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Rental house income

Old 12-29-2006, 09:11 AM
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Default Rental house income

With the "buyers" market now, I am considering buying a small house as an investment, and would like to rent it out. I have considered this many times before, and am aware of upkeep/renters damage/etc.

My question is this. Whats the deal with rental income? I am confident it's taxed, but can you offset the taxes with other things to negate it, or at least keep it to a minimum.

I am already invested in three mutual funds, have a 401K at work, and some savings, so I'm not looking for general investment advice. I am curious about rental income.

Thanks in advance for any help.

Pat
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Old 12-29-2006, 10:08 AM
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Default Re: Rental house income

Yes, rental income is taxed and you can deduct expenses like repairs, mortgage interest, property taxes, insurance and I'm pretty sure you can deduct depreciation as well.

You really should sit down with an accountant who specializes in rental property as you might want to consider putting all rental property into a LLC corporation.
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Old 12-29-2006, 12:20 PM
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Default Re: Rental house income

I think: if you use the depreciation on it, when you sell you may have tax on the gain unless you sell it at or below the depreciated value...
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Old 12-29-2006, 01:00 PM
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Default Re: Rental house income

The rental income is taxed as ordinary income, but it is often offset by your rental expenses as mentioned above, and can include depreciation of the property. If you choose to depreciate the property, you will have to form a basis, which is the value of the property when you begin to rent it. The depreciation amount is amortized over 20 years (at least it was 20 years when I had a rental - may be 30 years now), so you can also deduct the depreciation from the rental income to offset the income. When you go to sell the rental, you will be responsible for the gains, which will be the difference between the selling price and the now lower depreciated basis. You can avoid paying tax on that gain by doing a "like-in-kind-exchange", which means you have to purchase another similar property within 60-90 days.
Been a long time since I had a rental, so I'm probably incorrect on some of the details - hopefully you get the general idea.
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Old 12-29-2006, 01:06 PM
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Default Re: Rental house income


Thanks for the input, folks.

Chuck34, do you have anything specific I should consider(or be worried about) that would call for limited liability? I would certainly carry insurance for everything other than contents. My God, do I have to worry about getting sued if a tenant shoots another tenant on the property, or something crazy like that? Maybe this ain't such a good idea.

Thanks

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Old 12-29-2006, 01:09 PM
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Very similar to establishing new sub-divisions - you must always think of protecting yourself first and an LLC may be your best bet. Also, as noted you should meet with your accountant to discuss the tax ramifications and any associated benefit of using an LLC.
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Old 12-29-2006, 01:20 PM
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Default Re: Rental house income

If it is something that you would not mind living in then you can depreciate it and charge off repairs and tools to the rental and then live in it for two years before you sell it and earn up to $500K tax free when you sell it.

There is a local guy here in town that has bought 10 to 15 homes and is in the process of living in a home and remodeling it to sell then moving to the next one. He rents the homes until he is ready to move into them. This way he avoids capital gain when he sells them. Its a long term process but it has treated him well so far.
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Old 12-29-2006, 01:23 PM
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bsmit24 - 12/29/2006 1:20 PM

If it is something that you would not mind living in then you can depreciate it and charge off repairs and tools to the rental and then live in it for two years before you sell it and earn up to $500K tax free when you sell it.

There is a local guy here in town that has bought 10 to 15 homes and is in the process of living in a home and remodeling it to sell then moving to the next one. He rents the homes until he is ready to move into them. This way he avoids capital gain when he sells them. Its a long term process but it has treated him well so far.

thought this process was a 1 time deal, meaning you can only use the tax free once
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Old 12-29-2006, 01:47 PM
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Default Re: Rental house income

2005, the one time deal you are thinking about went away some years ago. You can do it as many times as you want now. And it is on each house you own as opposed to the old rules that capital gains were figured on all the houses you ever owned and you finally pay Uncle Sam on the last house.

onejacker, sorry, I don't have any specifics to give you other that discuss everything with a lawyer and/or accountant that specializes in rental property.
My brother has 4-5 rental houses and he has always had them in a LLC.
You can never be too careful and a LLC is probably your best way to go.
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Old 12-29-2006, 01:59 PM
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A LLC is the only way to go.

It was one of the best things I've ever done. Started with a rental, summer weeks on the lake, winter months or weekends for snowmobiling. Used it myself for a few weeks and unused weekends working to keep it up and improve it. Sold it 8 years later and tripled my $$. Bought a commercial, income producing property with the proceeds and have not looked back. While my new note isn't cheap because of it. The monthly check is great and it covers everything including my quarterly tax payments.

Everything that was done to the rental was a write off under the formed company. I don't think that you get that if you own it yourself but I am in no way a CPA.
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Old 12-29-2006, 02:19 PM
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had no idea they changed that law , thanks
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Old 12-29-2006, 03:23 PM
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Hey, I'm convinced. My next step will be looking into the process of forming a LLC. I have a customer who owns at least one LLC, and he's a good guy. I'll go to him first with a list of questions.

Thank you all for your advice/input. Not only has this been informative for me, but its very nice to have another thread on here that does'nt turn into a pissing contest or shouting match. I can do without the drama.

Any other input will be appreciated also!

Pat
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Old 12-29-2006, 03:30 PM
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An LLC will keep the liability with the property and not to you personally if some idiot falls off a deck and kills himself. Also having good tenants is the name of the game. id rather have one of my places sit empty than deal with a headache. You also want rental imcome coverage on your insurance.
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Old 12-29-2006, 03:31 PM
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Default Re: Rental house income

bsmit24 - 12/29/2006 1:20 PM

If it is something that you would not mind living in then you can depreciate it and charge off repairs and tools to the rental and then live in it for two years before you sell it and earn up to $500K tax free when you sell it.

There is a local guy here in town that has bought 10 to 15 homes and is in the process of living in a home and remodeling it to sell then moving to the next one. He rents the homes until he is ready to move into them. This way he avoids capital gain when he sells them. Its a long term process but it has treated him well so far.
It would take that guy 20 - 30 years to be able to avoid capital gains tax on all his properties. You have to have a home be your primary residence for 2 years and I think they have to be the last two years to be exempt from the 15% capital gains tax.
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Old 12-29-2006, 03:36 PM
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Default Re: Rental house income

onejacker - 12/29/2006 3:23 PM


Hey, I'm convinced. My next step will be looking into the process of forming a LLC. I have a customer who owns at least one LLC, and he's a good guy. I'll go to him first with a list of questions.

Thank you all for your advice/input. Not only has this been informative for me, but its very nice to have another thread on here that does'nt turn into a pissing contest or shouting match. I can do without the drama.

Any other input will be appreciated also!

Pat
I've had this exact discussion with my personal attorney friend. When I asked him this same question he replied that the benefits of an LLC or corporation to protect your assets is way overblown. That is why you have insurance. What if a Jehovah's Witness (or Mormon or Protestant or Atheist...) walks up to your house and twists an ankle? Your insurance pays up! No different than with a rental house. Now, if you have some obvious dangerous situation that you KNEW about, that would be different, but that would not be any different than with your primary residence.
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Old 12-29-2006, 05:04 PM
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Default Re: Rental house income

There is a growing sentiment for forming single member LLCs to own each piece of rental property as a liability protection. I have always told my clients that they also need to buy liability insurance as well. As far as the principal residence sale, the rule is that you have to use it as your principal residence for two of the five years ending on the date of sale. A person could use the house as a principal residence in years one and two and then rent it out in years three through five, selling it on the date that exactly hits five years. The gain would then be calculated and the only gain that would have to be reported is the depreciation that had been taken during the rental time and that would be called "unrecaptured Sec. 1250 gain". The balance of the gain, up to $500,000 on a jointly owned house with a jointly filed income tax return would be exempt from tax. If there is gain above $500,000, then tax may have to be paid. The depreciation life for residential property is 27.5 years straight line.

Also, the way the law is written a person could buy and sell a principal residence every two years and one day basically and never pay tax on the gain unless it exceeds the maximums allowed, $250,000 for a singel taxpayer and $500,000 for a joint tax return.

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Old 12-30-2006, 08:37 AM
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Default RE: Rental house income

I only have 2 things to add to Jal's comments. First, you should also check with your advisor to determine whether any annual losses from the rental will be deductible.
They are limited if your income is over a certain amount, which I believe is $150K. Also, it is possible that if you can deduct the losses, the benefit you receive from the cumulative annual depreciation deduction may be better than the tax you pay on the "unrecapture se. 1250 gain" which I believe is taxed at 25%.

The key over time is of course appreciation and good tenants.

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Old 12-31-2006, 09:50 AM
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Default Re: Rental house income

Real estate losses and gains are classisfied in 2 seperate way. If you are full time employed in the business of rentals then you are not subject to the normal rules of a passive investor who just collects checks on a few units. I dont know where you live but up here it is far from a great buyers market. Until about 6 years ago your average mortgage cost was equivalent to rent payments. Now you will be lucky to make half your monthly payment back. I cant believe a lawyer who tells you an LLC is overblown. If you have limited assets this would be the case. Your return an be much better on a 2 or 3 family structure so if youre going to do it, think about this.
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