Rental Property Tax Deductions

Earlier today I was asked to estimate the rental property tax deduction on a high-end duplex in town. Here is how I came up with a quick estimate.

Warning: Qualifications For Writing Off Rental Losses

First, figure out if you even qualify.
1) Is your participation active or passive? Active gets better tax breaks.
2) Is your income (MAGI) more than $100k? If so, tax benefit phases out.
3) Is rental loss more than $25k? If so, would have to carry over.

About the Rental Property

This property is a large duplex with 3BR/2.5BA on each side. The house is 3,800 sqft and the lot is ~10k sqft. The purchase price would be around $800k and monthly rent is estimated at $3k per side.

Calculating the Deduction

Assume you file a Schedule E with the IRS (2012 example).

You basically have income and expenses. Rent is the income. In this example, it’s $68,400 for the year with 95% occupancy.

For expenses, you can deduct a few smaller items (cleaning and maintenance) and a few bigger items (depreciation, mortgage interest, depreciation, and possibly a realtor commission). In my example the rental expenses came to $91,385.

Rental Property Tax Deduction Example


Calculate the Rental Property Income or Loss

By subtracting the $91,385 in expenses from the $68,400 in rental income we get a loss of $22,985. If your tax bracket is 25%, this would equate to a $478 tax savings per month. Note this deduction might be limited if you earn more than $100k in adjusted gross income per year.

Note this is mainly in the first year due to the realtor commission. The next year the property would basically break even with a $0 commission line item.

Going a Bit Deeper

In this example, the requestor really wanted to know what the net effect. How would purchasing this rental property compare to other investment options? The purchase would require almost $200k down, cashflow ~$500 per month, has a possible tax benefit of ~$500 per month for the first year. The biggest effect is to net worth: at 3% growth, this property increases in value about $2k per month.

The other option might be to invest $200k at a ~5% return. This might get ~$830 per month in income.

My gut? If you can manage it, the property might be a decent return. But if I didn’t need the monthly income off the $200k and could handle some risk I would look at buying a stake in a small business that targeted a higher return, say 20%+.

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