Question re: Income stream preferences

[scrabbler1]

About 40% of my non-IRA investment income (for 2011) is not subject to federal income taxes. Some of it is Qualified Dividends from my stock mutual fund. Some of it is long-term cap gains income. And some of it is from muni bonds. Most of this income (except for the in-state muni bonds), however, is subject to state income taxes.

The rest of the income is from dividends from a taxable bond fund and from short-term cap gains distributions.

Then I have a blob of income in my IRA which is not subject to any taxes (yet).

 

[Meadbh]

I can't answer the question, because I don't think the answer is one or the other, but a combination of both (sorry).

I am in a similar position. I currently own 3 rental properties (managed, as yours are) and my plan is to pay down 1 or 2 of them prior to ER, so that the income will pay down the third one toute de suite. at which point I will have a nice income stream. which in turn will protect my equity portfolio from the ravages of having to withdraw during downturns.

 

[l2ridehd]

The correct answer is both. I own rental properties, stocks and bonds. The rental properties provide tax advantages while income is high, equity build that someone else pays for, and I can chose to manage or hire that if I need income swing. I would hold all 3 rentals, continue to make those improvements and updates, continue to build equity, pay down the mortgage on at least one while still working, then use that income to pay down the others and set them up as an income stream once retired. Set up the timing of that schedule to minimize taxes and have all the benefits of diversification that holding both provides. You can always sell them if you get tired of owning them. Until then, let someone else build the equity value for you.

 

[WestLake]

Dallas is a good place to own property but also consider the upside potential for appreciation or danger of stagnation. We are talking about the location in the market.
Appreciation is flat to nil in some of the suburbs while close-in East Dallas with good schools has had double digit increases (16% and 12% the last two quarters).
33 homebuilders have gone broke on the edge of the suburbs and if your properties are there they will eventually have the competition of very new homes when it comes time to sell.
In addition traditionally stable suburbs such as Plano have shown signs of school turmoil and aging infrastructure. Also it has been in the news for previously unheard of crime.

 

[sheehs1]

I"m curious to how those of you with rental properties that are paid off handle the positive cash flow situation and income taxes. I did not buy rental properties when I was younger. Have been tempted to do so recently. BUT....every time I look at it...and weigh the burden of the management, the probable maintenance cost and the tax on the positive cash flow...I get put off. I would not buy student housing type property or anything like that so it would have to be decent housing that I would not mind living in if I had to. What am I missing?

For example:

$200,000 piece of rental property that is paid off with rents at $1,200 a month = $14,400 a year. $14,400 minus $2,500 property taxes and $1,000 homeowners = $10,900. If it is rented utilities can be paid by the renter. If it is not rented utilities become the owners burden so...let's say you have to have a buffer just in case. I'd say close to $150 a month = $1800. So $10,900 minus the possible utility bills = $9,100. No way to account for maintenance but just to know there will be some.
So let's just say the rental generates $10,000 a year net positive cash flow but you have to pay tax on it at 18%. The $10,000 becomes $8,200.

Take that same $200,000 equity in the rental and invest it in a tax free vehicle paying 5% = $10,000 tax free.

I think we all know what the risks are of each so I won't go into that.

Aside from buying early enough to have the renters help build equity and from the possible appreciation of said property over 20 years (which we may or may not see again for a while). (Heck it takes at least 10 years to start building any worthwhile equity anyway. ) AND assuming the stock market investment gives constant tax free dividend yields, what am I missing from a purely one on one "income stream" generation stand point?

 

[pimpmyretirement]

80k per year is a pretty comfortable spending level. You've probably got room to reduce that if times get tight or you want to start with a lower withdrawal rate.

Real estate does not appeal to me at all. Too much volatility.

 

[l2ridehd]

sheehs1

One thing your missing is that real estate as a rental is a depreciating asset. Assign a 30 year life and your 200K property has a tax deduction of $6600 a year plus all those expenses your deducting from gross income are also operating expense. My 3 rentals have a net positive cash flow and I still have them mortgaged as I am currently in a high tax bracket, but also have a negative return from a tax point of view. When you file your taxes, income equals all rent, and everything else, taxes, interest, utilities repairs, advertising, other and depreciation is deducted from that income.

So as long as I keep my net income below the expenses minus 1/30th of the value, no taxes. When I sell, I will have to account for that as a capital gain, but hopefully I will be in a much lower tax bracket when and if I decide to do that.

 

[sheehs1]

sheehs1

One thing your missing is that real estate as a rental is a depreciating asset. Assign a 30 year life and your 200K property has a tax deduction of $6600 a year plus all those expenses your deducting from gross income are also operating expense. My 3 rentals have a net positive cash flow and I still have them mortgaged as I am currently in a high tax bracket, but also have a negative return from a tax point of view. When you file your taxes, income equals all rent, and everything else, taxes, interest, utilities repairs, advertising, other and depreciation is deducted from that income.

So as long as I keep my net income below the expenses minus 1/30th of the value, no taxes. When I sell, I will have to account for that as a capital gain, but hopefully I will be in a much lower tax bracket when and if I decide to do that.

You are right. I forgot to include depreciation.
It's my understanding that for a joint tax return those making under $150K can deduct $25K in rental losses (where expenses are greater than income) and for those jointly making over $150K the allowed loss level is $15,000.

What goes back into your pocket in "real" terms? The $6,600 in depreciation?

 

[ERD50]

Assumptions:
1. Real estate is managed by a RE management company. Income is passive income.

I suspect that your assumption is flawed. I can't imagine owning rental properties and not needing to be active in it, even with a mgt co handling day-to-day stuff.

CEOs have staff to handle operations, but I don't think most of them could be viewed as earning 'passive' income - they are running a business!


-ERD50

 

[l2ridehd]

What goes in your pocket is total income - total expenses. What is taxed is total income - total expenses - depreciation. What is added to net worth is total income - total expense plus equity build. I work at keeping the taxable portion at a negative number. Add improvements, pay down mortgage, advertise, at some point will buy another property, do things to avoid adding to tax liability. I retire early in 2012 and will adjust that plan a little with the reduced income. I will maximize the income stream up to the tax bracket I hit with pension income.

My over all plan will be to start paying off the mortgage and use the rents for part of retirement income allowing me to delay SS. I manage the properties myself (2) and will probably add a third sometime soon. Three will be enough to keep me busy one day a week so I can ease into retirement a little.

I don't count my primary home in any AA, but I do count a low assigned value for the rentals. I also try to keep physical real estate investment value below 20% of total invest-able assets.

 

[Lisa99]

I suspect that your assumption is flawed. I can't imagine owning rental properties and not needing to be active in it, even with a mgt co handling day-to-day stuff.

CEOs have staff to handle operations, but I don't think most of them could be viewed as earning 'passive' income - they are running a business!


-ERD50

Passive income is the IRS definition. We do not actively participate in managing the property so it is passive income, not earned income.

And we've owned the properties for over 6 years. I pay the mortgages (which are on auto-pay), but the management company literally does everything else.

 

[Finance Dave]

Would you prefer your retirement income stream to come from rental properties or stock market investments? To keep the analysis simple, please make a binary answer: RE or stock market investments. Also, please include why you made your choice.

Assumptions:
1. Real estate is managed by a RE management company. Income is passive income.
2. Income is the same after tax for both the real estate and stock market choices.


Reason for my question: we will be early retiring in 4.5 years and have started analyzing income stream sources. We have three rental properties, that when paid off, would provide about 70% of our income needs (we have more than sufficient market investments now to make up the other 30%). To pay the rentals off we would have to stop investing in the market and put all excess money into paying off the rentals.

(OR)

We can sell the rentals now and put the profits into the stock market.

So, the reason for my question, RE or market investments, is to gleen what analysis I should be doing to determine the right course.

First I'll start with the binary answer, RE.

But....

to me it depends...I prefer some diversification...so if you all you have currently in RE, then I'd vote for equities. Another factor might be the market you're in...will property values hold or increase there? I know it's difficult to predict, but IMO if you're in an area that's already suffered a 40% drop, I doubt they'd go down another 40%...although it may take quite some time to increase.

Why did I pick RE? because ...

1) I already have a lot of equities.
2) People always need a place to live
3) RE is a tangible asset....IMO it will always have some value as a result
4) You have more control over the value of RE IMO...whereas with stocks your value could be wiped out by one greedy CEO, one drug that the FDA finds is dangerous, or one product that causes fires/explosions.

 

[Lisa99]

Thanks for the insight FinanceDave. We too have a lot of equities as well as the RE. I would never sell the equities to go all RE, but needed to analyze the pros and cons of each, therefore the binary question.

 

[Meadbh]

For example:

$200,000 piece of rental property that is paid off with rents at $1,200 a month = $14,400 a year. $14,400 minus $2,500 property taxes and $1,000 homeowners = $10,900. If it is rented utilities can be paid by the renter. If it is not rented utilities become the owners burden so...let's say you have to have a buffer just in case. I'd say close to $150 a month = $1800. So $10,900 minus the possible utility bills = $9,100. No way to account for maintenance but just to know there will be some.
So let's just say the rental generates $10,000 a year net positive cash flow but you have to pay tax on it at 18%. The $10,000 becomes $8,200.

Take that same $200,000 equity in the rental and invest it in a tax free vehicle paying 5% = $10,000 tax free.

You forgot leverage. I wouldn't put $200,000 down on a $200,000 property. I'd put $50,000. Now assume the same net income of $10,000 per annum. ROI is now 20%.

 

[FreeAtLast]

I have only stocks. I have never owned rental properties and do not intend to start now.
The value of both will have ups and downs, but real estate will have maintenance and people problems, and can't be sold with the click of a mouse.