Do you pay taxes on your Buy & Hold Property?
Investor · Janesville, WI · Member since 2013 · 180 posts · 155 votes
Do you pay taxes on your Buy & Hold Property?
Most Popular Reply
Jim KennedyPro Member
Accountant · Cherry Hill, NJ · Member since 2016 · 173 posts · 201 votesChris,
I am a CPA who prepares hundreds of investor returns annually. Also, I won an operate a series of residential and commercial properties. I am a financial statement auditor, and was a tax examiner for the IRS and also worked in their Criminal Investigation Division. Finaicial analysis is a large chunk of my expertise and your fact presentation actually provides the answers to your question about why your profits are so good (high)
First, thanks for sharing your data with us. I have clients who own a dozen properties each in low income cities and towns and the low cost is the key as to why you are paying taxes. Check this out:
- I noticed your depreciation was $2K or less. That tells me your houses cost you under $100K. Depreciation on a $100K house is about $3,000 a year so you are losing a writeoff there
- Since you're buying for a lower price, that means you have less interest expense than somebody who buys a duplex for, say, $140K and pays $3500 each in interest.
- I noticed the real estate taxes are $2K and less. Thats tied to the lower assessed value of your house, so you lose some there too.
- Your insurance rates are also a little lower there too - a $140K house could go $1100, you;re at 750-800
So you are getting serious rents with lower income area reduced expenses, resulting in taxable cash flow even though it appears you are writing off everything you could and should.Other write-offs I could suggest are not material here so I wont waste my time there and I saw previously somebody accurately stated you cannot fund a retirement plan with passive income. As such I cant understand why nobody suggested looking into becoming a real estate professional under IRC 469 et seq because then its possible that because of your material participation, passive limitations no longer apply and its a business. Structured properly, and reported properly on business tax returns, it could work nicely!!
Jim Kennedy, CPA
54 Replies
- Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes9y
There won't be a "gain" or "loss" on buy and hold. Just Income/Loss.
Have you factored in depreciation on the property and improvements?
Qualifying mileage?
Cpa costs?
All qualifying deductions?
I would have a CPA look over it. I can honestly say the greater majority of my clients with rentals don't end up with much/if any/ taxable income when all is said and done.
- Real Estate Broker · Naples, FL · Member since 2013 · 9k+ posts · 6k+ votes9y
I always have a tax bill. Most of that is due to being lightly leveraged as well as having another line of business. I don't know that you can ever "beat" the tax man but you can lighten the costs through buy and hold real estate.
- Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes9y
I do not want large expense deductions reducing my cash flow. I do have a depreciation expense that shelters my net cash flow, making it essentially tax free. I have some properties that I own free and clear that produce a net taxable income, and more properties that are financed so the mortgage interest deduction reduces my taxable cash flow.
Most rental property investors believe the ideal situation is to have their net cash flow equal their allowed depreciation expense. This way there is positive cash flow that stays in your pocket at the end of the year that is completely sheltered by your depreciation expense.
I do not believe this is the ideal outcome. While it is advantageous, I would much rather have a $1 million income tax bill, because that means my true income was probably two or three million.
- Investor · Janesville, WI · Member since 2013 · 180 posts · 155 votes9y
We've done the obvious: Pay property taxes, insurance, property management, utilities, leveraged nearly everything we could squeeze out of the properties with mortgages, write off interest, take depreciation on the value of the building, recorded all expenses down to $1 for duplicate keys, taken mileage for every trip to the bank, properties, courthouse, Home Depot, showings etc, we outsource all the contractor work and then broken down the quotes to painting, repairs, supplies, 5 year deprecation items, and 27.5 year depreciation (a contractor installing Blinds, Laminate Floors & Windows would have 3 breakout prices), we write off meals, permits, REIA meetings, BP Subscriptions, record CPA costs. We've ensured we've hired out for nearly every task as those costs would all be tax deductible as well. I've doubt we've missed any deductions we can legally take though I'm always willing to reach out to others and ask. We are still showing a taxable gain in the $1000s for each unit even when rents are only $550-$850. The more I ask around, the more I hear others end up not having a taxable income on their cashflow and was just looking to see if there are other investors that do fork over a bunch at the end of the year? Not from Flip related gains.
- Investor · Birmingham, AL · Member since 2016 · 315 posts · 206 votes9y
Mileage is huge expense. 2016 IRS rates are $.54 a mile so if you do 8000 miles a year that's $4320. You also have to show personal mileage also. The best thing I did was get a credit card in my company's name as a business account and then at tax time just pull up a summary and assign the expenses to the property or the overhead of the company. It much easier to keep up with the company's expenses. Good luck JP.
- Investor · Lebanon, OH · Member since 2016 · 144 posts · 87 votes9yChris Heeren Also depends on what your goals are. We have 5 rentals. The original plan was to purchase 1 additional per year (I have a well paying W2 job that I am not interested in giving up). However, my last purchase was more difficult than the previous 4. I have been able to offset the income pretty well, but on paper, that wasn't aligning with my goal of growing my portfolio. I have since made an effort to show less expenses and more income. It's a fine line to balance. Good luck! Michelle
- Investor · san antonio, TX · Member since 2016 · 133 posts · 43 votes9y
@Chris Heeren must be a by product of you sourcing your deals so cheap. our properties we source with a 1% rents to price ratio give us about 4k of additional deductions per door we cannot access as we arent taxed as real estate professionals yet.
Could you give us an example of the numbers of one of your properties youre paying income tax on? The idea is cray cray to me.
- Investor · Janesville, WI · Member since 2013 · 180 posts · 155 votes9y
Originally posted by @Steven Mitchell:
@Chris Heeren must be a by product of you sourcing your deals so cheap. our properties we source with a 1% rents to price ratio give us about 4k of additional deductions per door we cannot access as we arent taxed as real estate professionals yet.
Could you give us an example of the numbers of one of your properties youre paying income tax on? The idea is cray cray to me.
I only owned 2 properties in 2014 that have been through an entire tax calendar year as I mainly started buying & rehabbing in 2015. After we finish our 2016 Taxes I'll have about 15 more properties to compare against (The Single Family Houses look to be less with around $2K profit) - Here are the rough numbers from my previous tax return on my first Duplex and TriPlex. Duplex Rents out for $735/$850 & TriPlex Rents for $515/$550/$600 - Duplex was $55K & Triplex was $59K
Rent: $17,320 & $19,380 (2 month vacancy and 1 month vacancy)
Mortgage Interest: $2,700 & $2,145
Insurance: $750 & $800
Management: $1,040 & $1,200
Utilities: $1,400 & $1,500
Property Taxes: $2,000 & $1,600
Repairs: $1,700 & $1,500
Supplies: $75 & $50
Mileage: $100 & $100
5 Year Depreciation: $750 & $600
27.5 Year Depreciation: $2,000 & $1,900
This leaves a Taxable Profit of $4,805 & $7,985
Obviously the first year I own them I show a loss with all my additional repair expenses, vacancies, and the fact that I only owned it for a portion of the year. Though for 2017 I will now have 50+ units that are fully rehabbed, rented out and should be cashflow for a full 12 month period. I fully understand how buying a $100,000+ @ 1% will show a loss, but I also know that there are tons of investors that are buying cheaper houses at over the 2% rule but I haven't heard many (if any) ever mention they end up paying out quite a bit in tax at the end of the year. The ones that do are flipping properties, not using the buy and hold strategy.
- Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes9y
What do you consider "quite a bit" in taxes. If you are in the 25% tax bracket, your after tax cash flow is still around $9600 per year using your numbers. Your "problem" is caused by your investment strategy. You bought multi-plexes for what most of the rest of us pay for a single family dwelling. You are getting two and three times the rental income from your properties than the rest of us.
Seriously, why are you unhappy that some of your cash flow is taxable? Is it that the other investors you are talking to are not paying tax on their rental cashflow while you are? If so, you need to recognize that you may be comparing apples to oranges. You have two depreciable properties for a total of five doors. Most likely, the other investors you are talking to have only one door per property. If you compare your situation with another investor with the same number of doors in multiplex properties that cost the same as yours, you might find that your tax outcomes are roughly the same.
- Investor · Janesville, WI · Member since 2013 · 180 posts · 155 votes9y
Originally posted by @Dave Toelkes:
What do you consider "quite a bit" in taxes. If you are in the 25% tax bracket, your after tax cash flow is still around $9600 per year using your numbers. Your "problem" is caused by your investment strategy. You bought multi-plexes for what most of the rest of us pay for a single family dwelling. You are getting two and three times the rental income from your properties than the rest of us.
Seriously, why are you unhappy that some of your cash flow is taxable? Is it that the other investors you are talking to are not paying tax on their rental cashflow while you are? If so, you need to recognize that you may be comparing apples to oranges. You have two depreciable properties for a total of five doors. Most likely, the other investors you are talking to have only one door per property. If you compare your situation with another investor with the same number of doors in multiplex properties that cost the same as yours, you might find that your tax outcomes are roughly the same.
Dave - I never said I was unhappy? In fact, I can't wait for the day when I have to pay $1 Million in taxes. I have just heard enough podcasts mention "if you have buy and hold rentals you should never be paying tax" to start asking the question. I just recently heard a very intelligent CPA mention that if you are paying ANYTHING on buy and hold rentals, you do not have a good enough CPA. This makes me wonder, how many other investors out there do show positive gains on mortgage leveraged properties? And also, what could a CPA suggest I even do in my scenario to eliminate taxes.
I believe if I started buying properties in B+ area's, the depreciation would wipe out my gains on my C Class properties, however, I cannot justify touching anything in an appreciating market around my area at this time. The loss of equity in the next down turn wouldn't justify the savings on taxes. Also, I believe I could take my year end positive cashflow amount and invest that into a Solo 401K plan in which I could then reinvest back into real estate. This could help get me away from paying taxes on the gains but would also force me to stick my money in a retirement vehicle which I could not touch for another 30+ years.
- 9yBrian EastmanPro MemberSelf Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes
Actually, passive income from rental property cannot be used to make contributions to a Solo 401k plan. Only earned income qualifies.
Originally posted by @John Patton:
Mileage is huge expense. 2016 IRS rates are $.54 a mile so if you do 8000 miles a year that's $4320. You also have to show personal mileage also. The best thing I did was get a credit card in my company's name as a business account and then at tax time just pull up a summary and assign the expenses to the property or the overhead of the company. It much easier to keep up with the company's expenses. Good luck JP.
a lot of people don't know this but you can't expense mileage from your personal residence to the rental. the mileage starts when you arrive to the rental. I am unsure how it would be calculated if you left your personal residence to go to a seminar though.
be careful.
- Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes9y
@Scott W. Unless you have a home office then it's technically business to business driving and counts.
I would say 90% of CPA's honestly just take that mileage, even though there's not substantiating evidence that says it's allowable without the office. But it's also not a huge audit point either.
As far as I'm concerned (without the home office) your house to your rental is commuting...same as your house to your office if you owned a business.
- Investor · Janesville, WI · Member since 2013 · 180 posts · 155 votes9y
@Brian Eastman That is the first time I have heard of that - It's good to know and I'll obviously be looking more into it when the time comes.
@Scott W. I also have not heard of that before, I sent an email to my CPA on how exactly I should be logging mileage for a passive investment.
@Steven Hamilton II once posted this on here about the mileage rental thing?
- 9ySteven Hamilton IIPro MemberAccountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
Originally posted by @Chris Heeren:
Originally posted by @Dave Toelkes:
What do you consider "quite a bit" in taxes. If you are in the 25% tax bracket, your after tax cash flow is still around $9600 per year using your numbers. Your "problem" is caused by your investment strategy. You bought multi-plexes for what most of the rest of us pay for a single family dwelling. You are getting two and three times the rental income from your properties than the rest of us.
Seriously, why are you unhappy that some of your cash flow is taxable? Is it that the other investors you are talking to are not paying tax on their rental cashflow while you are? If so, you need to recognize that you may be comparing apples to oranges. You have two depreciable properties for a total of five doors. Most likely, the other investors you are talking to have only one door per property. If you compare your situation with another investor with the same number of doors in multiplex properties that cost the same as yours, you might find that your tax outcomes are roughly the same.
Dave - I never said I was unhappy? In fact, I can't wait for the day when I have to pay $1 Million in taxes. I have just heard enough podcasts mention "if you have buy and hold rentals you should never be paying tax" to start asking the question. I just recently heard a very intelligent CPA mention that if you are paying ANYTHING on buy and hold rentals, you do not have a good enough CPA. This makes me wonder, how many other investors out there do show positive gains on mortgage leveraged properties? And also, what could a CPA suggest I even do in my scenario to eliminate taxes.
I believe if I started buying properties in B+ area's, the depreciation would wipe out my gains on my C Class properties, however, I cannot justify touching anything in an appreciating market around my area at this time. The loss of equity in the next down turn wouldn't justify the savings on taxes. Also, I believe I could take my year end positive cashflow amount and invest that into a Solo 401K plan in which I could then reinvest back into real estate. This could help get me away from paying taxes on the gains but would also force me to stick my money in a retirement vehicle which I could not touch for another 30+ years.
A lot of this comes down to strategy. For every duplex/triplex you buy I'd want you to buy a much larger multifamily property. We can accelerate some of the depreciation from that property to offset the incomes of the others.
- Investor · Janesville, WI · Member since 2013 · 180 posts · 155 votes9y
Originally posted by @Steven Hamilton II:
A lot of this comes down to strategy. For every duplex/triplex you buy I'd want you to buy a much larger multifamily property. We can accelerate some of the depreciation from that property to offset the incomes of the others.
haha me to!! How about we partner together and figure out how to buy 2-3 large multifamily buildings per month! I'm not knowledgeable enough at the moment to do it but I bet it can be done...
- 9ySteven Hamilton IIPro MemberAccountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
Originally posted by @Natalie Kolodij:
@Scott W. Unless you have a home office then it's technically business to business driving and counts.
I would say 90% of CPA's honestly just take that mileage, even though there's not substantiating evidence that says it's allowable without the office. But it's also not a huge audit point either.
As far as I'm concerned (without the home office) your house to your rental is commuting...same as your house to your office if you owned a business.
@Scott W. I'm in agreement with Natalie A home office justifies it. Whereas if you don't have one it won't.
It all depends on how successful you are in your deals. If you buy a $50k property and rent it out for $1,100/month (I've seen it), it will be hard to not show "profit". Depreciation is the real magic here. You see lots of people saying depreciation (and maybe some smart expense) should wipe out any "profit" still leaving cash flow, but again if the deals you are making are awesome, showing a "profit" and paying taxes is never a BAD thing, assuming you do your accounting correctly.
- 9yJim KennedyPro MemberAccountant · Cherry Hill, NJ · Member since 2016 · 173 posts · 201 votes
Chris,
I am a CPA who prepares hundreds of investor returns annually. Also, I won an operate a series of residential and commercial properties. I am a financial statement auditor, and was a tax examiner for the IRS and also worked in their Criminal Investigation Division. Finaicial analysis is a large chunk of my expertise and your fact presentation actually provides the answers to your question about why your profits are so good (high)
First, thanks for sharing your data with us. I have clients who own a dozen properties each in low income cities and towns and the low cost is the key as to why you are paying taxes. Check this out:
- I noticed your depreciation was $2K or less. That tells me your houses cost you under $100K. Depreciation on a $100K house is about $3,000 a year so you are losing a writeoff there
- Since you're buying for a lower price, that means you have less interest expense than somebody who buys a duplex for, say, $140K and pays $3500 each in interest.
- I noticed the real estate taxes are $2K and less. Thats tied to the lower assessed value of your house, so you lose some there too.
- Your insurance rates are also a little lower there too - a $140K house could go $1100, you;re at 750-800
So you are getting serious rents with lower income area reduced expenses, resulting in taxable cash flow even though it appears you are writing off everything you could and should.Other write-offs I could suggest are not material here so I wont waste my time there and I saw previously somebody accurately stated you cannot fund a retirement plan with passive income. As such I cant understand why nobody suggested looking into becoming a real estate professional under IRC 469 et seq because then its possible that because of your material participation, passive limitations no longer apply and its a business. Structured properly, and reported properly on business tax returns, it could work nicely!!
Jim Kennedy, CPA
- Real Estate Professional · South Jordan, UT · Member since 2016 · 22 posts · 2 votes9yJim Kennedy really great response. Can you enlighten us on what would make an individual qualify as a real estate professional and the perks which follow for tax purposes? Thanks in advance. (New investor)
@Brian Eastman As a strategy for those who invest in buy/hold and maintain a W2 job, would you suggest rolling over an employer-offered 401k into a Solo 401k and ramping up contributions to lower your taxable income overall (assuming you file personal income taxes along with your rental business)? I also don't want to lose my company's 4% match on my 5% contribution. Any thoughts?
- Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes9y
Real Estate Professional status would let Chris write off his net passive losses without regard to the $25K net passive loss allowance cap . Since Chris does not have a net passive loss, Real Estate Professional status would not provide any tax benefit.
- 9yJim KennedyPro MemberAccountant · Cherry Hill, NJ · Member since 2016 · 173 posts · 201 votes
@Dave Toelkes
I respectfully completely disagree. You are correct about no loss/no advantage, but you missed the deeper concept about retirement income contributions. By being a r/e pro, income shifts from passive (which you cannot use as a basis for a retirement contribution) to active and is then eligible for a retirement plan if reported correctly on the correct type of corporate tax return (where you have a chance).
Jim Kennedy, CPA
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