Am I being silly to limit my properties to states w/o income tax?

Question

I'm in year 5 of real estate investing.  I've told my wife that I only want to own properties in states that don't have income tax.  The same goes for our personal residence.

I've heard stories of investors, for example, that owned one property in California, and a multiple properties in other states, and the state of California expected to collect income tax on all out of state properties and income just because the investor had a single property in California.  Is this kind of overreach real?

Russell Brazil · Answer

States with no income tax are typically going to have higher real estate taxes as an offset. So I dont think Id focus on that criteria.

Account Closed · Answer

Most of your rental income should not be taxed anywhere. Thats what depreciation is for. Property tax rates are far more important a consideration than state income taxes.

Nicholas Aiola · Answer

@Rob Newsom Your resident state taxes all income, regardless of where it is earned. So the short answer is yes - if you have net taxable income from a no-tax state but reside in a state that taxes income, there may be income tax due to your home state.

Typically, your resident state gives you a credit for taxes paid to other states to ensure your income is not double-taxed but this would not apply to you if all your investments are in states without income tax.

When dealing with CA, you'll also want to be mindful of their strict annual LLC fee laws. If you hold your investments in LLCs, you may be subject to the $800 annual LLC fee in CA, even if you don't invest in CA, simply for just being a resident of the state.

Sean Morrison · Answer

This seems like one of those situations where more effort is put into avoiding taxes than making money. Taxes are annoying, but they're a percentage of earnings. So is your effort better spent on creating more value, or avoiding taxes? Typically, earning more nets you more. If you're making tons of money in your states great, but don't forgo a great deal because of the tax rate.

John Teachout · Answer

It matters more where YOU live and less where your properties are. I live in GA which has income tax. I have property in FL which has no income tax. I pay GA tax on the FL property. I sold property in MI and paid MI capital gains tax on it but not GA capital gains. As stated above, you will usually only pay tax to one state. If you live in a tax free state and own property in a different tax free state, you likely wouldn't pay any tax to either state.

Steve Morris · Answer

I guess it'd depend if you can get tax shelter from state taxes with interest deduction and depreciation.

However, I'd avoid Cali like the plague, I'm running into more people getting chased down by the Cal FTB.

Account Closed · Answer

Maybe the investor in this case is a resident of CA? I have a hard time believing if you reside in a different state (Texas) but have properties in CA and other states that the state of CA is going to tax you on all those properties out of CA.

Sarah Dudley · Answer

I would avoid CA if possible because they will tax you on your income that you earn from properties in CA but if you find a deal that works out number wise (including taxes) I wouldn't turn it down just because of the state it's in. If you can find good deals in states that have low/no state income tax than it's not silly to avoid the states with high income tax just make sure you taking into account the property taxes.

Dave Toelkes · Answer

No, it is not silly. Your state of residence is one that does not tax personal income.  If you did live in a state that had a personal income tax, then you would have to pay income tax to your state on all sources of income just as you do for federal income taxes.  This would mean that your resident state would tax all your rental income from your out of state properties.

The story you hear about California is true for California residents, but not true for the taxpayer that lives in another state but invests in CA.  In this instance, CA will tax only the income that investor earns from his CA investment property but not all his income from everywhere else.

However, just owning an out of state property in a state with an income tax does not always have a state tax consequence.  For example, if you owned rental property in my state of SC, SC would tax your SC net rental income.  But, if your expenses plus depreciation makes your net taxable income zero or negative on your SC property, you would not have to pay any income tax to the state of SC, although you would still have to file a state nicome tax return.

Jana Cain · Answer

A nonresident would not get taxed on all of the properties. On a non-resident return, you carve out what amount of your total income is attributed to that state. Yes, all of the properties could be taxed if they're held together in an LLC, and then it becomes a question of what/which returns the LLC needs to file - typically it will need to register as a foreign entity if it does business in a different state than where it is initially registered.

Am I being silly to limit my properties to states w/o income tax?

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