Rental Property Investor · Geneva, NY · Member since 2015 · 65 posts · 17 votes
Hi, I saw post mentioning that the rental income isn't taxed the same as W-2, I'm wondering how I can go about figuring out exactly how much positive cashflow I will need to equate my current income of 65k. I know rental income isn't responsible for paying medicare tax or SS tax. Does anyone know how I can break this down in order to figure the minimum amount of cash flow i need to replace my income, or does anyone know of a website I can do this. Also just as a side note, if right now I'm saving over 50% of my income doesn't this bod well for me not needing a higher amount of cash flow that what I make now? Thank you for anyone that is able to shed some light on this confusing subject I appreciate it.
Certified Public Accountant (CPA) / Investor · Homer, NY · Member since 2016 · 68 posts · 52 votes
9y
Benjamin Allen
Yes as far as how W-2 income is taxed compared to rental income you are correct that you don't pay Social Security and Medicare.
For 2016 the rate is 7.65% for W-2 employees, it should be noted if you were self-employed it would be double that or 15.3% since the employer actually splits this tax with you.
So the simple answer is you can earn 7.65% less and still have the same take home income if you only had rental income as opposed to W-2 wages.
It's not really that simple though because as others have mentioned there is depreciation and other "on paper" expenses you have for tax purposes that don't impact your actual cash flow. You do also have to accurately forecast your expenses and capital expenditures because that too will impact your total rental income. If a toilet needs to be replaced at your employer it's not like your wages would be impacted, but if you have to replace a toilet at your rental it goes against your bottom line.
So if your goal is to replace your W-2 income you will want to really get to know what average maintenance is and also reserve for capital expenditures, vacancy, etc. because these things will happen.
Investor · Madison, CT · Member since 2014 · 710 posts · 458 votes
9y
@Benjamin Allen - That's partially true and partially not. Rental income is taxed by the IRS and the sate the same as your personal income, but when you own a rental property, you can deduct 2.5% of the purchase price of the structure (not the land, so it's not the full purchase price), per year, for 27.5 years. So it gets really complicated when you start trying to target a post-tax number. Maybe there is an accountant on here who has a quick formula to use, but your final number will depend on the purchase prices of the properties you have generating the income.
After you're done writing that stuff off, you are taxed on what is left. Repairs and maintenance are going to vary year-to-year and property-to-property, so it's very hard to generate an 'equivalent' number before you actually have the properties and are actually doing the maintenance, etc, but it should be something less than $65k/yr.
Rental Property Investor · KY · Member since 2013 · 1k+ posts · 539 votes
9y
@Kevin Siedlecki, I understand the 27.5 years, but I've not seen the 2.5%. I'm probably missing something overly simple, but maybe it's best illustrated with an example. I'll use one from the TurboTax website:
Property: $150,000
Depreciation: $150,000/27.5 yrs
Depreciation: $5,455/$150,000 = 3.63% (not 2.5%).
This is where I wonder where the 2.5% comes from. Here's a link to this example on TurboTax (scroll down quite a bit): https://turbotax.intuit.com/tax-tools/tax-tips/Rental-Property/Real-Estate-Tax-and-Rental-Property/INF12039.html
Investor · Madison, CT · Member since 2014 · 710 posts · 458 votes
9y
@Mark S. I've never actually done the math out, which is unusual because I love math. Thanks for pointing that out. I'll have to talk to my accountant and figure out why he's got 2.5% drilled into me.
Certified Public Accountant (CPA) / Investor · Homer, NY · Member since 2016 · 68 posts · 52 votes
9y
Benjamin Allen
Yes as far as how W-2 income is taxed compared to rental income you are correct that you don't pay Social Security and Medicare.
For 2016 the rate is 7.65% for W-2 employees, it should be noted if you were self-employed it would be double that or 15.3% since the employer actually splits this tax with you.
So the simple answer is you can earn 7.65% less and still have the same take home income if you only had rental income as opposed to W-2 wages.
It's not really that simple though because as others have mentioned there is depreciation and other "on paper" expenses you have for tax purposes that don't impact your actual cash flow. You do also have to accurately forecast your expenses and capital expenditures because that too will impact your total rental income. If a toilet needs to be replaced at your employer it's not like your wages would be impacted, but if you have to replace a toilet at your rental it goes against your bottom line.
So if your goal is to replace your W-2 income you will want to really get to know what average maintenance is and also reserve for capital expenditures, vacancy, etc. because these things will happen.
Right, 1/27.5 is roughly 3.64% so that's the annual write off of what is depreciable. Also, realize that only the building is depreciated so say you buy a property for $100k that is $75k building and $25k land then you only get to depreciate the $75k. This lowers that percentage if you are using the total purchase price as your factor. Maybe this was part of the confusion.
Also commercial property is depreciated over 39 years which is just over 2.5% so maybe that could be another source of confusion.