2

I live in California, and am considering buying a house in Vancouver, WA, to rent it out to friends. What I don't know, and seem to have trouble finding the answer to, is: how much taxes would I pay on my income from the rent they would pay me?

Would I be able to deduct the cost of the mortgage from the rental income?

If not, would I pay the ordinary income tax on that income? In particular, would I pay CA income tax on it, even though the property would be in WA?

1

how much taxes would I pay on my income from the rent they would pay me?

The same as on any other income. California doesn't have any special taxes for rental/passive income. Bothe CA and the Federal tax laws do have special treatment, but it is for losses from rental. Income is considered unearned regular income and is taxed at regular brackets.

Would I be able to deduct the cost of the mortgage from the rental income?

The cost of mortgage, yes. I.e.: the interest you pay. Similarly you can deduct any other expense needed to maintain the property. This is assuming you're renting it out at FMV.

If not, would I pay the ordinary income tax on that income? In particular, would I pay CA income tax on it, even though the property would be in WA?

Yes. Don't know how WA taxes rental income, but since you are a California tax resident - you will definitely be taxed by California on this, as part of your worldwide income.

  • Actually, I'd probably be renting it out at a bit less than FMV, would I still be able to deduct my expenses? – user4867444 Jun 23 '16 at 16:43
  • And just for the sake of completeness, there's no income tax in WA. – user4867444 Jun 23 '16 at 16:43
  • 1
    @user4867444 if you're renting below FMV, your deduction is limited to your income, you cannot have losses. – littleadv Jun 23 '16 at 16:44
3

I'd recommend you use an online tax calculator to see the effect it will have. To your comment with @littleadv, there's FMV, agreed, but there's also a rate below that. One that's a bit lower than FMV, but it's a discount for a tenant who will handle certain things on their own. I had an arm's length tenant, who was below FMV, I literally never met him. But, our agreement through a realtor, was that for any repairs, I was not required to arrange or meet repairmen. FMV is not a fixed number, but a bit of a range.

If this is your first rental, you need to be aware of the requirement to take depreciation. Simply put, you separate your cost into land and house. The house value gets depreciated by 1/27.5 (i.e. you divide the value by 27.5 and that's taken as depreciation each year. You may break even on cash flow, the rent paying the mortgage, property tax, etc, but the depreciation might still produce a loss. This isn't optional. It flows to your tax return, and is limited to $25K/yr. Further, if your adjusted gross income is over $100K, the allowed loss is phased out over the next $50K of income. i.e. each $1000 of AGI reduces the allowed loss by $500. The losses you can't take are carried forward, until you use them to offset profit each year, or sell the property.

If you offer numbers, you'll get a more detailed answer, but this is the general overview. In general, if you are paying tax, you are doing well, running a profit even after depreciation.

  • 2
    +1 for mentioning FMV as a range. Even without an explicit agreement to do property maintenance, etc., there's a difference between a deal that means "at the low end of the market rent range" and a deal that means "definitely below the market rent range". – BrenBarn Jun 23 '16 at 18:11
  • Thanks. Actually, I should have made these 2 separate thoughts. – JTP - Apologise to Monica Jun 23 '16 at 19:20
  • Thanks for this thorough answer. Not sure I get the "phasing out to $150k" part; does that mean it's not relevant if I make > $150k ? My total income already is more than that, so I can't take depreciation? – user4867444 Jun 23 '16 at 20:00
  • Awful writing by me. I edited. Let me know if that's better. – JTP - Apologise to Monica Jun 23 '16 at 20:11
-2

I use a spreadsheet for that.

I provide house value, land value, closing/fix-up costs, mortgage rate and years, tax bracket, city tax rate, insurance cost, and rental income. Sections of the spreadsheet compute (in obvious ways) the values used for the following tables:

First I look at monthly cash flow (earnings/costs) and here are the columns:

  • MINUS Loan 1 payment
  • MINUS Loan 2 payment
  • MINUS City/county taxes
  • MINUS Insurance
  • subtotal (of costs in a rentless month)
  • PLUS Rental income
  • Total monthly cash flow gain/loss, ignoring taxes.

Next section looks at changes in taxable reported income caused by the house, And this too is monthly, even though it'll be x12 when you write your 1040.

  • PLUS rental income since this reports as income
  • MINUS Loan 1 interest only (month 1 - will decrease)
  • MINUS Loan 2 interest only (month 1 - will decrease)
  • MINUS property taxes at per month rate
  • MINUS Deductible insurance (this is a fraction of total insurance cost based on how much of the building you offer for rent).
  • MINUS Depreciation (again only applies on the rentable parts)
  • TOTAL additional income (or net deductions)
  • MULTIPLY by incremental tax rate (i.e. tax bracket) and here I combine both Federal and State in one number for simplicity.
  • EQUALS Expected additional tax (or tax savings)

The third table is shows the monthly cash flow, forgetting about maintenance and assuming you adjust your quarterlies or paycheck exemptions to come out even:

  • Pre-tax earnings (costs) from above
  • MINUS additional taxes (or plus tax savings)
  • EQUALS net monthly cash flow allowing for taxes, but not maintenance.

Maintenance is so much of a wildcard that I don't attempt to include it.

My last table looks at paper (non-cash) equity gains:

  • Loan 1 principal paid down first month (will increase)
  • Loan 2 principal paid down first month (will increase)
  • Total "paper" equity gains 1st month
  • Net paper gain (including cash gains/losses)

I was asked how I compute some of those intermediate values. My user inputs (adjusted for each property) are:

  • Purchase Price, Anticipated Closing/Fixup costs, Value of Land,
  • Monthly Rental Income, Cash Down
  • First Mortage: Interest Percentage, % house value i.e. 80%, Years i.e. 30,
  • Second Mortgage: Interest %, Years,
  • incremental tax bracket (combining state+Federal), Municipal Property Tax Rate
  • my unfulfilled Standard Deduction, if I don't already itemize
  • expected Insurance costs, and percentage of building I expect to live in and NOT rent

My intermediate values are:

  • Total to finance: Sale Price + closing/fixup - Amount Down
  • 1st Mortgage Amt Financed: Minimum of Total to Finance; or; Sale Price * % Value in 1st / 100.
  • 1st Monthly Payment: Excel =-PMT(%MortgageRate/100/12,Years*12,Amount Financed)
  • Amount Financed 2nd Mortg.: Total to finance - Amount Financed 1st Mort.
  • 2nd Monthly Payment: Excel =-PMT(%MortgageRate/100/12,Years*12,Amount Financed)
  • Monthly Std Deduction: Standard Deduction / 12
  • City taxes per year: Sale Price * Tax Rate% / 100 (or /1000 if you do millage)
  • City taxes per month: City taxes per year / 12
  • Monthly insurance: Annual insurance / 12
  • % of building you intend to rent: 100 - % of building you live in
  • Deductible part of insurance per month: Monthly insurance * % you rent / 100
  • Value of improvements (over bare land): Sale price - land value
  • Depreciation Deductible: Value of Improvements * % you rent / 100
  • Depreciation Deductible Per Year over 27.5 years: Depreciation Deductible / 27.5
  • Depreciation Deductible Per Month: Depreciation per year / 12
  • Very interesting, thanks. Any chance you could spare said spreadsheet? – user4867444 Jun 26 '16 at 19:47
  • It has some glitchy stuff that makes sense to me but isn't really fit for publication... I'd just get downvotes if I did. (like I compute the second section in the negative, plus deductions minus rental income, and I have a factor for subtracting out standard deduction, because itemizing isn't helpful until you exceed that, but that seems stupid.) – Harper - Reinstate Monica Jun 27 '16 at 0:46
  • See what I mean about the downvotes ---- So are those because I won't post it, or because what I did post is wrong? I could polish it up, but honestly I'm not entirely sure how to post a spreadsheet. – Harper - Reinstate Monica Jun 27 '16 at 10:04

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.