US standard fixed rate mortgage on a rental property. If rent is $X/month and all in mortgage is also $X/month, it would suck to need to pay income tax on $X x 12 for the year, when it all went towards paying the mortgage. Thankfully, I can count depreciation against the income to net it to $0 liability at tax time. This is great, but what happens when the depreciation is fully utilized? Outside of raising rent such that the net proceeds equal the amount due at tax time, or throttling the depreciation taken such that I am liable for a manageable Y% of the ($X x 12)’s tax liability for a longer time period, can anything be done here? I get that I gain in terms of equity in the home even with tax-net negative cash flow, but this would be quite straining from a month to month cash perspective. This seems like it would be a common issue for most rental property owners… how is this typically handled? Or can nothing be done?
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17It's a business like any other business. Income gets taxed. If you aren't making a profit on the property after taxes despite (presumed) appreciation, you have the option of selling it and getting out of the rental business, or raising rent until you do, or...– keshlamCommented Mar 25, 2023 at 22:30
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You can sell that property and buy a new one that you can depreciate. The one you sell will incur taxes to recapture the depreciation.– Ross MillikanCommented Mar 27, 2023 at 4:42
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@RossMillikan depreciation recapture is at fixed 25% rate, which is higher than LTCG rates (can be 0%, depending on your total income, and capped at 20%).– littleadvCommented Mar 27, 2023 at 4:44
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2What a whacky world we live in, where paying a mortgage is seeing as purely an expense, as if it were wages or utility bills. You're building equity in your house. Your expense is the interest you're paying on top, but the principle portion of the payments is essentially a kind of forced-savings account.– AlexanderCommented Mar 27, 2023 at 11:36
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you don't accrue equity as you repay your mortgage? you don't consider that this retained value is an income?– njzk2Commented Mar 27, 2023 at 21:25
2 Answers
Several comments first:
If rent is $X/month and all in mortgage is also $X/month, it would suck to need to pay income tax on $X x 12 for the year, when it all went towards paying the mortgage
This is incorrect. The $X/month mortgage payment includes at least two components: interest and principal. Sometimes there's also escrow for insurance and/or property taxes, and PMI if applies. All these components except for principal are tax deductible and reduce your taxable rent income. So with $X in rents and $X in mortgage payments, there's a $Y (<$X) which you don't pay taxes on because it is a deductible expense.
Thankfully, I can count depreciation against the income to net it to $0 liability at tax time. This is great, but what happens when the depreciation is fully utilized? Outside
Usually depreciation on residential rental properties in the US is 27.5 years. Mortgages are usually <30 years. So you have at most 2.5 years of such gap, at the end of your mortgage, almost 3 decades after purchasing the property. If by that time your rent is still the same as your mortgage payments - you have a much bigger problem.
or throttling the depreciation taken
I'm not familiar with such a concept. Depreciation is a formula that doesn't not depend on your cash flow or income/expense balance. You do get PAL that you can accumulate in worse years and deduct in better years, though.
can anything be done here?
Sell the property or refinance the mortgage to make payments affordable.
This seems like it would be a common issue for most rental property owners… how is this typically handled?
I have yet to meet a homeowner who 30 years after purchasing a property is still struggling with negative cash flow. There may be some, but that means that they can't chose a property or price their rents right. If the property is losing money for you - lose the property.
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1If he's in negative cash flow he almost certainly has repairs to deduct; but that won't get him out of negative.– JoshuaCommented Mar 27, 2023 at 20:11
Renovate an apartment, then use the receipts for the supplies & time worked as a deduction for taxes. It decreases your capital gains and increases your property value.
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You cannot deduct time. To use the receipts to deduct you need to first spend the money. The OP's problem is cashflow, so spending money doesn't really help solving that. Commented Mar 27, 2023 at 4:42
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Yes, but if he renovates an apartment he can raise the rent. That would add cash flow. Commented Mar 27, 2023 at 5:08
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Why do you need to renovate an apartment to be able to raise rent? If you're talking about investors' hellholes like San Francisco - then just don't invest there. But in the end it all boils down to understanding that rental investment is a business and needs to be treated as such. If you don't have a business plan you're going to have a bad time. Commented Mar 27, 2023 at 5:35