, HI · Member since 2014 · 95 posts · 45 votes
    7y

    If I am understanding you correct you would not receive any of that back as a refund because it was never paid.  Your operating costs are paid throughout the year and when you file your taxes at the end of the year they are deductible against the income you generated.  I guess if you were paying estimated taxes throughout the year you would receive a refund of that amount at the end, but I don't think that'd be the case because you would pay your estimated based on what you predict your net income to be.  

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