Investment Property - Tax Question

[MMM]

I am thinking about purchasing a 2nd house as investment. The house is located in a very nice neighbourhood with large lot size. I plan to use it as rental property and maybe build a dream house a few years later.

Hope the forum can help me answer a few tax questions. I have mortgage for the house I am living in. There are two options to come up down payment for the 2nd house. Option 1: take out home equity loan from my first house as down payment; Option 2: take loan from my 401K plan. Obviously, I also need mortgage for the 2nd house. If I choose option 1, do I get tax deductions for the mortgage on 1st house, home equity loan, and mortgage on 2nd house? If I can only get two tax deduction for 2 loans, therefore option 2 is a better way.

The rental market is not very strong in that area, and I expect to rent this house for $2000 to $2500. The rent is not enough to cover mortgage, property tax, and insurance. Can I claim business loss for the rental to reduce my overall tax?

I believe there are a lot of experienced real estate investors here to answer my question. Thanks in advance for your help.

[jm1fd]

I am thinking about purchasing a 2nd house as investment. The house is located in a very nice neighbourhood with large lot size. I plan to use it as rental property and maybe build a dream house a few years later.

Hope the forum can help me answer a few tax questions. I have mortgage for the house I am living in. There are two options to come up down payment for the 2nd house. Option 1: take out home equity loan from my first house as down payment; Option 2: take loan from my 401K plan. Obviously, I also need mortgage for the 2nd house. If I choose option 1, do I get tax deductions for the mortgage on 1st house, home equity loan, and mortgage on 2nd house? If I can only get two tax deduction for 2 loans, therefore option 2 is a better way.

The rental market is not very strong in that area, and I expect to rent this house for $2000 to $2500. The rent is not enough to cover mortgage, property tax, and insurance. Can I claim business loss for the rental to reduce my overall tax?

I believe there are a lot of experienced real estate investors here to answer my question. Thanks in advance for your help.

I'm fairly certain you can only take the mortgage interest deduction on your primary residence....so taking out a 2nd or a HELOC for the down payment would probably be your best bet at least from a tax perspective.

[Leon]

Yes but there are limitations. If your MAGI is below $100K, you can have up to $25K (I think this is the right number, you might want to download "Rental Real Estate" publication at the IRS website) of rental loss that could be deducted from the taxable income. However, if your MAGI is above $100K you are SOL - losses can be carried over to the following year, however. There are different rules if you are a real estate professional but I assume this does not apply to you.

Here is what I suggest:

Fire up your excel and see which house should carry the debt. I.e. if you are not subject to AMT, your principal residence 2nd mortgage is tax deductible. So if your MAGI is > 100K, it might be better to have 2nd loan on the primary residence (otherwise you end up with non-deductible losses on your real estate if you have a loss on rental). Also, do not forget to deduct depreciation from your rental income in your estimate (usually straight line over 27.5 years for building only). Remember, that depreciation saves you your marginal tax rate, while capital gains tax (to be paid when you sell the property years down the road) is only 15%, so maxing out depreciation is a good idea.

[ProHouston]

I never suggest taking a loan from your 401k. Why take money and future earnings from yourself when you can get it somewhere else. Also, I'm not sure an investment property is an approved option for taking a 401k loan.

[Mr. Chenevert]

I never suggest taking a loan from your 401k. Why take money and future earnings from yourself when you can get it somewhere else. Also, I'm not sure an investment property is an approved option for taking a 401k loan.

Because you are paying yourself back the interest instead of giving it to a bank.

[ProHouston]

Because you are paying yourself back the interest instead of giving it to a bank.

But in the meantime you're losing out on any gains you would have made off the borrowed money. And that lasts for as long as it takes to "repay" yourself.

[sevfiv]

yeah, i was wondering if the interest repaid would be as much as the money would earn left alone (although paying interest to a bank stinks, too).

also, since i don't know much about this - if you were to change/lose the job, wouldn't you be required to repay the balance fairly quickly?

[travelguy_73]

yeah, i was wondering if the interest repaid would be as much as the money would earn left alone (although paying interest to a bank stinks, too).

also, since i don't know much about this - if you were to change/lose the job, wouldn't you be required to repay the balance fairly quickly?

It varies by employer, but generally you can take a loan out for anything you wish. I believe a primary home loan will let you borrow for a longer period, though.

I'm trying to think of a circumstance when the interest you repay yourself in a 401k loan will equal the effect of compounded interest in the X years it takes to repay the loan. And the interest isn't deductible. And if you leave your company (voluntary or not), you generally have a very limited time to pay the loan back or take a 10% tax penalty on the outstanding portion of the loan (it will be considered an early distribution). There are some good calculators online that will give you an idea of lost income.

Edited September 27, 2007 by travelguy_73

[TAK]

here's what i've done...

set up a separate business for the the investment property. keep all of the expenses and incomes of the investment property separate from your "personal" income, but also be sure to apply every expense you can to the business / investment property (related cell phone bills, mileage, supplies, closing costs, marketing costs, etc.).

i would do everything i can to keep my personal property away from my investment property - for various liability and tax reasons.

You don't need to get a HELOC or a 2nd to get the deduction. you can certainly claim losses - including cost of capital (mortgage interest) on the rental property loan - up to a certain amount (i don't know what it is, my CPA does my taxes - and i suggest you have a professional do yours if you're going to have your money and time tied up in real estate investments).

ha.... i've just re-read your post, i don't think i directly answered your question... if you're looking for a down payment, and those are your only two options, i'd suggest a HELOC or 2nd - depending on how much equity you have - and i'd stay away from the 401k.)

i'm guessing you expect a lot of appreciation (or are getting a big discount) if you're going to tie up a property now - hold it at a significant loss - so you can build on the lot later. since it doesn't sound like your cash position is strong, i can't think of any other reason to take the loss now, except to lock in a low price now - or you have a high future earnings potential. either way, as long as you can manage it... but it sounds a bit risky.