Tax advantage in negative cash flow property

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Tax advantage in negative cash flow property

Manoj N.
Louisville, CO · Member since 2015 · 64 posts · 4 votes

I am planning to buy a rental property in Boulder, CO. The property will result in slightly (about -$500 annual) negative cashflow after considering all usual costs (P&I, HOA, Repair etc). However, if I buy this property, this negative cash flow will be offset by a $1700 tax savings since another rental property I own generate considerable taxable income. I will get a positive cash flow of $1200 if I buy this property because I will owe less tax. Is this a good reason to buy this property ? Thanks

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Mike Dymski
Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
9y

Profit in real estate comes from (1) cash flow (2) principal reduction (3) appreciation and (4) tax benefits. I would recommend calculating your total return (IRR) rather than just the cash flow. Having a property that meets your IRR targets and also offsets other taxable income is a common strategy, particularly for the wealthy. They buy for the return and for the tax benefits, not just the tax benefits.

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  • Natalie KolodijBusiness Member
    Moderator
    Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
    9y

    Um no. 

    You want a property that shows negative ON PAPER to get that loss against your positive rental income. You should be positive in cash flow- negative after on paper deductions like depreciation

    Not a property that actually loses you money. 

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    9Reply
  • Manoj N.
    OP
    Louisville, CO · Member since 2015 · 64 posts · 4 votes
    9y

    Thanks Natalie. Perhaps my question was not clear. If buying this property can get me a tax refund of $1700 per year, could that be justified in buying -$500 property ? Agreed, if the new property generates a positive cashflow, it will be a bonus. But getting something like that in Boulder, CO region is very difficult.

    0Reply
  • Jeff Bridges
    Investor · Hyattsville, MD · Member since 2012 · 822 posts · 441 votes
    9y

    positive cashflow IS the point of rental property, not a bonus. Buying a cashflow negative property is not a successful tax avoidance strategy. You still are losing money, you're just losing is less slowly due to some tax deductions. when you have the opportunity, you want to be buying cashflow positive businesses, otherwise its just a liability... You do want to increase your income in the long term don't you? Use that up front investment money you would have otherwise spent for these purposes!!!

    0Reply
  • Mike Dymski
    Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
    9y

    Profit in real estate comes from (1) cash flow (2) principal reduction (3) appreciation and (4) tax benefits. I would recommend calculating your total return (IRR) rather than just the cash flow. Having a property that meets your IRR targets and also offsets other taxable income is a common strategy, particularly for the wealthy. They buy for the return and for the tax benefits, not just the tax benefits.

    15Reply
  • Sandra B.
    Orange County, CA · Member since 2017 · 36 posts · 24 votes
    9y
    @Navin Naik Agree with Mike Dymski . If you have a healthy income outside of real estate, investing in a property in a market with healthy long term fundamentals at essentially a break even will, in the long term, contribute dramatically to your net worth. I'm not talking about a bet on appreciation. I'm talking about long term principal paydown at low or no cost to you along with providing additional tax advantages. Just ask yourself, if the market cools and you are forced to reduce rents to keep the unit occupied, are you comfortable carrying a more substantial loss every month? This is a possible outcome that you should consider. On the other hand, if real estate investment is your primary source of income, then you would want to focus on finding positive cash flow properties. It is really a question of your total financial position and long term goals.
    0Reply
  • Natalie KolodijBusiness Member
    Moderator
    Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
    9y
    Originally posted by @Manoj N.:

    Thanks Natalie. Perhaps my question was not clear. If buying this property can get me a tax refund of $1700 per year, could that be justified in buying -$500 property ? Agreed, if the new property generates a positive cashflow, it will be a bonus. But getting something like that in Boulder, CO region is very difficult.

     You're going to need to explain to me how you figured that you'd get a $1700 cash refund based on owning this second property. 

    Podcast Guest on Show Pay Less Tax to the IRS This Year With THESE Real Estate Tax Strategies
    Kolodij Tax & Consulting
    WebsiteView Page
    0Reply
  • Kyle McCorkel
    Rental Property Investor · Hummelstown, PA · Member since 2015 · 638 posts · 653 votes
    9y

    I would want a property to at the very least, worst case, break even on cash flow.  Cash is king...you can't use your appreciation or future tax savings to put food on the table.

    I can understand the point that others have made, that if you have income from other sources, it might be OK...but personally I don't want one investment to be dependent on another to stay afloat.  I want each of them to be able stand by itself.  If it doesn't, then if something goes wrong with one investment (or your JOB which you might theoretically be using to subsidize your negative cash flow property) then it could cause a chain reaction and you could lose everything.

    2Reply
  • Thomas S.
    Member since 2016 · 13k+ posts · 12k+ votes
    9y

    The higher your profits the more taxes you pay. That's a good thing, making money I mean.

    If you can not find cash flow properties in Boulder you don't invest in Boulder.

    1Reply
  • Ben Zimmerman
    Rental Property Investor · Raleigh, NC · Member since 2016 · 396 posts · 995 votes
    9y

    When I choose to invest in an area, my primary concern is the long term health and growth of that area, immediate cashflow has nothing to do with my investment strategy.  You could throw a dart at a map of the Midwest and hit a cashflow positive house, but that doesn't mean that investing in that home is a sound long term plan. 

    The buy and hold strategy isn't a get rich quick scheme, and yet some people have entirely too short sided of a viewpoint and only worry about what kind of returns it gets TODAY.  What is the immediate cashflow, instead of what is the long term outlook towards my financial goals.  A cash flow neutral home in an up and coming area will blow away any $200 a door cashflow home in the Midwest over the long run.  People seem to love investing in Cleveland for cashflow, until you realize that since 2000, homes have depreciated by roughly 5% per neighborhoodscout.com.  And average rent, and household income during those time frames aren't really any better for the area.  Over 50% of homes were built in the 1930s and only a trivial amount of new construction since the 70s.  I'm not saying Cleveland is a bad place to invest, especially if you are at the end of your investment lifecycle and are looking for a safe place to park your money and ride out retirement, but as I am a 30's something male I wouldn't want to invest there in the hopes of growing a future.

    You look like a young guy, so I would advise picking a location with good future growth, and worry slightly less with the immediate cashflow situation.  With that said, I don't know anything about the Boulder market, and I don't know if this pricepoint would be the norm or if you could find a better deal.  However if you can afford to carry the trivial loss (sounds like roughly $40 a month if expense calculations are truly accurate) AND if you think that the area has a large amount of long term growth potential, AND if this is the best deal you are able to find in the area, then I would say go for it. 

    7Reply
  • Manoj N.
    OP
    Louisville, CO · Member since 2015 · 64 posts · 4 votes
    9y

    All. Thanks for your feedback. In my view, the Denver-Boulder metro area has strong growth potential. For example, about 100K new comers are settling in this area every year for the past 5-6 years.  Coming to Mike Dymski's comment that RE investment has 4 advantages - (1) cash flow (2) principal reduction (3) appreciation and (4) tax benefits - I think I cover all except the first. But with a modest increase (4%) in rent, I will turn positive cash flow in 3 years. In the meantime, I guess the tax advantage can offset the negative cash flow.

    0Reply
  • Steve B.
    Engineer · Portland, OR · Member since 2014 · 1k+ posts · 1k+ votes
    9y
    Your taxed on both gains and losses at your marginal rate. You need to review how income is taxed, you're confused on elementary tax law.
    0Reply
  • Manoj N.
    OP
    Louisville, CO · Member since 2015 · 64 posts · 4 votes
    9y

    Steve. Yes that is the case. I ran my numbers through my tax professional. 

    0Reply
  • Ralph R.
    Investor · Bethel, AK · Member since 2013 · 1k+ posts · 852 votes
    9y
    Navin Naik That property will most likely grow in value due to boulder county's building moratorium and historically being anti development. You didn't say your income but it's important to remember that depreciation does not help your taxes after your w-2 reaches $150k per year. If your investing for appreciation and or value add then that's one thing. Somebody that makes less than the $150k cap on the allowable income for the tax break to do them any good definitely needs to look elsewhere for a tax break. Any tax professional recommending real estate as a tax break to somebody who makes less than 150 k a year is offering poor advice at best. Besides you have to pay depreciation recapture when you sell. It's not really saving you money. It's kicking the can down the road. RR
    2Reply
  • Mike Dymski
    Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
    9y

    Be careful of the advice you get on BP.  Depreciation can help your taxes when your W-2 is above and below $150k and losses on one passive activity can certainly offset passive income on another property (which is your question).

    4Reply
  • Manoj N.
    OP
    Louisville, CO · Member since 2015 · 64 posts · 4 votes
    9y

    Mike, my thoughts exactly. The idea is to offset my taxable income from one property with a loss from the other. I think 150k is irrelevant here. Loss is very small when not considering depreciation. And loss is offset by the tax advantages. And I don't mind kicking the can 27 years down the road:-)

    0Reply
  • Steve Vaughan
    Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
    9y

    If you can almost (within $500/yr) break-even on a good house in a good neighborhood of Boulder, I say go for it.

    Ask any one of many multi-millionaires from the Bay area, Seattle, Portlandia, NY, etc how buying good assets  in good areas has affected their wealth.  I have a couple houses that are crummy rentals from a cash-flow standpoint, but have had great balance sheet returns.  Selling one now and only one, to stay under a tax threshold.  Appreciation is nice.

    In the end, the important number is your IRR. If this will help you get below an EIC threshold, all the better. Good asset in a good neighborhood in a great market purchased under FMV is a go in my book @Manoj N.!     Share some numbers!

    3Reply
  • James Wise
    Real Estate Broker · Cleveland Dayton Cincinnati Toledo Columbus & Akron, OH · Member since 2013 · 30k+ posts · 20k+ votes
    9y
    Originally posted by @Manoj N.:

    I am planning to buy a rental property in Boulder, CO. The property will result in slightly (about -$500 annual) negative cashflow after considering all usual costs (P&I, HOA, Repair etc). However, if I buy this property, this negative cash flow will be offset by a $1700 tax savings since another rental property I own generate considerable taxable income. I will get a positive cash flow of $1200 if I buy this property because I will owe less tax. Is this a good reason to buy this property ? Thanks

     Cashflow is not the only reason one should be buying rental property. Utilizing OPM is the real key to the business. So if you are able to have a tenant pay for 70-75% of a high quality asset you should go for it. Folks that make huge buying decisions based on Netting $500 a year in cash flow or loosing $500 a year in cash flow are in my opinion missing the boat. 

    $500 per year one way or the other is an irrelevant sum of money to your life and overall wealth building strategy.

    5Reply
  • Manoj N.
    OP
    Louisville, CO · Member since 2015 · 64 posts · 4 votes
    9y

    My analysis of the rental property here. 

    http://www.calculator.net/rental-property-calculat...

    0Reply
  • Manoj N.
    OP
    Louisville, CO · Member since 2015 · 64 posts · 4 votes
    9y
    Originally posted by @Natalie Kolodij:
    Originally posted by @Manoj N.:

    Thanks Natalie. Perhaps my question was not clear. If buying this property can get me a tax refund of $1700 per year, could that be justified in buying -$500 property ? Agreed, if the new property generates a positive cashflow, it will be a bonus. But getting something like that in Boulder, CO region is very difficult.

     You're going to need to explain to me how you figured that you'd get a $1700 cash refund based on owning this second property. 

     Pretty basic accounting. The new property will wipe off about $6800 from my Sch E in the first full year. I owe less according to my tax bracket.

    0Reply
  • Ralph R.
    Investor · Bethel, AK · Member since 2013 · 1k+ posts · 852 votes
    9y

    @Manoj N.  are the numbers in you calculator figures actual or estimated?  I own 9 rental properties in Colorado. I admit my boulder county property is vacant land ( no insurance) but every rental I own in 3 different Colorado city's is at least 40 dollars a month for insurance. Some are 75. I am familiar with the wind in parts of boulder itself. That will affect insurance rates. I dunno your exact location but I think your insurance number and your vacancy number is low. 8% vacancy is only one month a year and doesn't allow for turnover costs. 2% is the same thing as saying it will have one vacancy every 4 years. And you will cover turn over out of pocket. If this is a house in Nedarland or ward and built in 1920 your maintenance is too low. Your maintance cost is slightly low if  it's a beer house and your figuring cap-ex with it. I'm assuming you will self manage as well.   I'm not trying to talk you out of this thing but I have enough expierence to know beginning numbers will never be the same numbers in a year or even 5 years. If it's close now and markets change or something goes wrong than a break even property can really hurt you when something goes south. If you have deep enough pockets to carry this thing in bad times should they occur and you are looking for appreciation  I would do it. If I was looking for a tax break I would donate to charity  or increase my Ira contribution. The latter kicks the can down the road until you retire. RR 

    0Reply
  • Manoj N.
    OP
    Louisville, CO · Member since 2015 · 64 posts · 4 votes
    9y

    This is a townhouse with large HOA. Hence the small insurance. Actually I overestimate the maintance cost. I think you are completely missing the point when you equate charity with investment for long term.

    0Reply
  • Jared Bouzek
    Lender · Denver, CO · Member since 2015 · 404 posts · 227 votes
    9y

    @Manoj N. Actually considering the HOA's I've seen on townhouses and condos in our area, that $176/month is pretty reasonable. The decision to invest in a negative cash-flow is entirely personal. If you make a nice employment income and have a very long-term view on the investment, I think it can be ok if you don't mind biting the bullet for a couple of years while rents increase. You seem like a numbers guy, so I'm sure you've looked at the alternatives you have to invest your money in. While there are tax advantages tied to investing in rental properties, I don't know if I would lean on that to justify the investment.

    To get down to the basics, the decision is: By deploying your capital in this investment, does your expected overall return beat the other alternatives that you have and does it do so to a degree that justifies the risk of this investment?

    2Reply
  • Ralph R.
    Investor · Bethel, AK · Member since 2013 · 1k+ posts · 852 votes
    9y

    @Jared Bouzek  amen. I agree 100%. RR

    0Reply
  • Manoj N.
    OP
    Louisville, CO · Member since 2015 · 64 posts · 4 votes
    9y
    Originally posted by @Jared Bouzek:

    @Manoj N. Actually considering the HOA's I've seen on townhouses and condos in our area, that $176/month is pretty reasonable. The decision to invest in a negative cash-flow is entirely personal. If you make a nice employment income and have a very long-term view on the investment, I think it can be ok if you don't mind biting the bullet for a couple of years while rents increase. You seem like a numbers guy, so I'm sure you've looked at the alternatives you have to invest your money in. While there are tax advantages tied to investing in rental properties, I don't know if I would lean on that to justify the investment.

    To get down to the basics, the decision is: By deploying your capital in this investment, does your expected overall return beat the other alternatives that you have and does it do so to a degree that justifies the risk of this investment?

    Good question. I must admit that I have not looked at a lot of alternative scenarios. Currently my down-payment equivalent is parked in an S&P 500 fund which gives me reasonable return, especially in the past year. I am considering RE investment to push the return above the 8-9% average S&P. Since I like to buy properties close to where I live and since I have full-time day job and a demanding family, I am not considering places far outside Boulder. I have analyzed more than 50 properties in the past year and most of them barely comes to break even in cash flow sense. However, even with a 4% appreciation the IRR from a typical Boulder property is > 13% with about 10-20 years of holding period. This number is modest considering the Case-Shiller-Denver estimate of 10% annual increase over the past 25 years, primarily propelled by new comers settling in the area. This is kind of the background of my original question, sorry that I should have been clear about this at the beginning. I really appreciate all BP gurus posting their views - I learned a lot.

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