Well I don’t think we’re disagreeing too much. I’m with you that it has to be justifiable, but that being said, I’ve seen some pretty liberal things expensed by a variety of small businesses.
The whole of Europe seems to be caught up in some sort of moral panic about tax, brought on by all the stories about Starbucks, Amazon et al paying miniscule amounts of corporations tax. The mentality seems to have spread into personal income tax and everyone now believes that you need to pay “your fair share” which seems to actually mean “as much tax until you’re no longer above average wealth”
I, however, seem to be going in the other direction and would happily avoid it as much as possible without getting hammered by the law.
Agree, there’s certainly ways for this to go wrong. Many people learned in 07/08 how bad things can get if you don’t take a conservative approach. I’d only do this if i can put 20% down, have 12-18 months rent in the bank and probably $10,000 in an ‘emergency fund’ for major repairs.
However, the returns on that money over my lifetime would be high enough to overcome the occasional 6 month vacancy period. I’m 28, so if I started this now and upgrade the rental property every 15-20 years through 1031 exchanges tax free…I’d own a pretty large asset by the time I retire.
My town is pretty unique. We’re home to one of the best medical centers in the world. Doctors and nurses will move here willingly from all over the country/world to do their residency and then take that shiny accomplishment and go cash in somewhere else. So there’s very high demand for rental properties in the town. Like you said, you can only depreciate the home value, not the land. Fortunately for our town were surrounded by miles and miles of corn fields, so the land is pretty cheap here. I’d imagine in a major city like DC and the surrounding area the situation would be the exact opposite, with the land being worth more than the actual home value in many cases.
Is it being expensed on their books? Or deducted on their tax return? These are two separate and distinct things.
You can run anything you want through the books. You can expense “hookers and cocaine fees” on your books. But you can’t deduct that on a tax return. A good, law-abiding accountant will, in theory, catch that and disallow the deduction.
[original post removed]
@Huskie - Here’s my problems with rental real estate:
-
Large capital outlay. Generally banks don’t like to loan money for rental houses, so you’ll probably have to pay mostly cash for your house.
-
High leverage. If you do borrow money for the house, then you are leveraged, which is OK if real estate prices are up. But it’s bad if they are down. Really, really bad.
-
Non-divisible. If you have $100k of stock and you need $20k, then you sell 20% of your shares. If you have a $100k house and you need $20k, then how can you carve out 20% of the house?
-
High transaction costs. Be prepared to lose 6-10% when you buy the house, and another 6-10% when you sell the house.
-
Wealth taxes. Property taxes in my area are 2 to 2.5%. And they increase as the property value increases, but usually don’t decrease as values decrease, unfortunately.
-
Low income. You said it yourself. “There’s almost no income left to be taxed.” Which kinda defeats the purpose of an investment.
-
Low capital gains. If you buy a house for $100k, and sell it 20 years later for $200k, (well, $175 once you recapture your depreciation at 25%) then your CAGR is 2.84%. But wait–inflation is 2.5%, and property taxes are 2.5%, so your real CAGR is actually negative.
-
Vacancy. Just because you go two or three months without a tenant doesn’t mean you have to stop paying the bills associated with the house.
-
Maintenance. I don’t know how many 3 a.m. “please come unclog my toilet” phone calls I can handle. Alternatively, you could hire a property manager–at 8% of gross rents. (That’s probably your entire profit margin.)
Well, that’s all I can think of for now. Let me know how your real estate endeavor goes.
For me–I’d rather invest in CD’s than rental real estate. Your CAGR isn’t negative and you don’t have all these problems. About the only good thing in all this is the potential gain if real esatate prices increase and you’re highly levered. (But in real life, if real estate prices are going up, nobody wants to rent–they all want to buy.)
What’s the difference between the two?
One is deducted on your tax return. The other isn’t. And there’s nothing sinister about your “tax income” looking different from your “book income”. In fact, it’s very normal and required by law.
If you really want to geek out about it, then look at a business tax return (Form 1120, 1120-S, or 1065). Book-tax differences go on Sch. M-1 (or M-3, if it’s a big company). This schedule reconciles the income per books with the income per the tax return.
It’s common to have book-tax differences. EG - Officer’s life insurance premiums are not deductible. You can (and should) expense them on your books, since it’s a legitimate business expense. So it becomes a book-tax difference on the M-1 (or M-3 for a big business).
Similarly, life insurance proceeds are not taxable. So when the officer dies and the company receives the proceeds, it also gets booked (since it is an income item) but not added to taxable income. So it becomes a book-tax difference on the M-1.
Ok, no, these guys were definitely talking about paying through the corporate accounts for the tax benefit. So these were deductions.
Look, I understand case law plays a role and there is the spirit of the law. But in practice, from everything I’ve seen (and some of these guys have been audited, including my Dad’s company) things are very lenient as long as a reasonable justification is there. You’re right, in an audit, some of the deductions may come back on you with some interest, but as long as there’s not clear and obvious purposeful abuse from what I’ve witnessed you’re not going to jail. I don’t know what else to tell you, this is just what I’ve seen.
To ghibli’s point about the motorhome, there are definitely exceptions, but if your company is on the road a lot, every vehicle is a company vehicle.
^I’m not disagreeing with you that there’s a whole lot of leniency and gray area. I’ve got a guy that’s deducting not one but two planes and a lake house right now. I’ve talked to him about it and I’ve told him that if he gets audited, he’s going to pay me $150/hr to defend it, and he still might lose. He’s okay with that.
But Robert Kiyosaki says “To take tax deductions, you must own a corporation. Then everything in the world is deductible, including your vacation and your Ferrari and your Rolex.” This isn’t true. Not even close.
Yeah I agree with what you’re saying.
Just FYI:
I’m looking at a tax return that somebody else prepared last year. They are coming to us this year. The wife makes $175,000 in W-2 wages at a bank. (Don’t know what she does.)
She also has her own Sch. C business that rakes in $749 in revenue. (That’s a little less than $1,000.) From that, she deducted $33,000 in depreciable asset (studio, production costs, consulting fees for CD release), $25,000 in “wardrobe and appearance” fees, $20,000 in "business promotions), and $10,000 in “video expenses”.
I think Greenie may have the risk aversion of an accountant when it comes to real estate. Getting attractive returns on real estate isn’t just due to price appreciation and it is the easiest way typical people can get leverage. And I’ve never seen a bank not lend for rental houses – perhaps this is some weird West Texas hold up. I’m not saying it’s the be-all-end-all investment, but you can get good returns. It’s easy to just pick random numbers to buy and sell to calculate a CAGR, but that ignores the rental income or lack of rental expenses (depending why the real estate was bought). But it all comes down to your cap rate – of course it is probably a bad idea if you are buying some 4% cap rate rental property
I think real estate has been going up for 20+ years in NYC and they still have a lot of renters. So not sure how much of Greenies post is thoughtful vs sarcastic. Just what someone wants doesn’t mean it is what someone does
The physicians I was dealing with were committing tax fraud, it wasn’t even a question. Their accountants were either complicit or negligent. I think they were complicit. Nothing’s illegal until you get caught though, right?
Maybe it is a local thing. The local banks have a certain amount of capital to lend, and they can either lend it to an oil and gas company, or to a guy who wants rental real estate. I know which way they’re going to lean (at least out here in the oil patch).
Granted, some of it is hyperbole. But Husky seems to think that this is the life of a landlord:
- Buy a house
- If you buy it, they (renters) will come.
- Sit back and earn free mailbox money.
- Sell the house in 30 years.
- Party with the billions that it will provide.
And I tend to disagree. I do lots of tax returns. I see lots of rental houses. And I have yet to see anybody make money hand-over-fist in rental real estate, especially for the amount of capital they have tied up in it.
What happened to AF? We’re discussing savings rates?
The benefits of leverage trump all those negatives.
That’s why I never judged a pros/cons sheet by the number of items on each side. Some items are worth much more than others.
speaking of taxes
http://www.vox.com/policy-and-politics/2016/3/25/11293258/tax-plan-calculator-2016
My boss owns 2-3 rental homes, mostly because he bought the houses originally to live in and then moved up as his family grew and instead of selling them started renting the old ones out. Even he described them as a way to “build wealth slowly”.
My rental unit has a cap rate of 7%. Not shabby. My ROE was 12.5% last year. Again, not shabby for diversification. And this isn’t even an optimal rental unit, but like Krazy’s boss, just a property that I upgraded from. With the quickly declining values in my market, I’m considering getting a couple more units or even subdividing one house into a couple rentals. It’s a good diversification piece, but it shouldn’t be your whole portfolio.