Depreciation not enough to offset taxes
Hi,
If the yearly depreciation is less than the Income minus all other expenses, do we need to start paying taxes on the left over income?
example :
Net Income : Rent - (mortgage+insurance+tax+expenses) = $7,500 per year
Property Purchase price : 200,000
Depreciation = 200,000 / 27.5 = $7,272 per year
Do I have to pay taxes on the $228?
Does this mean there is too much equity in the property? We did a refi last year.
Thank you,
Azi
#2 Tax, SDIRAs & Cost Segregation Contributor
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#2 Tax, SDIRAs & Cost Segregation Contributor
- CPA, CFP®, PFS
- Florida
Correct! Your portfolio has to be balanced if you are trying to avoid taxes on your passive income. Mortgage payments are deductible, only interest portion is.
#3 1031 Exchanges Contributor
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I hope you’re paying someone to do your taxes. Your income calculation and your depreciation calculation are both wrong.
You need to add principle paydown to your income and not subtract your mortgage payment.
You need to subtract the value of the land from your purchase before calculating depreciation.
If you corrected your calculations and care out with the exact same numbers and didn’t want to pay $50 in taxes in $7500 in income (less than 1% (0.66%) tax rate which pretty good.) Then you could add $20/mo in expenses like a cellphone for contacting tenants or looking up properties. Or internet access to answer emails and look for properties. Or a newspaper or magazine subscription to keep up on real estate news. Of course you’d be spending $200 more per year but your taxes would be zero.
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#1 Tax, SDIRAs & Cost Segregation Contributor
- Tax Accountant / Enrolled Agent
- Houston, TX
Equity has nothing to do with your taxes, and refi has almost nothing to do with it. Your calculation is off, for the reasons mentioned by @Bill Brandt and for other reasons.
That said, if your net income after all expenses and depreciation is positive, you do pay taxes on that net profit. Which is usually a good thing indicating a healthy cash flow.
And you might be able to reduce it further to zero or negative, with an accountant's help.
What @Michael Plaks said. I recommend having your accountant take a look.
you don't depreciate the land only the building.
- Real Estate Broker
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@Azin Eftekhari be careful always showing no income... one of the things a lot of investors miss early on is that if you have no income for tax purposes then it can become an absolute bear to try to get a loan for a house in the future! You always have to balance this as you grow.
The other thing to consider is how state taxes will work. You are mostly focusing on federal taxes in this post, but there are different rules for state and federal taxes for sure. This is why I hire an accountant. Taxes are not my strength, and I would rather focus on the investing side.
Great points, Thank you John
Quote from @Paul De Luca:
What @Michael Plaks said. I recommend having your accountant take a look.
Thank you!
Quote from @Paul De Luca:Thanks Paul
What @Michael Plaks said. I recommend having your accountant take a look.
Quote from @Michael Plaks:
Equity has nothing to do with your taxes, and refi has almost nothing to do with it. Your calculation is off, for the reasons mentioned by @Bill Brandt and for other reasons.
That said, if your net income after all expenses and depreciation is positive, you do pay taxes on that net profit. Which is usually a good thing indicating a healthy cash flow.
And you might be able to reduce it further to zero or negative, with an accountant's help.
Thank you Michael!
Quote from @Bill Brandt:
I hope you’re paying someone to do your taxes. Your income calculation and your depreciation calculation are both wrong.
You need to add principle paydown to your income and not subtract your mortgage payment.
You need to subtract the value of the land from your purchase before calculating depreciation.
If you corrected your calculations and care out with the exact same numbers and didn’t want to pay $50 in taxes in $7500 in income (less than 1% (0.66%) tax rate which pretty good.) Then you could add $20/mo in expenses like a cellphone for contacting tenants or looking up properties. Or internet access to answer emails and look for properties. Or a newspaper or magazine subscription to keep up on real estate news. Of course you’d be spending $200 more per year but your taxes would be zero.
Thank you Bill, I had H&R block tax specialist and CPA do the taxes, I will follow up with them, but very likely, I misunderstood and misrepresented what they did ( I hope!).
Quote from @Ashish Acharya:
Correct! Your portfolio has to be balanced if you are trying to avoid taxes on your passive income. Mortgage payments are deductible, only interest portion is.
Thank you Ashish
You could look into a cost segregation study and factor in bonus depreciation, but it may not be worth it on one single family home.
Thank you Ryan