Tax on turnkey Cash Flow

14 Replies

Hi

using a 100K property as an example (turnkey), with a 25 year loan, 76K, 5.6% p.a. that would mean the first year roughly 4K interest, and the depreciation would be 100k/27.5=3.6K, so total 7.6K - 630 USD/month.

Now did I understand correctly that the 630 $ should taken out against the monthly cashflow without a loan, not including vacancy, capex ? Since pretty much all the other expenses are tax deductible?

This would leave some 300 odd $ a month I need to pay taxes of (rental income 1250$/month)...so how do people manage to get a tax loss? Or should this also betaken into account?

thanks

@Chaim Rosenstadt Do you own land and a building or just a building?  Probably need to allocate some of your $100k example purchase price to land which isn't depreciable or amortizable.

"Now did I understand correctly that the 630 $ should taken out against the monthly cashflow without a loan, not including vacancy, capex ? Since pretty much all the other expenses are tax deductible?"

Having trouble understanding what you're asking... Depreciation is not a cashflow. Depreciation and amortization are non-cash transactions. It's not like $630 a month is evaporating. You'll only see depreciation on your financial statements and your tax returns. Depreciation is tax deductible. 27.5 years on residential real estate.

"This would leave some 300 odd $ a month I need to pay taxes of (rental income 1250$/month)...so how do people manage to get a tax loss? Or should this also betaken into account?"

If my math is correct,

1250 revenue

(333) mortgage interest

(630) depreciation

---------------------------

287 <--- what you're calling taxable income

Where is the insurance expense, the property taxes, management fees, repairs/maintenance, advertising, etc?  Once you add those in you should probably be at a tax loss.

the mortgage interest is already included in the depreciation (the 630$?)

good point about the building vs land, but how do I find out how much the building it self is worth if the buying price was 100K?

my questions was more if the 630 (or less if only depreciating the building), would be how large the taxable income can be, before tax needs to be paid (ie. anything above the 630 $ is taxable)?

and if there is a tax loss, would it lower my tax on a 1040?

thanks

Originally posted by @Chaim Rosenstadt :

Hi

using a 100K property as an example (turnkey), with a 25 year loan, 76K, 5.6% p.a. that would mean the first year roughly 4K interest, and the depreciation would be 100k/27.5=3.6K, so total 7.6K - 630 USD/month.

Now did I understand correctly that the 630 $ should taken out against the monthly cashflow without a loan, not including vacancy, capex ? Since pretty much all the other expenses are tax deductible? 

This would leave some 300 odd $ a month I need to pay taxes of (rental income 1250$/month)...so how do people manage to get a tax loss? Or should this also betaken into account?

thanks

A few things need to be broken out here....

So the $4k of interest will be deductible 

On a 100k property only the building value will be depreciated. Not the value of the land. So likely closer to half of your estimate. 

Your estimate isn't accounting for any other expenses. Property taxes are also deductible. As are property management costs. Utilities, ect. 

Typically, people end up will a loss on paper because of depreciation. It's a tax deduction but not something you actually have a cash outflow for. So it allows for cash flow/profit at year end- but a tax loss on paper. 

@Chaim Rosenstadt "good point about the building vs land, but how do I find out how much the building it self is worth if the buying price was 100K?"

Generally a proration of purchase price based on the most recent county assessment or appraisal.

"my questions was more if the 630 (or less if only depreciating the building), would be how large the taxable income can be, before tax needs to be paid (ie. anything above the 630 $ is taxable)?"

"and if there is a tax loss, would it lower my tax on a 1040?"

On the surface these seem like simple questions but they're not.  You haven't mentioned what your other taxable income looks like.  Can't really answer these without knowing your facts and circumstances.

@Natalie Kolodij "On a 100k property only the building value will be depreciated. Not the value of the land. So likely closer to half of your estimate."

Is it common to have 50% of the purchase price allocated to land value in the PNW?  It's closer to 20-25% in the southeast I find. 

@Chaim Rosenstadt

You need a system that analyzes the deals. I have very comprehensive systems like this. 

All the interest, depreciation, amortization are accurate and taxes are approximate. 

the interest will decrease with time, but by then maybe capex will start kicking in, but first year/max 4000K/year-333$/month.

The depreciation, if building is only 50 % - 151$/month, if 20% - 60$/month, with interest total 393-484$/month.

Vacancy (10%) 125$/month, and capex 183 $ /month, total 308 $/month, which would leave 85-176 $/month for positive cash flow that isn't taxable,  not a lot and that number only goes down with time. So again worst case scenario, with only 85$/month, most properties (again turnkey) have a bit higher positive cash flow, and the proponents of paying down the loan ASAP, that means the 300 $ of interest will suddenly be taxable.

@Eamonn McElroy My original questions stand, how do people get a tax loss, unless all these properties don't have positive cash flow (85$/month isn't much)?

@Chaim Rosenstadt "My original questions stand, how do people get a tax loss, unless all these properties don't have positive cash flow (85$/month isn't much)?"

It's very simple.  When tax deductible expenses exceed taxable income, you have a tax loss.  Boom, bang, done.  Whether or not you can use that tax loss to offset your other taxable income is a separate question.

I think the real question you're asking however is 'what am I missing'?  It's hard to tell because there's not a lot of transparency surrounding your numbers.  When asked about the other expenses above you said "that the expenses are deductible I know".  That doesn't help us help you very much.  If would be helpful to have everything you believe to be tax deductibled lined out.

Let's get down into the weeds....

First,

"The depreciation, if building is only 50 % - 151$/month, if 20% - 60$/month, with interest total 393-484$/month."

It shouldn't be that hard to pull county records and really dial this in.  I don't know anywhere that has buildings that would be allocated 20% of the purchase price as cost basis.  Maybe NYC or San Fran, but it would certainly be an anomaly to have a property with a rent ratio of 1.25 and a building value of 20% of the purchase price.

"Vacancy (10%) 125$/month, and capex 183 $ /month, total 308 $/month, which would leave 85-176 $/month for positive cash flow that isn't taxable, not a lot and that number only goes down with time."

Monthly vacancy and capex reserves are absolutely taxable.  And they don't actually reduce cash flow.  You're just calling them 'restricted funds' in a nutshell.  Cash flow is net cash in/(cash out).  Carving out a portion of monthly cash in to reserve accounts doesn't cause cash to leave.

"the proponents of paying down the loan ASAP, that means the 300 $ of interest will suddenly be taxable."

I'm having trouble figuring out what you mean by this?  I'm assuming you mean your net taxable income will be $300 higher because you have no interest expense to offset from a mortgage.  The way you're phrasing it is a little confusing.

It would help everyone who is responding to you greatly if you lay out your actual numbers, e.g.

xxxx  Rent Revenue

(xxx)  Interest Expense

(xxx)  Insurance

(xxx)  Property Taxes

(xxx)  Mgmt Fees

(xxx)  Lawncare/repairs/maintence

(xxx)  Advertising

(xxx)  Tax Depreciation

(xxx)  Loan Costs Amortization

(xxx)  etc

-------------------------

xxx/(xxx)  Projected net taxable inc/(loss)

@Chaim Rosenstadt

It appears you live overseas based on your other post.  Your wife is a US citizen and I assume you're classified as non-resident alien.

Really this post is great to educate you on the mechanics of calculating taxable income for a rental property but it's focusing on the minutiae a little bit considering your personal situation.

High level thoughts:

-Does your wife have an FBAR and/or 8938 obligation?  Are they being filed if so?

-Who will own the properties?  Your wife?  You?  If you have ownership, will owning the properties necessitate a 1040NR with Sch E for you?  FIRPTA exposure?

-What does the relevant US tax treaty have to say?  

-Does making the election for a non-resident alien to be taxed as a resident alien as you're married to a US Citizen make sense?

-Does your wife own any foreign (non-US) businesses?

-Can entity structuring mitigate some complications or negative effects above?  Possibly.

Best to consult a professional who can have a conversation with you about these issues.

Originally posted by @Eamonn McElroy :

@Chaim Rosenstadt "good point about the building vs land, but how do I find out how much the building it self is worth if the buying price was 100K?"

Generally a proration of purchase price based on the most recent county assessment or appraisal.

"my questions was more if the 630 (or less if only depreciating the building), would be how large the taxable income can be, before tax needs to be paid (ie. anything above the 630 $ is taxable)?"

"and if there is a tax loss, would it lower my tax on a 1040?"

On the surface these seem like simple questions but they're not.  You haven't mentioned what your other taxable income looks like.  Can't really answer these without knowing your facts and circumstances.

@Natalie Kolodij "On a 100k property only the building value will be depreciated. Not the value of the land. So likely closer to half of your estimate."

Is it common to have 50% of the purchase price allocated to land value in the PNW?  It's closer to 20-25% in the southeast I find. 

Yep 50% or more to land per the county assessor is very common. 

If you own a 1920's 800 sq foot house on Queen Ann it's not the house worth $900k. It's the land it's sitting on. 

Originally posted by @Chaim Rosenstadt :

Hi

using a 100K property as an example (turnkey), with a 25 year loan, 76K, 5.6% p.a. that would mean the first year roughly 4K interest, and the depreciation would be 100k/27.5=3.6K, so total 7.6K - 630 USD/month.

Now did I understand correctly that the 630 $ should taken out against the monthly cashflow without a loan, not including vacancy, capex ? Since pretty much all the other expenses are tax deductible? 

This would leave some 300 odd $ a month I need to pay taxes of (rental income 1250$/month)...so how do people manage to get a tax loss? Or should this also betaken into account?

thanks

 Unfortunately, you can't depreciate the land, so you can only depreciate the improvements. Vacancy and repairs can easily eat up that $300 a month leaving you with a tax loss for the year. 

@James Miller How does vacancy contribute to a tax  loss (unless we are talking about actual vacancies and not money put aside)

I was asking about money being put aside for vacancy, Capex and such, which as far as I know would be taxable. My question was how people "deduct"/don't pay tax on those expenses.

To provide numbers, again this on a property, but not one I currently own (tenant in place for 1 year so no ads, turnkey so should have low repairs, but I still use 8%).

income 1250$/month

Taxes 177$/month

Insurance 100 $/month

mgmt fees 100$/month

maint 100$/month

Vacancy (not actual money put aside) 125 $/month

Capex 183$/month

mortgage 440$/month of which Interest 4000K/year (330$/month)

monthly expenses:1225$/month

projected net income: 25$/month

@Eamonn McElroy @Natalie Kolodij wow 50% to land, that's the first I've heard....  I don't typically see anything over 30% (we consider 30% to be very conservative) and that's for properties in the SF Bay Area and HI.  One step further, we'll generally see MF Properties lower, around 20% land.

@Chaim Rosenstadt when i compute your numbers above (assuming $440 mortgage includes principal & interest) I get $333 in cash flow. Vacancy and Capex are not cash out expenses, they are reserves that you should hold for when you do have vacancy or a large capital expenditure - so you have funds to pay for those items - and they will be expensed or capitalized in the year/month they occur. If you factor in ~$200 in depreciation (random number since we don't really know what your depreciable basis or land allocation is), you are looking at taxable income of $133 but you received $333 in cash.

Often times a "tax loss" occurs when you have monthly expenses that bring your taxable income close to zero, and then non cash expenses like depreciation and amortization further reduce your taxable income below zero, creating said "tax loss".

disclaimer: been working a long day today, so please feel free to fact check my math :)

Originally posted by @Chaim Rosenstadt :

@James Miller How does vacancy contribute to a tax  loss (unless we are talking about actual vacancies and not money put aside)

I was asking about money being put aside for vacancy, Capex and such, which as far as I know would be taxable. My question was how people "deduct"/don't pay tax on those expenses.

To provide numbers, again this on a property, but not one I currently own (tenant in place for 1 year so no ads, turnkey so should have low repairs, but I still use 8%).

income 1250$/month

Taxes 177$/month

Insurance 100 $/month

mgmt fees 100$/month

maint 100$/month

Vacancy (not actual money put aside) 125 $/month

Capex 183$/month

mortgage 440$/month of which Interest 4000K/year (330$/month)

monthly expenses:1225$/month

projected net income: 25$/month

 Your expenses remain the same (I guess they could decrease if you're covering utilities or something) when you're vacant, so you'll likely lose money each day you are unrented.