US standard fixed rate mortgage on a rental property. If rent is $X/month and all in mortgage is also $X/month, it would suck to need to pay income tax on $X x 12 for the year, when it all went towards paying the mortgage. Thankfully, I can count depreciation against the income to net it to $0 liability at tax time. This is great, but what happens when the depreciation is fully utilized? Outside of raising rent such that the net proceeds equal the amount due at tax time, or throttling the depreciation taken such that I am liable for a manageable Y% of the ($X x 12)’s tax liability for a longer time period, can anything be done here? I get that I gain in terms of equity in the home even with tax-net negative cash flow, but this would be quite straining from a month to month cash perspective. This seems like it would be a common issue for most rental property owners… how is this typically handled? Or can nothing be done?
2 Answers
Several comments first:
If rent is $X/month and all in mortgage is also $X/month, it would suck to need to pay income tax on $X x 12 for the year, when it all went towards paying the mortgage
This is incorrect. The $X/month mortgage payment includes at least two components: interest and principal. Sometimes there's also escrow for insurance and/or property taxes, and PMI if applies. All these components except for principal are tax deductible and reduce your taxable rent income. So with $X in rents and $X in mortgage payments, there's a $Y (<$X) which you don't pay taxes on because it is a deductible expense.
Thankfully, I can count depreciation against the income to net it to $0 liability at tax time. This is great, but what happens when the depreciation is fully utilized? Outside
Usually depreciation on residential rental properties in the US is 27.5 years. Mortgages are usually <30 years. So you have at most 2.5 years of such gap, at the end of your mortgage, almost 3 decades after purchasing the property. If by that time your rent is still the same as your mortgage payments - you have a much bigger problem.
or throttling the depreciation taken
I'm not familiar with such a concept. Depreciation is a formula that doesn't not depend on your cash flow or income/expense balance. You do get PAL that you can accumulate in worse years and deduct in better years, though.
can anything be done here?
Sell the property or refinance the mortgage to make payments affordable.
This seems like it would be a common issue for most rental property owners… how is this typically handled?
I have yet to meet a homeowner who 30 years after purchasing a property is still struggling with negative cash flow. There may be some, but that means that they can't chose a property or price their rents right. If the property is losing money for you - lose the property.
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Renovate an apartment, then use the receipts for the supplies & time worked as a deduction for taxes. It decreases your capital gains and increases your property value.
