A question about tax on rental income in the long run...

[charleedog]

Hey everyoneWell, I guess this post also doubles as my first post as well, so here`s a very brief introduction of myself and my relatively inexperienced background in real estate:
The name`s Chris, I`m 25 and I hail originally from Lloydminster (Alberta side), but now much-more-happily residing in Victoria BC.

Business has been good the last few years, so I`ve been trying to be smart about stuff and get it into some equity. I own revenue properties in Regina SK, Kelowna BC and Victoria BC. All are multi-family and all cash flow positive, with a particularly nice monthly ROI from the Regina prop.

I am looking at options for the future about how/if to scale this up and get into larger MF properties, etc. My basic plan is buy and hold. Seems to make the most sense, at least for me.

But there`s a few snagging questions I have, of which this is currently the most prominent...

What happens tax-wise once your payments are largely principle and not as interest-heavy?

I realize that there will likely be people on Mars by the time my mthly payments are largely principle, but still - since CRA sees rental income as taxable and only considers debt service INTEREST & associated fees as an expense (the rest is capital asset, obviously), when the time comes when...

...the properties are producing $100,000 a year in rental income (or whatever, just an easy number to work with)

...and my principle payments are, say about $50,000 a year and the interest is only $10,000 a year (instead of the other way around like it is now)

That means that CRA is seeing $90,000 a year in personal income.

Even though you`re still SPENDING $60K of that on debt service.

You`d have $40K left over, alot of which goes to maintenance, mgmt, insurance, prop tax, etc.

So let`s say half that. You`re left with $20K.

BUT... when the taxman comes along, your taxes owing would actually (likely) exceed what you`ve accumulated. Tax on 90K in BC, for example in 2009 is about $22 grand. This means you go in the hole each year, or you actually have to work extra hard to "afford" your investments which are now a type of liability...

Do you just refinance every so often and eat the pre-payoff penalties from time to time?

Is this where declaring a CCA comes into play?

Something else?

This question is probably screaming "newbie" (and I am), but still, I`m quite curious as to what you guys do to deal with this predicament as the years progress and equity builds.

Any pointers you may have would be awesome...

Thanks

-Chris

 

[Thomas Beyer]

QUOTE (charleedog @ Oct 21 2009, 04:04 PM) ...

...the properties are producing $100,000 a year in rental income (or whatever, just an easy number to work with)

...and my principle payments are, say about $50,000 a year and the interest is only $10,000 a year (instead of the other way around like it is now)

That means that CRA is seeing $90,000 a year in personal income.

Even though you`re still SPENDING $60K of that on debt service.

You`d have $40K left over, alot of which goes to maintenance, mgmt, insurance, prop tax, etc.

So let`s say half that. You`re left with $20K...
indeed you do 2 things:
a) you celebrate monthly on your awesome passive income .. preferably on your own yacht !
b) you deduct CCA .. which is 4% of property value .. so in your case with a rent roll of 100K the property is worth let`s say $1M or even 800K .. so 4% of that is 30-40K .. exceeding your cash-flow .. thus NO TAXES payable until sold or CCA runs out!

After 25 years of owning an asset your CCA is now 0 .. then you sell a few properties here and there to pay taxes .. and you invite all your (REIN) friends to celebrate with you on your yacht !!

of course 100K in annual rental income is NOT that big .. it is a 10 to 15 plex .. it was a typo perhaps ? You meant monthly ?

 

[brentdavies]

Income-operating expenses-interest payments on debt=net income

Net income less depreciation = taxable income.

So 100,000 income- expenses (???) say 10,0000 (taxes, repairs, mgt)-interest payment $50,000 = $40,000 net income

net income $40,000 less depreciation (say 4% of $200,000) =$32,000 taxable income.


I don`t put on new financing for tax writeoffs, i try to pay down my mortgage, so I get to keep the rental income. Refinance is great to take out equity to buy other property.

 

[bizaro86]

QUOTE BUT... when the taxman comes along, your taxes owing would actually (likely) exceed what you`ve accumulated. Tax on 90K in BC, for example in 2009 is about $22 grand. This means you go in the hole each year, or you actually have to work extra hard to "afford" your investments which are now a type of liability...

Greetings! I have also not reached this point yet, but I know what I would do if I did, especially if at this point you were considering "retiring."

Instead of refinancing to a larger mortgage, just extend the amortization of the existing balance.

Example: Say you have a 30 year amortization mortgage, and 20 years have gone by, so your payments are increasingly comprised of principal as you now have a 10 year amortization. As you mentioned, you still have to pay the principal, but its not a tax deduction. So why not, when your mortgage comes up for renewal, extend the term back out to 25 years. This reduces your principal payments, and gives you more cash each month to pay for taxes/lifestyle. If you do it at renewal, then you won`t have to pay any early termination fees.

Michael

 

[Thomas Beyer]

QUOTE (brentdavies @ Oct 22 2009, 06:13 AM) ..

net income $40,000 less depreciation (say 4% of $200,000) =$32,000 taxable income.
..
if rent is $100,000 then asset value is more than $200,000 .. more like $1M or more even .. so 4% of $1M = 40,000 .. thus NO INCOME TAXES payable !

Mortgages can be extended .. so every 5 years you can go back to a 25 year amortization if you wish !!

 

[charleedog]

Hi Everyone - thanks very much for all the responses and help...So I guess there`s a few options, then:

1) Extend mortgage(s) at renewal to restore the principle vs interest tax equilibrium

2) Claim CCA each year to reduce taxable income by increasing loss

3) Refinance to accumulate further properties, which decreases principle payment in the overall portfolio

4) A mix or all of the above.

I just have one question though - when your CCA "runs out" as Thomas put it, what happens when you sell?

I was reading through the CRA`s stuff on CCA "recapture" and it`s hard to make sense of what actually happens when a property is sold and the owner has been claiming CCA...

I suppose my philosophy up to this point has been:

1) Buy posi-cash props

2) Hold long-term until mortgages clear off in 30 years (at which point I would be 54 - 55)

3) Retire and live off cash-flow and/or

4) Sell them all and "go out with a bang"

So it seems that - and correct me if I`m wrong - this is either a game of income or equity.

You can`t (really) have both...

Am I correct?

Thanks again , guys...

-Chris

 

[Thomas Beyer]

QUOTE (charleedog @ Oct 25 2009, 03:35 PM) ...
1) Buy posi-cash props

2) Hold long-term until mortgages clear off in 30 years (at which point I would be 54 - 55)

3) Retire and live off cash-flow and/or

4) Sell them all and "go out with a bang"..
single family homes are NOT the best source of cash-flow ! A single family home is an EQUITY BUILDER, through value appreciation and mortgage paydown.

To retire, better income vehicles exist, with less work such as REITs, income trusts, dividend stocks, commercial buildings, apartment buildings, storage facilities ..

 

[gwasser]

QUOTE (charleedog @ Oct 25 2009, 04:35 PM) Hi Everyone - thanks very much for all the responses and help...So I guess there`s a few options, then:

1) Extend mortgage(s) at renewal to restore the principle vs interest tax equilibrium

2) Claim CCA each year to reduce taxable income by increasing loss

3) Refinance to accumulate further properties, which decreases principle payment in the overall portfolio

4) A mix or all of the above.

I just have one question though - when your CCA "runs out" as Thomas put it, what happens when you sell?

I was reading through the CRA`s stuff on CCA "recapture" and it`s hard to make sense of what actually happens when a property is sold and the owner has been claiming CCA...

I suppose my philosophy up to this point has been:

1) Buy posi-cash props

2) Hold long-term until mortgages clear off in 30 years (at which point I would be 54 - 55)

3) Retire and live off cash-flow and/or

4) Sell them all and "go out with a bang"

So it seems that - and correct me if I`m wrong - this is either a game of income or equity.

You can`t (really) have both...

Am I correct?

Thanks again , guys...

-Chris

 

[charleedog]

Godfried - seems your reply got eaten by the filters(?)

Also, Thomas, I appreciate the input. The properties I currently have are either multi-family or suited.

Would like to step it up into commercial, etc. but before I do I`d like to know the "game" a little better.

-Chris

 

[Thomas Beyer]

QUOTE (charleedog @ Oct 27 2009, 02:28 AM) ..
Also, Thomas, I appreciate the input. The properties I currently have are either multi-family or suited.

Would like to step it up into commercial, etc. but before I do I`d like to know the "game" a little better.
mutli-family or commercial is good for cash-flow with no or low mortgages !

Commercial is usually higher yield if fully leased .. but higher risk of vacancies and higher cost to re-tenant .. not necessarily better !

 

[gwasser]

QUOTE (charleedog @ Oct 27 2009, 03:28 AM) Godfried - seems your reply got eaten by the filters(?)

Also, Thomas, I appreciate the input. The properties I currently have are either multi-family or suited.

Would like to step it up into commercial, etc. but before I do I`d like to know the "game" a little better.

-Chris


I spend at least 20 minutes typing my comments and then the forum/on-line connection crashed. Now I am too P.O.`d to retype the whole story. Sorry, maybe luckier on the next thread (or not depending on the value of my comments in the first place).