Rental property income investing

12 Replies

Hi all!!

I think I know the answer is yes, but I want to get some input.

If I profit $10k (or any amount) from rentals and invest all that into the next rental purchase to add to my portfolio, do I pay taxes on that $10k?

Like I said above, I believe the answer is yes, because it is still income. Then I think, well I am investing it into the LLC to build the business, and I get a second guess in the back of my mind that it may be able to be written off as a business expense.

Any advice would help, thanks in advance.

Hey Travis, this is a really complex question of which their are many variables. 

I think the way you posed the question, definitely you'll have to pay taxes. 

But, I think once you factor in all of the things you can write off, including depreciation, you won't be near that $10,000. I think when we sit back and analyze properties, we say things in our heads like "this profits $300 per month after all expenses" but in reality, that isn't exactly true. I think it is definitely true if you forecast the performance of the property out 10-30 years. But, our pretty capex, repairs/maintenance, vacancy percentages don't actually correspond to real financials. The first few months of owning the property, its possible to have a repair or capex item that eats up your budgeted percentages for the next 2-3 years.

I'm not completely sure that it is possible to both grow your portfolio and show true profit at the same time, unless you're not taking advantage of the full tax benefits available to you. 

@Ryan Ingram , thank you for the input. I do believe that I will end up paying taxes on some of it, but as you mentioned I will just have to make sure my tax guy takes advantage of all my write offs. What I do is live off my W2 income and use the rental income to compound more rental income, so with my W2 income I am will likely have to pay taxes on the income I am reinvesting into the new house. 

@Travis Odette yes rental income is taxable income. As already said you can save some through depreciation. Also as "Passive" income you don't pay social security taxes on it.

When you really start to grow you can sell a property and exchange the profit into another property tax free. You can also borrow money as the equity builds up and use that money tax free for other investments.

Be careful about the concept of the tax feee exchange. It works a bit like a 401k contribution works... you get an up front tax benefit when exchanging if there being no tax when you go into the 1031 exchange...but when you sell the property you exchanged into, tax is due on both the profits of the first deal, and the profits of the second, etc. So you are in essence kicking your ‘tax can' down the road to when you sell. Hopefully increased appreciation wins out, but ultimately you will pay the taxes from the first property... no free lunch. Exchange it enough and there could be little to no profit from your last sale due to cumulative taxes due. I opt not to use 1031 exchanges, but for some I'm sure it's beneficial. I'm not a total expert on 1031's... so will defer to others.


Keep in mind there is the "defer 'till you drop" strategy as well.  You can continually do 1031 exchanges until death and the basis resets to current market value.  Great for your heirs!  

At some point in the process, when you are tired of managing rentals, you can consider a Delaware Statutory Trust (DST), which is a way to do a fractional 1031 exchange with other investors. You'll maintain your tax exemption and have someone else do the heavy lifting of acquisition, property management, and operations while you receive the income and growth. It's a beautiful thing!

@Travis Odette , If you're talking regular income then it's all part of your operations which includes income, expenses, and deductions for tax purposes.  That's a question that others have alluded to - how to minimize your perceived profit for tax purposes and still generate growth.

If you're talking about income from a sale of that property then the way to defer the tax on profit and depreciation recapture is through a 1031 exchange as @Randall Alan said. It does act like a 401K or IRA but is used for property that you own outside your IRA or 401K. But you do not have to ever pay that tax if you play the game well. As long as you hold the new property you'll never have to pay the tax. As long as anytime you sell you'll never pay the tax. If you die holding the property your heirs get it at a step up in basis so the tax goes away like @Paul Moore said.  You can also convert an investment property into your primary residence and end up with a prorated amount of the gain tax free.

Plenty of ways that the 1031 can be used throughout your entire life to benefit you rather than paying the tax on the sale - if that was your question.

@Dave Foster thank you for the input. Yes it is for income reasons, I don’t plan on selling the current place I have now. I meant I have made $10,000 from rental income thus far and I want to use that $10,000 as part of a down payment on a new property. So then it is income, I believe and not a write off expense, and I will pay taxes on that $10,000 at the end of the year and need to keep that in my mind. Unless there is depreciation and costs that can help offset that initial income.

@Travis Odette , Ahhh.  This is where the slight of hand IRS gift of depreciation comes in.  You get to pretend that your property loses 1/27th of its value every year.  And that offsets income as well as expenses do.

Being the Scrooge he is, Uncle Sam wants that depreciation back when you sell.  But this is there the 1031 comes in.  If you do a 1031 when you sell you get to indefinitely defer the tax on gain and depreciation recapture.

@Travis Odette

The net rental income would be added to your taxable income if the amount is positive.
The goal, if possible, to make that amount negative with the help of your expenses including depreciation.