How is rental income taxed?

[Costin I.]

In my planning for retirement, I estimate my family annual expenses to be about 100K. I want to know how much do I need to clear in rental income to be able to cover that.

Obviously, the depreciation should make the taxable rental income question better, but to keep things simple, we’ll not consider the depreciation, just all the deductible expenses (mortgage interest, taxes, insurance, repairs, materials, management, any and all other expense rental related). Also, we'll assume there is no other income (no job, no interest on savings, no investments) other than rental income, and I need to clear 100K after all the deductible expenses (mortgage interest, property taxes, insurance, repairs, materials, management, any and all other expense rental related) and TAXES.

Or, to reverse the net into taxable gross, how much do we need to clear in net rental income, so that after paying taxes on it, will have 100K free and clear?

[Scott Mac]

Hi Costin, 

Be sure to project for inflation, and whatever number that turns out to be (if you really want to be safe) double it, because you can never tell with rentals.

For instance I've seen a solid Class B+ neighborhood go to D in a couple of years simply due to swings in the economy and population replacements in the area.

Also, if you have not already done so, you might want to look at a Living Trust.

Good Luck!

[Bjorn Ahlblad]

Once you no longer have a 9-5 'job' talk to your accountant about you becoming a full time REI. I won't elaborate on all the qualifications or benefits on the forum here-I am not an accountant. Your CPA will outline all that for you, see if that can work for you.

[Joe Scaparra]

From my experience I spend about 40% or gross rental income on expense to include property taxes, insurance, maintenance and capital expenditure but not Federal Income Tax.  I do my own property management,  Based on that you would need $167,000 of gross annual rent to net %100,000.  But that does NOT include what you would owe in Federal Income Tax.  Assuming a 22% tax rate you would need another 22k so you would need approximately $200,000 gross rental income to net $100,000 spendable income after you pay your Federal Tax.  Realize that does NOT include servicing a mortgage.  This assumes your property is paid off.  However, since you laid down the parameters it does not include the benefits of depreciation or income from other sources like social security, pensions, or 401k RMD payments/withdrawals all of which would lower the income required from your investment real estate income.  Cheers..

[Costin I.]

@Joe Scaparra - thanks Joe for your helpful answer. Been trying to figure out an answer to this dilemma for awhile now, even my CPA is taking a long time to get back to me.

From my research (after I posted here...sometimes just trying to formulate the question leads you to the answer) this is what I found:

1. Rental income is taxed as ordinary income according to your Internal Revenue Service (IRS) tax bracket. 

2. I used a net-to-gross calculator to estimate a gross "paycheck" of $132,156.90 nets $100,000.00 (filling status married, zero on everything else). 

So, basically, we'll need to net $132K after rental expenses and(!) depreciation to clear 100K after federal taxes. 

What should be the gross rental income is very much dependent on specific situation, what are your rental expenses (all of them, including property management), like @Joe Scaparra mentioned, if you have mortgages or not, what is your depreciation (and have to careful there, if you used CSS to accelerate depreciation, and how will it affect you in later years). Since we see the same kind of ~40% going to expenses, the gross will have to be 200Kplus for sure.

Now, if only any of the tax experts could concur on these findings... 

[Basit Siddiqi]

Everyone's tax situation is different, we also dont know how much gross rental income you will have and how much your expenses are.

A lot of people don't pay any taxes on their real estate income.

If you want $100,000 of income during the year, divide that by the months in the year(12) and divided by the amount of dollars you receive per house or door.

So if you normally get $200 a door per month and you want $100,000 a year, you would need 42 doors.

[Jeremy H.]

There is so much variability here - that's what makes it tough 

Rental income is going to be taxed as ordinary income. So you need to reduce your income. How? Deductions. What kind of deductions? Anything that is necessary and ordinary to operate your business. On top of that being a REP (Real Estate Professional) would help, if not be basically required. 

So you either need a **** ton of doors, or a ton of doors with deductions. Now how many deductions can you take? Can you buy a property or multiple properties a year, do a cost segregation study, take that big deduction in year one, and do it every year...and then never sell the property?

As a rule I estimate my net income to be half of my gross income in the long term (this is just a rule of thumb) so my guess would be somewhere in the 175k-200k range. 

[Costin I.]

@Basit Siddiqi - the question is not how many doors, and @Jeremy H.- the question is not how to bring the taxes on rental income to zero. Nor it matters what your expenses are, or depreciation is, for the purpose of this inquiry.

My question is the from the other end - how much do I need to make, after deducting expenses and depreciation (which can be variable), so that after taxes I get 100K clear?

Let's say Person 1 makes 300K in gross rental income, has 110K in deductible expenses and another 60K in depreciation, which leaves him with 130 (???) taxable income, for which he pays 30K (???) income tax, leaving him with 100K net clear.

Let's say Person 2 makes 220K in gross rental income, has 50K in deductible expenses and another 40K in depreciation, which leaves her with 130 (???) taxable income, for which he pays 30K (???) income tax, leaving him with 100K net clear.

Different people, different situations, but ultimately both clear 100K. They both end up with the same taxable income (assuming no other income from other sources, and no itemized deductions or otherwise, filling jointly married, no state tax), and after paying income tax, they end up with 100K.  The question is "what is the taxable rental/passive income, and what is the tax paid, that results in 100K after tax" ???

I want to know where (the $ figure) I need to be after rental expenses and depreciation, that after taxes will net 100K. What dollar amount taxed as passive income (assuming no other income from other sources, married filling jointly, no state tax and no itemized deductions or other than standard deduction $25,900) results in 100K after taxes?

[Costin I.]

Let's see if I got it right this time (the 132K calculation I posted 4 days ago is wrong, because that is Net to Gross Paycheck calculator, as in salary or W2 income that gets taxed for Social Security and Medicare):

My number (let's call it N) plus the standard deduction and minus the taxes owed for it should be 100K.

According to https://www.nerdwallet.com/art..., the standard deduction is a specific dollar amount that reduces your taxable income and for the 2022 tax year, the standard deduction is $25,900 for joint filers.

That means N minus the taxes = 100K - 25,900 = $74,100  (...and now I know how to calculate the taxes, what tax bracket to use)

According to https://www.nerdwallet.com/article/taxes/federal-income-tax-brackets, in 2022: Married, filling jointly, with a taxable income of $22,001 to $89,450 fall into the 12% tax rate - meaning they will pay $2,200 plus 12% of the amount over $22,000.

Put in a mathematical expression that means:

  N – [12% x (N - $22,000) + $2,200] = $100,000 - $25,900 = $74,100  

  N – 12% x N + 12% x $22,000 - $2,200 = $74,100

  88% x N = $74,100 + $2,200 - $2,640

  88% x N = $73,660

  N = ($73,660 x 100)/88

 N = 83,704 - the taxable amount after standard deduction.

 Or $109,604 (including standard deduction).

Verification:

  Applying the standard deduction for Married filling jointly of $25,900 to $109K, results in taxable 109,604 - 25,900 = $83,704

  The taxes on 83.7K are $2,200 plus 12% of the amount over $22,000, or $2,200 + 12% x (83,704 – 22,000) = $2,200 + 12% x 61,704 = 2,200 + 7,404 = $9,604 taxes

  $109,604 – 9,604 = $100,000 

That means, in 2022, if someone gets $109.6K in taxable rental income (after rental expenses and depreciation), after taxes they will get 100K clear.

The number I was looking for is $109,604. I need to get 109.6K (after substracting rental expenses and depreciation from my gross rental income), so that after paying 9.6K in taxes, I clear 100K.

Do you concur? Or am I wrong somewhere?