You don't write off your rental income. You depreciate the rental property over 27½ years and write that off against your rental income. Few rental properties will have under a 3.7% ROI where depreciation would cover all the income. At best you might be paying half tax. In your example, you'd pay no tax, but you'd lose out on the potential income you could have had with better investments (and lose about 6 years' worth of depreciation by the depreciation then being too fast).
And flipping to more and more expensive properties through 1031s requires more and more capital and only makes it cover less taxes. There's no tax benefits versus just keeping the first property and paying all the taxes and buying a separate property to depreciate.
If you sell a $500k property earning $40k/year where the depreciation covered 45% of your income, and you buy a $1 million property earning $80k/year, you get a new $500k to depreciate $18k/year. Then the depreciation only covers 22% of your income.
Depreciation is very fundamental to business tax law. I'm not sure how you'd "fix" that without penalizing non-rental companies for expanding.
You're skipping over the (extremely important) part where you take out a mortgage on property.
So you buy the $500k property with $125k in cash and a $375k mortgage (25-30% down is typical for investment mortgages). Depreciation *plus mortgage interest expense* leads you to (for tax purposes) more or less break even on this investment after 10 years and so you pay no tax.
After those 10 years are up, you've now paid off around $68k of the principal, plus the asset has gained $250k in value. So from your initial $125k of capital invested, you now have ~$400k in capital that you can leverage into a $1.6M property in a 1031 exchange. That bigger loan comes with a much larger mortgage interest expense, so you continue to earn no taxable income while growing a larger and larger asset and taking a (relatively modest) cash-on-cash return.
This is very common. We have it in Norway too. It started in 1882. At that time, it was mainly farmers who had mortgages, so the idea was to encourage productivity, making it less costly for them to buy new land for cultivation (You might wonder, wouldn't this just drive up land prices? I wonder, too.)
But once you have them, they're hard to get rid of. When they were in charge for 40+ years, Labour defended them because they wanted to push for homeownership so working people didn't have to live at the mercy of landlords. In the 80s I believe they considered changing it, but then the Conservatives (who of course benefit disproportionately from the deduction) were in a position to block it. These days there is an interest deduction on ALL loans, not just mortgages. Why and how that happened I have no idea.
The deduction of business mortgage interest payments is still always less than the money you lose by having to pay interest. Paying cash will always make you more money than a mortgage unless you have something else to do with the cash.
That doesn't change my point that the only way you can pay no tax is to have less than a 3.7% ROI before mortgage principal payments.
Again, that's a bad investment. If they put the money in the stock market or a better real estate market and got a 7% return, that would be 60% higher, even after taxes.
Sure, you build equity in the properties, but you'll have to pay all those taxes you've been putting off if you ever try to use that equity. I guess the kids could sell it before they depreciate it, but I can't imagine who would intentionally waste the potential of their money so they don't have to pay the (low) capital gains tax. Again, you'd make more money paying taxes on any almost investment making over 4.3%.
This is certainly not my area so I could be missing something basic. But after you sell a property, why shouldn't that force a reevaluation on past depreciation writeoffs? In idkyall's post, they mention the scenario of depreciating your property down to an effective value of $0 and then selling to buy another property to start again. You've argued that this only covers a fraction of your income. But at a basic level, if you get enough from the sale to buy a new property, then the old one must have been worth much more than $0 so one was wrong for decades about claimed depreciation ... right? In which case, it seems like it should be natural and fair to have to pay up on taxes from those previous years.
If I can invest in real estate, rent it out for decades, and then sell it at a significant profit (which seems to be the case in many in-demand cities), then why should _any_ amount of that rental income get a to be balanced against imaginary depreciation?
What you describe does happen, unless they use that transfer process described, but by doing so they reduce the effective cost basis of the new property by the difference between the cost basis of the old one and the sale price.
Yeah, I guess the unintended? consequence here is that the lack of a time window allows indefinitely propagating it, maybe the exchange should come with a time window phase out.
We need a third party to validate both of your claims, because I don't know where to start to understand who is right. This is an example of someone (me) who wants to understand the issue, but would need to google for days to understand both arguments.
The rebuttal by mminer237 is much closer to right [0].
Also it isn't even as good as mminer237 mentions, as many states also have a much lower exemption, and there is work in congress to get rid of the step-up in basis (a bad thing, imo) and to reduce the $12MM lifetime gift & estate exemption (a very good thing).
So yes, there are some advantages, but OP is vastly exaggerating as if it is some freebie to landlords when it is not. There were some freebies introduced in the bills in the Trump term for the type of LLCs that Trump runs, but IDK if they were fixed in legislation in this term.
If you want a general complaint, perhaps the angle is that capital is taxed much less than labor, under some notion that lower taxation is necessary to get people with capitol to actually deploy it in investments. I think that is provably false, and certainly does not require the level of tax code favoritism it currently enjoys.
[0] source: tax & estate attny at biglaw firm in the household, although this is just from info absorbed by osmosis over years and is NOT a detailed legal analysis.
It may not be a freebie for landlords, but it is much more "cost neutral" or "tax neutral" to own an investment property than to own a primary residence. Consider:
Investment property:
* Deduct maintenance costs
* Deduct insurance costs
* Deduct property taxes
* Deduct mortgage closing costs
* Deduct mortgage interest
* Deduct HOA dues
* Deduct property management fees
* Take advantage of depreciation deductions
* Avoid paying cap gains taxes on sale using 1031 exchanges
Primary residence:
* Deduct property taxes (only on federal taxes, and only up to $10k, assuming you don't have other SALT to deduct)
* Deduct mortgage interest (only up to a loan value of $750k)
* Avoid paying up to $250k in cap gains taxes on sale
Doesn't that seem incredibly lopsided to you? The current tax regime makes it very attractive to own an investment property, but a basic need -- housing! -- doesn't give you much in the way of tax breaks. And the breaks that are there, are capped.
Of course there are more deductions when an object is a BUSINESS instead of a piece of PERSONAL PROPERTY.
No, it does not seem the slightest bit lopsided.
There is zero difference between the deductability of expenses you mentioned and expenses for any other business.
Businesses are generally taxed on their PROFITS, which are [INCOME] MINUS [COSTS].
The regular homeowner is not running a business.
The same thing is true of a truck or racecar. If you own it as personal property, you don't get to deduct much of anything. If you own it and run it as a business, you can deduct your expenses before counting profits and paying taxes.
The same object can be either a personal property or a business, and it is the ACTIVITY that matters, not the object.
Your argument is either attitude & ignorance gone wild, or demagoguery attempting to confuse the issue with sleight of hand.
If you think that home ownership should be more subsidized than just the mortgage interest deduction, just say so and advocate for those subsidies. It'd be much more cogent, but you evidently don't want that discussion, or expect it to be a loser, which it likely is.
> Businesses are generally taxed on their PROFITS, which are [INCOME] MINUS [COSTS].
Sure. But why does it get such a sweet deal?
It's because we want to encourage business, since businesses produce things of value.
But how much does a landlord actually produce things of value, and how much is he just extracting value others are producing (a.k.a "rent")? That's an important thing to consider when we look at having this tax/tax break or not.
The distinction between extractive vs value-creating profits is very important.
That said, it's not automatically a "sweet deal", and identifying that difference is nontrivial. The same activity could be one or the other, depending on how it is done. Your example with a landlord is particularly thorny:
>>But how much does a landlord actually produce things of value, ...?
A good landlord creates a building from nothing, and maintains it in good condition for his/her tenants. What was an undeveloped parcel of land is now homes for all the families who live there. Considering all of the people yelling about lack of housing, that is something of real value. Even maintaining a building in good condition is a very expensive activity, and if the maintenance is not done, the homes will certainly revert to rubble.
So that good landlord is absolutely creating, for both his renters and society at large, serious value.
OTOH, a bad landlord doing superficially the exact same activity can be completely extractive - merely collecting rents and failing to maintain the building(s) in any way beyond what will keep them out of immediate trouble. The bad landlord extracts everything they can for current cashflow and allows the building(s) to degrade towards rubble, an anti-creative activity.
One is definitely creating value that is highly needed in our society, and the other is destroying and extracting it, yet both have the same business type, both have the same income and cost structure, etc..
Even more difficult, the same landlord can look like one or the other in different times - in high-demand times and/or markets, they can charge premium rents and profit while still doing lots of maintenance & upgrades, but in a down market, they may have high vacancy, and still lose money while doing the absolute minimum.
So, how do we tell the difference and tax them differently?
That's a serious question, and one which, if we can find an answer will really help the society improve.
Rent extraction from the underpriveleged for basic needs in a deliberately skewed market is hardly "business", it's raw exploitation at the systemic and the social level. Justify your habit of cannibalism however you may.
If I buy a widget for $100,000 and sell it of for $105,000 do you expect me to pay income taxes on the $105k or on just my $5k profit?
The former would be absurd and in most cases would make it impossible to be in business-- you'd take a net loss on every transaction unless your markup was greater than your tax rate. Good that went through fewer hands would be astronomically less expensive.
So why do you think that it's weird that a landlord doesn't pay taxes on the portion of his income that goes to the costs of operating the business?
> If you want a general complaint, perhaps the angle is that capital is taxed much less than labor, under some notion that lower taxation is necessary to get people with capitol to actually deploy it in investments.
Yes, I recall when cap gains taxes dropped significantly during GWB and was, sadly, happy. Of course, I was just a dumb 20-something and didn't realize how much of boon to the wealthy it was.
Please point to the "boon". If you mean people got to keep their jobs = boon, then I guess you are right. The problem is, wealth was transferred upstream, en masse, and not taxed anywhere near labor.
Here is some data that solidly debunks your disguised claim of "trickle down":
> It's a boon to anyone whose job was created by it as well
You then say:
> If you mean people got to keep their jobs = boon
No, I said the job in the first place is funded by investment. I couldn't have made it clearer.
If investors don't invest in your startup/scaleup then there is no job in the first place. Nothing about being grateful for keeping your job.
> The problem is, wealth was transferred upstream, en masse, and not taxed anywhere near labor.
You're thinking in terms of groups instead of individuals, and that the groups are static. You shouldn't (as it will lead to so many broken ways of thinking) and they aren't.
> Here is some data that solidly debunks your disguised claim of "trickle down"
It's not trickle down - I only go for nonpolitical theories, and the US left wing's labels to oversimplify and demonise some fairly standard economics doesn't hold up by that measure.
I'd rather you replied to what I said than straw man it. You will mislead casual readers by doing so.
It contains the ASSUMPTION that the favorable capital tax rate (vs labor tax rate) is NECESSARY for the investment to happen.
This is obviously not the case. People with capital will want to deploy it so that it grows, as long as the tax rate on the profits is <100%.
What we do not have is the curve - how high can the tax rate be set relative to the tax on labor income before investment is ACTUALLY discouraged?
Only an assumption, based on the obviously self-serving assertions of people who own capital, that higher tax rates will make them just sit on their money and not deploy it profitably.
As you can see above, I'm happy to debunk oversimplification & demonization from the LW or RW, but "trickly down" is pretty much what the RW called it when it was flogged as a concept in the '80s, that "freeing up capital" for the rich would trickle down to everyone in the economy. The ACTUAL result was the opposite. Ratios of executive vs worker pay only increased from ~70x to over 300x, and the share of the total GDP going to labor declined to the lowest point ever.
The actual fact of the matter is that with lowering tax rates on capital, the "boon" you speak of is actually available to fewer people than ever.
> The ACTUAL result was the opposite. Ratios of executive vs worker pay only increased from ~70x to over 300x, and the share of the total GDP going to labor declined to the lowest point ever.
You're assuming a cause effect relationship. The far more likely causes of this are automation (allowing more work done by machines than people) and globalisation (allowing reach of larger markets).
That's the mechanisms. As for the philosophy: I don't buy the idea that a CEO getting richer hurts me. What's important is that my standard of living is better than my parents', and my children's will be better still. If someone wants to risk it all for a big win then good for them. They will probably fail, and lose years off their life, but occasionally they will succeed. Only pointing at the people whose risk-taking paid off and saying "See!" is not a good way to understand (or communicate) the full picture of what's going on when people invest or run their own company.
Do we actually have strong evidence that these sorts of tax breaks actually stimulate this kind of economic activity to the degree where it's actually worth it?
It... doesn't seem like we do? I mean, it's not like pre-1990 we had skyrocketing unemployment and underinvestment in business, and lowering capital gains taxes fixed it.
Yes, the question is how much of a boon it needs to be.
The fact of the matter is that people with capital want to invest and grow that capital. It is absolutely false that if that activity is taxed, it will disappear. Just as obviously, if all capital gains are taxed at 100%, it will disappear. The question is the balance - how much to tax it so that the wealthy don't merely get wealthier at everyone elses' expense.
It may also be a good idea to tax underutilized capital, as land is taxed.
If you get all of that just right you may even extract enough money to pay for all the many governmental systems required to administrate it. Sadly none of that will have done anything as useful as an investment in a company that makes people's lives cheaper or better.
ummm, the mortgage interest deduction does NOT apply to rental properties, only your primary residence or a 2nd home that you spend at least 14 days or >10% of the time you rent it out. So, if you are talking about a fully rental property, it is incorrect.
I'm not saying that there are no advantages or deductions, only that this character is trying to portray it as the govt basically giving landlords all the funding to become landlords. If that were the case, he should simply do it — there's plenty of no/low money down ways to get into it —, but I notice that he is not doing it. It just smacks of a lot more attitude than fact.
This is already the case. You can only depreciate the building value not the land portion. So single family homes have much lower depreciation since most of the value is typically in the land vs an apartment which is the opposite.
> Since for most properties the majority of the value is in the land itself
I'm not sure that's the case for the majority of the country. At-least it's not here in my greater metro area (suburbs or rural... yuppie downtown areas... perhaps, but again, downtown is not majority for most places)
It may be not true right now amid difficulty in finding labour and materials. Much like cars, the value of a used home is proportional to the cost of building a new home. When new homes are difficult to acquire, cost of used homes go up. Used cars have also increased in value lately for the same reason. This is not typical, however. These are normally depreciating assets.
Under usual market conditions, houses are headed to being on the older side and reaching the end of their effective lifetime, leaving little value left in the structure. You can renovate a home to bring it back to new-like condition, which restores value to the structure, but that cost must be maintained in the equation.
I'd think anywhere where apartments are viable to build it would be true, and of course large rural properties. Whether they make up "most properties" I'm not sure - it would surprise me if much less than half of properties in Australia were sitting on land worth more than the house itself (despite the enormous amount of undeveloped/low-value land we have!).
When you are the owner/user and not the landlord you should be paying the taxes because most of the taxes are for use in the local community and most of that is schooling. The landlord gets no benefit from the majority of that stuff. The tenant does.
How does he benefit from the rental property? He doesn't live there an use the services. If he lives somewhere else in the town he pays taxes based on that. He charges rent for the other location to cover the taxes because he doesn't benefit from those taxes. The renter does.
But he passes the cost of those taxes on to the renter because the renter is the one benefiting from the schools/roads/police/fire/etc that the taxes fund.
That is often true. A vacant rental still owes the taxes though. I can only say my time as a landlord I have not always covered those costs with rental income. Sometimes the property is empty or doesn't command enough income to cover all your costs.
I actually don't understand why the laws are written that way, apart from the political goal of causing W2 workers ("suckers") to bear a disproportionate tax burden. A W2 worker incurs expenses that are necessary to earn their income, including food, transportation, clothing, and healthcare. If they were able to account for these necessary expenses as a business does, the expenses would be directly deducted from income.
And that's not even getting into the S-corp self-employment-tax dodge.
For one, no, those expenses aren't deductible even if you do itemize. They're considered "personal expenses" even though they were necessary to earn that W-2 income. If you buy a car and use it at least 50% to get to 1099 client(s) you can deduct that portion of it (including accelerated depreciation). But if your income is coming from W-2 job(s), you simply cannot.
For two, the standard deduction is better seen as a personal exemption (which it subsumed), giving everyone a level of income that they don't have to pay tax on. Especially given that business expenses generally flow through as direct subtractions regardless of the standard deduction.
There is definitely tension between allowing deductions to account for actual income fairly, and the resulting (de facto) requirement that everyone do minutiae accounting for their personal finances.
Unless your property taxes are over $20K per year, you can? It's just most people don't because their standard deduction is greater than what they have records for itemizing. https://www.thebalance.com/property-tax-deduction-3192847
The link you provide points out the SALT deduction cap of $10k. With the standard deduction up to $12k+ now, if your only itemized deduction is your property and state income taxes, itemizing isn't going to be worth it.
We were so close to losing the cap on SALT deductions with the Inflation Reduction Act; I'm super bummed it didn't make it into the final bill.
I think the only long term solution is a federal land and building tax. This is too important to leave to states (and definitely local) governments. A high tax with no credits, deductions, exemptions.
Then, from this tax, we can pay "forward" every adult tax payer (not children, only adults) a fixed amount that pays the cost of an imaginary nationwide median cost of a two bedroom unit. Only adults, all adults, regardless of whether you have no child or eight children. Must file a federal income tax return to qualify. Median nationwide cost somehow calculated and weighted by population, hopefully updated more than once a decade.
Everybody from Amazon.com to Walmart pays this land + building tax regardless of whether they are in Manhattan, New York or Deport, Texas. No exceptions.
Well yes but that's also the case with property taxes. A reasonable figure based on current market values seems simpler to calculate for unimproved land than it does for property tax, which includes the value of the unimproved land as well as everything else built or changed. And because it's the value of the _unimproved_ land it's based on, the value would be relatively stable over time as well as not varying much between one area and similar areas nearby, whereas property taxes are based on values that can change dramatically over time from one place to the next, which can lead to mis-valuations and general stress from constant changes.
Aside from a 1031 you can do what I do and take loans against the property to buy the next property. Keeps your tax basis lower. At least in LA county the appreciation is limited to 2% a year while the increase in property value has been 20%+ the last few years.
You can do this indefinitely with commercial real estate including multi-family dwellings. Lenders are comfortable with 50% loan-to-value. You do need to have some cash flow from the properties to service the debt. It does require the properties to either appreciate over time or for you to build up more equity in them by paying down your loan.
You can do this indefinitely with commercial real estate including multi-family dwellings. Lenders are comfortable with 50% loan-to-value. You do need to have some cash flow from the properties to service the debt. It does require the properties to either appreciate over time or for you to build up more equity in them by paying down your loan.
> Depreciation is very fundamental to business tax law. I'm not sure how you'd "fix" that without penalizing non-rental companies for expanding.
You can fix it by only deprecating the original cost. A person who buys a 50 year old house shouldn't be able to depreciate a second time, (then next owner again)
"Few rental properties will have under a 3.7% ROI"
This is a leveraged investment (meaning you have a mortage). What that means is for your 20% down payment (the actual money you invest), that 3.7% writeoff on income can be an 18.5% cash on cash yield (ROI) in which you pay no taxes, ever. Few properties on the market can get you a better yield than that. If your ultimate yield is less than that you can roll those losses over year over year, so that then later if/when you get more yield you still* don't have to pay any taxes. It's a really big tax loophole and is the reason Donald Trump pays almost nothing in taxes (and he admitted as much in the presidential debate).
*I own 3 properties in buffalo, one of the best rent to value markets in the US, and it's hard to find better yield than that even in that market. https://simplepassivecashflow.com/rv/
And flipping to more and more expensive properties through 1031s requires more and more capital and only makes it cover less taxes. There's no tax benefits versus just keeping the first property and paying all the taxes and buying a separate property to depreciate.
If you sell a $500k property earning $40k/year where the depreciation covered 45% of your income, and you buy a $1 million property earning $80k/year, you get a new $500k to depreciate $18k/year. Then the depreciation only covers 22% of your income.
Depreciation is very fundamental to business tax law. I'm not sure how you'd "fix" that without penalizing non-rental companies for expanding.