Buying a Rental

[waitingpatiently]

Hey guys just trying to run numbers and need some help. Along with our house we are thinking about buying a rental. Other than mortgage, insurance and HOA’s, what other costs are associated with having a rental? What sort of tax deductions can we make? We are looking for a 3/2sfr in the Shadowridge area of Vista, which are renting for about 1800-2000.

And no we aren’t buying yet…I just want to start educating myself 🙂

WP

[blue_sky]

Costs, all of which are deductible vs your rental income:

Property Tax
Mortgage Interest
Insurance
Utilities not paid by tenant
Maintenance
Cleaning
Advertising
Property Management if you use a service
Bounced check fees, collection fees, court costs, etc

Note that when (not if) you have a rental loss, you get to suck it down, you can’t apply it against your regular income.

Things which must be depreciated:

Closing costs
Improvements

In your projections make sure you include allowances for vacancy, in SoCal that’s somewhere between 5-10%.

Do you understand what Cap Rate means? If not, go learn it. I don’t buy property at less than a 10% cap rate. You won’t find anything like that around San Diego though, you’ll be lucky if you get 5%.

If you need a starter, buy this: http://www.johntreed.com/HGS.html

[blue_sky]

Costs, all of which are deductible vs your rental income:

Property Tax
Mortgage Interest
Insurance
Utilities not paid by tenant
Maintenance
Cleaning
Advertising
Property Management if you use a service
Bounced check fees, collection fees, court costs, etc

Note that when (not if) you have a rental loss, you get to suck it down, you can’t apply it against your regular income.

Things which must be depreciated:

Closing costs
Improvements

In your projections make sure you include allowances for vacancy, in SoCal that’s somewhere between 5-10%.

Do you understand what Cap Rate means? If not, go learn it. I don’t buy property at less than a 10% cap rate. You won’t find anything like that around San Diego though, you’ll be lucky if you get 5%.

If you need a starter, buy this: http://www.johntreed.com/HGS.html

[blue_sky]

Costs, all of which are deductible vs your rental income:

Property Tax
Mortgage Interest
Insurance
Utilities not paid by tenant
Maintenance
Cleaning
Advertising
Property Management if you use a service
Bounced check fees, collection fees, court costs, etc

Note that when (not if) you have a rental loss, you get to suck it down, you can’t apply it against your regular income.

Things which must be depreciated:

Closing costs
Improvements

In your projections make sure you include allowances for vacancy, in SoCal that’s somewhere between 5-10%.

Do you understand what Cap Rate means? If not, go learn it. I don’t buy property at less than a 10% cap rate. You won’t find anything like that around San Diego though, you’ll be lucky if you get 5%.

If you need a starter, buy this: http://www.johntreed.com/HGS.html

[blue_sky]

Costs, all of which are deductible vs your rental income:

Property Tax
Mortgage Interest
Insurance
Utilities not paid by tenant
Maintenance
Cleaning
Advertising
Property Management if you use a service
Bounced check fees, collection fees, court costs, etc

Note that when (not if) you have a rental loss, you get to suck it down, you can’t apply it against your regular income.

Things which must be depreciated:

Closing costs
Improvements

In your projections make sure you include allowances for vacancy, in SoCal that’s somewhere between 5-10%.

Do you understand what Cap Rate means? If not, go learn it. I don’t buy property at less than a 10% cap rate. You won’t find anything like that around San Diego though, you’ll be lucky if you get 5%.

If you need a starter, buy this: http://www.johntreed.com/HGS.html

[blue_sky]

Costs, all of which are deductible vs your rental income:

Property Tax
Mortgage Interest
Insurance
Utilities not paid by tenant
Maintenance
Cleaning
Advertising
Property Management if you use a service
Bounced check fees, collection fees, court costs, etc

Note that when (not if) you have a rental loss, you get to suck it down, you can’t apply it against your regular income.

Things which must be depreciated:

Closing costs
Improvements

In your projections make sure you include allowances for vacancy, in SoCal that’s somewhere between 5-10%.

Do you understand what Cap Rate means? If not, go learn it. I don’t buy property at less than a 10% cap rate. You won’t find anything like that around San Diego though, you’ll be lucky if you get 5%.

If you need a starter, buy this: http://www.johntreed.com/HGS.html

[surveyor]

tax deductions

Don’t forget the biggest tax deduction of all: depreciation of the property itself (the value of the property minus the cost of the land).

There are also chattel depreciation, which allows you to depreciate items such as carpet/floors, appliances.

There are other tax deductions you can access once you start running a real estate business (which you are essentially doing when you are renting out properties) such as the home office tax deduction.

Note that when (not if) you have a rental loss, you get to suck it down, you can’t apply it against your regular income.

I don’t think that’s correct. Here’s the IRS’s take on it:

“Losses From Rental Real Estate Activities

If you or your spouse actively participated in a passive rental real estate activity, you can deduct up to $25,000 of loss from the activity from your nonpassive income. This special allowance is an exception to the general rule disallowing losses in excess of income from passive activities. Similarly, you can offset credits from the activity against the tax on up to $25,000 of nonpassive income after taking into account any losses allowed under this exception.

If you are married, filing a separate return, and lived apart from your spouse for the entire tax year, your special allowance cannot be more than $12,500. If you lived with your spouse at any time during the year and are filing a separate return, you cannot use the special allowance to reduce your nonpassive income or tax on nonpassive income.

The maximum amount of the special allowance is reduced if your modified adjusted gross income is more than $100,000 ($50,000 if married filing separately).

Example.

Jane is single and has $40,000 in wages, $2,000 of passive income from a limited partnership, and $3,500 of passive loss from a rental real estate activity in which she actively participated. $2,000 of Jane’s $3,500 loss offsets her passive income. The remaining $1,500 loss can be deducted from her $40,000 wages.
Active participation. You actively participated in a rental real estate activity if you (and your spouse) owned at least 10% of the rental property and you made management decisions in a significant and bona fide sense. Management decisions include approving new tenants, deciding on rental terms, approving expenditures, and similar decisions.

Example.

Mike is single and had the following income and losses during the tax year:
Salary $42,300
Dividends 300
Interest 1,400
Rental loss (4,000)

The rental loss resulted from the rental of a house Mike owned. Mike had advertised and rented the house to the current tenant himself. He also collected the rents, which usually came by mail. All repairs were either done or contracted out by Mike.

Even though the rental loss is a loss from a passive activity, because Mike actively participated in the rental property management, he can use the entire $4,000 loss to offset his other income.”

As long as you qualify, you should be able to deduct rental losses against your normal/active income.

In any case, anyone who is going into the rental business should really do more research. I recommend the book “Real Estate Investing Loopholes” (http://www.amazon.com/Insiders-Guide-Estate-Investing-Loopholes/dp/0471711799/ref=sr_1_6?ie=UTF8&s=books&qid=1211235006&sr=8-6) and Lisa Vander’s “The Real Guide to Making Millions in Real Estate” (http://www.amazon.com/Guide-Making-Millions-Through-Estate/dp/1932531785/ref=sr_1_1?ie=UTF8&s=books&qid=1211235053&sr=1-1).

[surveyor]

tax deductions

Don’t forget the biggest tax deduction of all: depreciation of the property itself (the value of the property minus the cost of the land).

There are also chattel depreciation, which allows you to depreciate items such as carpet/floors, appliances.

There are other tax deductions you can access once you start running a real estate business (which you are essentially doing when you are renting out properties) such as the home office tax deduction.

Note that when (not if) you have a rental loss, you get to suck it down, you can’t apply it against your regular income.

I don’t think that’s correct. Here’s the IRS’s take on it:

“Losses From Rental Real Estate Activities

If you or your spouse actively participated in a passive rental real estate activity, you can deduct up to $25,000 of loss from the activity from your nonpassive income. This special allowance is an exception to the general rule disallowing losses in excess of income from passive activities. Similarly, you can offset credits from the activity against the tax on up to $25,000 of nonpassive income after taking into account any losses allowed under this exception.

If you are married, filing a separate return, and lived apart from your spouse for the entire tax year, your special allowance cannot be more than $12,500. If you lived with your spouse at any time during the year and are filing a separate return, you cannot use the special allowance to reduce your nonpassive income or tax on nonpassive income.

The maximum amount of the special allowance is reduced if your modified adjusted gross income is more than $100,000 ($50,000 if married filing separately).

Example.

Jane is single and has $40,000 in wages, $2,000 of passive income from a limited partnership, and $3,500 of passive loss from a rental real estate activity in which she actively participated. $2,000 of Jane’s $3,500 loss offsets her passive income. The remaining $1,500 loss can be deducted from her $40,000 wages.
Active participation. You actively participated in a rental real estate activity if you (and your spouse) owned at least 10% of the rental property and you made management decisions in a significant and bona fide sense. Management decisions include approving new tenants, deciding on rental terms, approving expenditures, and similar decisions.

Example.

Mike is single and had the following income and losses during the tax year:
Salary $42,300
Dividends 300
Interest 1,400
Rental loss (4,000)

The rental loss resulted from the rental of a house Mike owned. Mike had advertised and rented the house to the current tenant himself. He also collected the rents, which usually came by mail. All repairs were either done or contracted out by Mike.

Even though the rental loss is a loss from a passive activity, because Mike actively participated in the rental property management, he can use the entire $4,000 loss to offset his other income.”

As long as you qualify, you should be able to deduct rental losses against your normal/active income.

In any case, anyone who is going into the rental business should really do more research. I recommend the book “Real Estate Investing Loopholes” (http://www.amazon.com/Insiders-Guide-Estate-Investing-Loopholes/dp/0471711799/ref=sr_1_6?ie=UTF8&s=books&qid=1211235006&sr=8-6) and Lisa Vander’s “The Real Guide to Making Millions in Real Estate” (http://www.amazon.com/Guide-Making-Millions-Through-Estate/dp/1932531785/ref=sr_1_1?ie=UTF8&s=books&qid=1211235053&sr=1-1).

[surveyor]

tax deductions

Don’t forget the biggest tax deduction of all: depreciation of the property itself (the value of the property minus the cost of the land).

There are also chattel depreciation, which allows you to depreciate items such as carpet/floors, appliances.

There are other tax deductions you can access once you start running a real estate business (which you are essentially doing when you are renting out properties) such as the home office tax deduction.

Note that when (not if) you have a rental loss, you get to suck it down, you can’t apply it against your regular income.

I don’t think that’s correct. Here’s the IRS’s take on it:

“Losses From Rental Real Estate Activities

If you or your spouse actively participated in a passive rental real estate activity, you can deduct up to $25,000 of loss from the activity from your nonpassive income. This special allowance is an exception to the general rule disallowing losses in excess of income from passive activities. Similarly, you can offset credits from the activity against the tax on up to $25,000 of nonpassive income after taking into account any losses allowed under this exception.

If you are married, filing a separate return, and lived apart from your spouse for the entire tax year, your special allowance cannot be more than $12,500. If you lived with your spouse at any time during the year and are filing a separate return, you cannot use the special allowance to reduce your nonpassive income or tax on nonpassive income.

The maximum amount of the special allowance is reduced if your modified adjusted gross income is more than $100,000 ($50,000 if married filing separately).

Example.

Jane is single and has $40,000 in wages, $2,000 of passive income from a limited partnership, and $3,500 of passive loss from a rental real estate activity in which she actively participated. $2,000 of Jane’s $3,500 loss offsets her passive income. The remaining $1,500 loss can be deducted from her $40,000 wages.
Active participation. You actively participated in a rental real estate activity if you (and your spouse) owned at least 10% of the rental property and you made management decisions in a significant and bona fide sense. Management decisions include approving new tenants, deciding on rental terms, approving expenditures, and similar decisions.

Example.

Mike is single and had the following income and losses during the tax year:
Salary $42,300
Dividends 300
Interest 1,400
Rental loss (4,000)

The rental loss resulted from the rental of a house Mike owned. Mike had advertised and rented the house to the current tenant himself. He also collected the rents, which usually came by mail. All repairs were either done or contracted out by Mike.

Even though the rental loss is a loss from a passive activity, because Mike actively participated in the rental property management, he can use the entire $4,000 loss to offset his other income.”

As long as you qualify, you should be able to deduct rental losses against your normal/active income.

In any case, anyone who is going into the rental business should really do more research. I recommend the book “Real Estate Investing Loopholes” (http://www.amazon.com/Insiders-Guide-Estate-Investing-Loopholes/dp/0471711799/ref=sr_1_6?ie=UTF8&s=books&qid=1211235006&sr=8-6) and Lisa Vander’s “The Real Guide to Making Millions in Real Estate” (http://www.amazon.com/Guide-Making-Millions-Through-Estate/dp/1932531785/ref=sr_1_1?ie=UTF8&s=books&qid=1211235053&sr=1-1).

[surveyor]

tax deductions

Don’t forget the biggest tax deduction of all: depreciation of the property itself (the value of the property minus the cost of the land).

There are also chattel depreciation, which allows you to depreciate items such as carpet/floors, appliances.

There are other tax deductions you can access once you start running a real estate business (which you are essentially doing when you are renting out properties) such as the home office tax deduction.

Note that when (not if) you have a rental loss, you get to suck it down, you can’t apply it against your regular income.

I don’t think that’s correct. Here’s the IRS’s take on it:

“Losses From Rental Real Estate Activities

If you or your spouse actively participated in a passive rental real estate activity, you can deduct up to $25,000 of loss from the activity from your nonpassive income. This special allowance is an exception to the general rule disallowing losses in excess of income from passive activities. Similarly, you can offset credits from the activity against the tax on up to $25,000 of nonpassive income after taking into account any losses allowed under this exception.

If you are married, filing a separate return, and lived apart from your spouse for the entire tax year, your special allowance cannot be more than $12,500. If you lived with your spouse at any time during the year and are filing a separate return, you cannot use the special allowance to reduce your nonpassive income or tax on nonpassive income.

The maximum amount of the special allowance is reduced if your modified adjusted gross income is more than $100,000 ($50,000 if married filing separately).

Example.

Jane is single and has $40,000 in wages, $2,000 of passive income from a limited partnership, and $3,500 of passive loss from a rental real estate activity in which she actively participated. $2,000 of Jane’s $3,500 loss offsets her passive income. The remaining $1,500 loss can be deducted from her $40,000 wages.
Active participation. You actively participated in a rental real estate activity if you (and your spouse) owned at least 10% of the rental property and you made management decisions in a significant and bona fide sense. Management decisions include approving new tenants, deciding on rental terms, approving expenditures, and similar decisions.

Example.

Mike is single and had the following income and losses during the tax year:
Salary $42,300
Dividends 300
Interest 1,400
Rental loss (4,000)

The rental loss resulted from the rental of a house Mike owned. Mike had advertised and rented the house to the current tenant himself. He also collected the rents, which usually came by mail. All repairs were either done or contracted out by Mike.

Even though the rental loss is a loss from a passive activity, because Mike actively participated in the rental property management, he can use the entire $4,000 loss to offset his other income.”

As long as you qualify, you should be able to deduct rental losses against your normal/active income.

In any case, anyone who is going into the rental business should really do more research. I recommend the book “Real Estate Investing Loopholes” (http://www.amazon.com/Insiders-Guide-Estate-Investing-Loopholes/dp/0471711799/ref=sr_1_6?ie=UTF8&s=books&qid=1211235006&sr=8-6) and Lisa Vander’s “The Real Guide to Making Millions in Real Estate” (http://www.amazon.com/Guide-Making-Millions-Through-Estate/dp/1932531785/ref=sr_1_1?ie=UTF8&s=books&qid=1211235053&sr=1-1).

[surveyor]

tax deductions

Don’t forget the biggest tax deduction of all: depreciation of the property itself (the value of the property minus the cost of the land).

There are also chattel depreciation, which allows you to depreciate items such as carpet/floors, appliances.

There are other tax deductions you can access once you start running a real estate business (which you are essentially doing when you are renting out properties) such as the home office tax deduction.

Note that when (not if) you have a rental loss, you get to suck it down, you can’t apply it against your regular income.

I don’t think that’s correct. Here’s the IRS’s take on it:

“Losses From Rental Real Estate Activities

If you or your spouse actively participated in a passive rental real estate activity, you can deduct up to $25,000 of loss from the activity from your nonpassive income. This special allowance is an exception to the general rule disallowing losses in excess of income from passive activities. Similarly, you can offset credits from the activity against the tax on up to $25,000 of nonpassive income after taking into account any losses allowed under this exception.

If you are married, filing a separate return, and lived apart from your spouse for the entire tax year, your special allowance cannot be more than $12,500. If you lived with your spouse at any time during the year and are filing a separate return, you cannot use the special allowance to reduce your nonpassive income or tax on nonpassive income.

The maximum amount of the special allowance is reduced if your modified adjusted gross income is more than $100,000 ($50,000 if married filing separately).

Example.

Jane is single and has $40,000 in wages, $2,000 of passive income from a limited partnership, and $3,500 of passive loss from a rental real estate activity in which she actively participated. $2,000 of Jane’s $3,500 loss offsets her passive income. The remaining $1,500 loss can be deducted from her $40,000 wages.
Active participation. You actively participated in a rental real estate activity if you (and your spouse) owned at least 10% of the rental property and you made management decisions in a significant and bona fide sense. Management decisions include approving new tenants, deciding on rental terms, approving expenditures, and similar decisions.

Example.

Mike is single and had the following income and losses during the tax year:
Salary $42,300
Dividends 300
Interest 1,400
Rental loss (4,000)

The rental loss resulted from the rental of a house Mike owned. Mike had advertised and rented the house to the current tenant himself. He also collected the rents, which usually came by mail. All repairs were either done or contracted out by Mike.

Even though the rental loss is a loss from a passive activity, because Mike actively participated in the rental property management, he can use the entire $4,000 loss to offset his other income.”

As long as you qualify, you should be able to deduct rental losses against your normal/active income.

In any case, anyone who is going into the rental business should really do more research. I recommend the book “Real Estate Investing Loopholes” (http://www.amazon.com/Insiders-Guide-Estate-Investing-Loopholes/dp/0471711799/ref=sr_1_6?ie=UTF8&s=books&qid=1211235006&sr=8-6) and Lisa Vander’s “The Real Guide to Making Millions in Real Estate” (http://www.amazon.com/Guide-Making-Millions-Through-Estate/dp/1932531785/ref=sr_1_1?ie=UTF8&s=books&qid=1211235053&sr=1-1).

[(former)FormerSanDiegan]

surveyor is correct. You can deduct up to 25K of losses from real estate against regular income, up to income limits. Starts phasing out at 100K and completely phases out at 150K. Different rules apply for real estate professionals. These losses may be carried forward to future years and may be used against passive income (no limit) or against regular income up to the limits described above. Also, they may be used when the property is sold.

If you exceed these income limits … After owning rentals for a number of years, it is pretty easy to build up 10’s of thousands of dollars in carryover losses, even on properties that break even after taxes due to the depreciation. These losses you build up in early years of ownership translate into tax free cash in later years as you either pay off the loan or rents increase. If you think tax rates will be higher 20 years from now, carryover losses may not be a bad thing.

One other aspect you should get familiar with is loan eligibility and requirements. This is changing and likely to revert back to the more conservative end, particularly for better rates. Lenders have typically included 75% of the gross rental income when computing debt-to-income ratios. Also, down payment requirements for the best rates are likely to be in the 20-30% range.

[(former)FormerSanDiegan]

surveyor is correct. You can deduct up to 25K of losses from real estate against regular income, up to income limits. Starts phasing out at 100K and completely phases out at 150K. Different rules apply for real estate professionals. These losses may be carried forward to future years and may be used against passive income (no limit) or against regular income up to the limits described above. Also, they may be used when the property is sold.

If you exceed these income limits … After owning rentals for a number of years, it is pretty easy to build up 10’s of thousands of dollars in carryover losses, even on properties that break even after taxes due to the depreciation. These losses you build up in early years of ownership translate into tax free cash in later years as you either pay off the loan or rents increase. If you think tax rates will be higher 20 years from now, carryover losses may not be a bad thing.

One other aspect you should get familiar with is loan eligibility and requirements. This is changing and likely to revert back to the more conservative end, particularly for better rates. Lenders have typically included 75% of the gross rental income when computing debt-to-income ratios. Also, down payment requirements for the best rates are likely to be in the 20-30% range.

[(former)FormerSanDiegan]

surveyor is correct. You can deduct up to 25K of losses from real estate against regular income, up to income limits. Starts phasing out at 100K and completely phases out at 150K. Different rules apply for real estate professionals. These losses may be carried forward to future years and may be used against passive income (no limit) or against regular income up to the limits described above. Also, they may be used when the property is sold.

If you exceed these income limits … After owning rentals for a number of years, it is pretty easy to build up 10’s of thousands of dollars in carryover losses, even on properties that break even after taxes due to the depreciation. These losses you build up in early years of ownership translate into tax free cash in later years as you either pay off the loan or rents increase. If you think tax rates will be higher 20 years from now, carryover losses may not be a bad thing.

One other aspect you should get familiar with is loan eligibility and requirements. This is changing and likely to revert back to the more conservative end, particularly for better rates. Lenders have typically included 75% of the gross rental income when computing debt-to-income ratios. Also, down payment requirements for the best rates are likely to be in the 20-30% range.

[(former)FormerSanDiegan]

surveyor is correct. You can deduct up to 25K of losses from real estate against regular income, up to income limits. Starts phasing out at 100K and completely phases out at 150K. Different rules apply for real estate professionals. These losses may be carried forward to future years and may be used against passive income (no limit) or against regular income up to the limits described above. Also, they may be used when the property is sold.

If you exceed these income limits … After owning rentals for a number of years, it is pretty easy to build up 10’s of thousands of dollars in carryover losses, even on properties that break even after taxes due to the depreciation. These losses you build up in early years of ownership translate into tax free cash in later years as you either pay off the loan or rents increase. If you think tax rates will be higher 20 years from now, carryover losses may not be a bad thing.

One other aspect you should get familiar with is loan eligibility and requirements. This is changing and likely to revert back to the more conservative end, particularly for better rates. Lenders have typically included 75% of the gross rental income when computing debt-to-income ratios. Also, down payment requirements for the best rates are likely to be in the 20-30% range.

[Author]

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