Tax Tip Thursday

For those of you who have a rental property (or considering taking one on), make sure you are evaluating cash flow AND taxable income.

Cash flow is NOT taxable income and the financial differences could be significant.

If you have (or are planning) a rental property that breaks even every month, you figure you are good and will NOT have an income tax bill. That is most likely wrong.

Quick Example

Rent: $2,000/mo

Expenses:

• Mortgage: $1,500/mo
• Property Taxes: $400/mo
• Insurance & Bank Fees: $100/mo

Total Expenses: $2,000/mo

Net: $0/mo

Look at at that, your rents are covering your expenses! That works out perfectly!

The problem is that your total mortgage payment of $1500 is not all deductible; only the interest is deductible.

Your interest might only be $1000 of the $1500. This means in a year, you will pay $18k in mortgage payments, but only the $12k in interest is deductible.

This means that you are going to be paying tax on the $6000 difference at tax time. Depending on your tax bracket, you could be paying as much as $3000 in taxes on that amount! The longer you have owned the house, the higher the probability that this will happen, and the numbers will get worse and worse every year!

What Can You Do?

Really only a couple of strategies for an existing tenant situation:

1. Restructure your mortgage such that your payments have a higher interest component (which makes more of it deductible). I am working with a client right now and we are considering this strategy.
2. Put aside some of the money each month to cover your tax bill at year-end.

The long and the short of it is that just because you are breaking even on the monthly payments does not mean that you will break even for tax purposes. Know that there is most likely a tax bill coming your way at the end of the year. Like I always say, be prepared!

Considering a Rental Property?

For those who have never owned a rental property or run the numbers (both for cashflow and taxable income), you should know that there are a ton of costs associated with owning one. Maintenance, repairs, roofs, appliances, furnaces, etc.

AND, even just a $500,000 mortgage can cost you $2,500 per month in mortgage payments. Add on property taxes and insurance and you will be looking at over $3,000 per month. Then know that there will be a tax bill coming at the end of the year for some of that!

Do Your Math, Be Prepared

Do you already own a rental property? How did tax season go last year? Make sure you hire an accountant to help you prepare your taxes so there are no surprises!

Are you considering investing in a rental property? It’s not an easy venture! If it were, everyone would do it. If you would like some help evaluating your business model for a rental property, please book your appointment today.

Disclaimer:

This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal or tax advice nor can it or should it be relied upon. All tax situations are specific to each individual. If you have specific tax questions you should book an appointment for a 1 on 1 consultation.