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Investment Property Advice
Old 08-09-2013, 07:08 AM   #1
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Investment Property Advice

Hi everyone,

Question regarding an investment property I own. I bought my house in the summer of 2007 and watched as prices dropped. In 2012 I moved in with my then girlfriend, now fiancee into her house. At the time, my house was about $20K underwater.

I didn't feel like raiding my investment accounts to pay down the mortgage to sell it, and I always wanted to have a portfolio of rentals, so I rented it out.

I currently have a tenant (who resigned a lease through 6/14) and she is great - takes almost as good care of the place as I did. I charge her above market rate for rent. The problem is, even with the rental income, I still lose money each month, to the tune of $225.

The $225 is after taking everything into account - mortgage, taxes, insurance, HOA, etc. The house is still underwater, roughly $15K.

When I get married later this year, my fiancee and my combined income will exceed $150K, which if I understand correctly, means I can't write off the rental losses anymore.

I'm not sure if I should bite the bullet and pay the mortgage so that it isn't underwater and sell or keep it and refi or keep it and do nothing.

My current interest rate is 6.375%. If I were to refi, I'd need even more cash since my understanding is that I need 20-25% equity to refi an income property. I've run the numbers and assuming I could refi to 4%, my monthly loss would change to a gain of $275.

I'm just not sure how to analyze this. I think my thoughts are being clouded by having a good tenant and always wanting to amass a handful of rental properties to provide income so I could retire early. I need an outsiders thoughts.

Thanks...and sorry for the length! I can provide more detailed info if requested.
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Old 08-09-2013, 07:56 AM   #2
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Some quick thoughts:

1. Is your $225 per month "loss" based on cash flow or tax reporting? Example, only mortgage interest is deductible on tax return, principle payments are not (but it is a cash flow outlay). But depreciation is an expense on tax reporting, but you don't see any change in cash flow. Hope you've been reporting your rental activity correctly. Not uncommon to have negative cash flow but show a profit from tax reporting.

2. You don't "lose" the rental loss on your tax return just because you are not allowed to take a loss against other income in any given tax year. The unallowed losses carry forward to future tax years and are released (all accumulated carry forward losses) upon disposition of the property. Would need to file Form 8582 to calculate allowed losses and carry forward unallowed losses (it's a PITA). The future is unpredicable, one of you may have a period of unemployment and suddenly you can take some losses in that year!

You seem focused on your monthly losses. Is cash flow an issue or can you handle it?
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Old 08-09-2013, 08:01 AM   #3
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Oh, and welcome to the forum, just noted that this was your first post.
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Old 08-09-2013, 08:30 AM   #4
Confused about dryer sheets
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My $225 monthly loss is a cash flow loss. Even when I take into account depreciation, I still end up with a loss for the year, albeit not a very big loss.

I am focused on the negative cash flow right now only because the goal with rental property is to make money on them, not lose it.

I can handle the loss each month, it's just frustrating.

Thanks for welcoming me!
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Old 08-09-2013, 08:37 AM   #5
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Welcome. I concur with RE2Boys that in calculating the $225 you should reduce it for any mortgage principal if the $225 is after deducting your entire monthly mortgage payment.

Does the $225 include depreciation or no? IOW is the property cash flow negative or just showing a negative after you include depreciation?

So for discussion purposes, let's assume you are cash flow negative $225/month and you aren't getting any tax benefit. That's $2,700 a year. Is the market appreciation of the property more than $2,700 a year on average? That is another factor to be considered.

Also, the phaseout is based on MAGI exceeding $150k, not income, so make sure you are reducing your combined gross income for any 401k contributions you each make, deductible IRA/HSA contributions and other items that enter into MAGI.

Also consider:
Quote:
If you spend considerable time in real estate activities during the year, you may be eligible for a favorable special rule. For so-called real estate professionals (as defined by IRS guidelines), the passive activity rules don't apply to losses from certain rental real estate activities, which means the losses can usually be fully deducted in the year they occur. For more information on this beneficial special rule, consult IRS Publication 527: Residential Rental Property (Including Rental of Vacation Homes).
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Old 08-09-2013, 08:39 AM   #6
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Quote:
Originally Posted by moneysma View Post
My $225 monthly loss is a cash flow loss. Even when I take into account depreciation, I still end up with a loss for the year, albeit not a very big loss.....
But if the $225 is cash flow then including depreciation would make the loss greater, not lower, right?
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Old 08-09-2013, 10:04 AM   #7
Confused about dryer sheets
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Originally Posted by pb4uski View Post
But if the $225 is cash flow then including depreciation would make the loss greater, not lower, right?
Sorry, I'm still half asleep!!

I looked back on my spreadsheet. The $225 does take into account deprecation. Through June of this year, income less expenses, including depreciation, I am at a loss of $1,550.

As for the MAGI, I understand this. With our combined income, plus maxing out 401(k)s and HSA's we are still well north of $150K. She makes much more than I do!

The development where the house is in is not FHA approved, so prices have not rebounded very much as compared to other homes in the area.
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Old 08-09-2013, 10:40 AM   #8
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So before including depreciation, are you cash flow positive? How much depreciation in included in the $1,550 YTD loss?

IOW, is rent income - mortgage interest - property taxes - HOA fees - insurance - maintenance, etc (but ignoring depreciation) positive?

If so, then enjoy! Holding the property isn't costing you anything (other than perhaps the principal you are paying on your mortgage) and hopefully over time it will increase in value as the economy/area recovers. Plus, as previously mentioned, the tax benefits are deferred due to your high income but will be realized when you sell.
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Old 08-09-2013, 12:03 PM   #9
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Originally Posted by pb4uski View Post
So before including depreciation, are you cash flow positive? How much depreciation in included in the $1,550 YTD loss?

IOW, is rent income - mortgage interest - property taxes - HOA fees - insurance - maintenance, etc (but ignoring depreciation) positive?

If so, then enjoy! Holding the property isn't costing you anything (other than perhaps the principal you are paying on your mortgage) and hopefully over time it will increase in value as the economy/area recovers. Plus, as previously mentioned, the tax benefits are deferred due to your high income but will be realized when you sell.
When I don't take into account depreciation, I am cash flow positive. Depreciation is $341/mo. YTD I am positive roughly $750 before depreciation.

I guess I need to look at it a different way. Originally, and confusing me, I was looking at the total amount paid each month. When my renter pays me and I in turn pay the mortgage, interest, taxes, HOA, I have to pay some more out of my own pocket. But I shouldn't look at the principal portion of the payment since that can't be accounted for when it comes to taxes.

Thanks for helping me understand this all. And for the record, what does IOW stand for?
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Old 08-09-2013, 12:46 PM   #10
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IOW = in other words

Think of the mortgage principal that you are paying this way: for each $1 you pay it means a $1 more of equity in the property that you will get back when you sell (all else being equal) and increasing your net worth. So while it is cash outflow that you have to fund and have no discretion to avoid paying, it is paying down the loan rather than an expense.
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Old 08-09-2013, 12:50 PM   #11
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I'm totally confused now as depreciation has nothing to do with cash flow, it is an accounting convention used to allow for the fact that a property is "used up" over its life.

Cash flow is simply what money you collect in rent minus what money you expend to own & manage the property.

Cash flow would include your full mortgage payment.
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Old 08-09-2013, 01:47 PM   #12
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I think we all agree that depreciation has nothing to do with cash flow. The OP's $225 loss per month was after depreciation of $341 per month, so before depreciation he had a $116/month profit.

It is still unclear to me if the $116/month profit is after deducting the full mortgage payment or just mortgage interest.

But let's say for discussion purposes that the $116 is only after mortgage interest and that mortgage principal he pays averages $200/month. To me the nature of the $84/month net cash outflow is different in that the $84/month is resulting in a $200/month increase in his equity in the property.
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Old 08-09-2013, 02:27 PM   #13
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If you account for depreciation in your taxes, doesn't that adjust/lower the basis for the property, so that if you sell it, the "spread" is greater, and might subject you to taxes on the sale?

NOTE: I might not be using correct terminology here.

I'm just thinking that the tax breaks now for claiming depreciation have some kind of negative effect later if you sell. Might not be too critical right now, but something to be aware of in the future?
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Old 08-09-2013, 02:33 PM   #14
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If you sold it, how long before you would recoup your losses with the net money you spend on the house? Over time you will most likely benefit more from investing the cash in equities. Also, you can write off the losses at 3 grand per year from income and offset capital gains with the rest. I like real estate if you are getting a decent return of or are buying at a sharp discount. It doesnt sound like you are getting a decent return or you are going to make out with appreciation.
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Old 08-09-2013, 03:26 PM   #15
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Quote:
Originally Posted by LoneAspen View Post
If you account for depreciation in your taxes, doesn't that adjust/lower the basis for the property, so that if you sell it, the "spread" is greater, and might subject you to taxes on the sale?

NOTE: I might not be using correct terminology here.

I'm just thinking that the tax breaks now for claiming depreciation have some kind of negative effect later if you sell. Might not be too critical right now, but something to be aware of in the future?
Yes, any depreciation that you take would reduce your basis and increase any gain on sale (or reduce any loss) but, if the gain is long-term it would also be at favorable tax rates. IIRC, depreciation is not optional - you can't chose not to take it - if you chose not to take a deduction that you would otherwise be entitled to it would reduce your basis anyway - that is why in the OP's case where their income will be too high to deduct the loss the loss carries forward until it can be used or the property is sold.
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