PDA

View Full Version : Structure and taxes for rental house



sfskseg
06-11-2012, 05:34 PM
Hello,

I'm purchasing a property in Dallas TX and plan to rent it out. I am putting 40k down and taking a 15-year mortgage on the remaining 60k. The mortgage will be in my name.

1. My first question is should I create an LLC? I assume the answer is yes. If so, should the title be in my name or the name of the LLC? Can that even be done? If I plan to close July 10, do I even have time to form an LLC? Is there anything else I should know about this?

2. How will taxes work? Specifically, I don't plan to make a cent of profit until the house is paid off. I am going to put the entire rental income towards the mortgage every month. That being the case, will I be paying taxes on anything as I have not made any profit (until the house is paid off)?

3. Finally, how do I treat my initial 40k investment when tax season comes around?

Thank you!

ArcSine
06-12-2012, 08:00 AM
Very generally, it's frequently a good idea to put some separation between you (i.e., your personal assets, cash, retirement funds, home, cars, ...) and real property you own for rental or commercial purposes. The idea is to minimize the odds that any claims arising against the real property (e.g., someone gets injured or worse on the premises) might be allowed by a court to be satisfied from your personal assets.

No such liability firewall is bulletproof but a common basic structure would have you owning an LLC which in turn owns the rental property.

The wrinkles here are (1) the mortgage in your name; and (2) state law. An advisor familiar with lending practices in your area will likely have to guide you on what options are available to you in structuring the financing side of this deal. Re (2), liability claims issues are state-specific (particularly w.r.t. real estate), and where TX statutes fall on the "plaintiff-friendly / defendent-friendly" spectrum will influence the details of how you should structure the arrangement; for example, if there are certain provisions you should have in your LLC documentation in order to create an effective liability insulation in TX. An attorney familiar with TX law will be the go-to on that one.

Re the timeline, check out the TX SOS website here (http://www.sos.state.tx.us/)for info on getting the LLC established; you might even give 'em a call and ask how quickly it can be done. Many states have so-called "expedited filing" options which are analogous to the grocery store express lane for setting up LLCs (although usually for a fee, natch).

On the income tax front, if you expect to have rental income which exceeds the mortgage interest and other operating expenses (i.e., you'll have a net positive cash flow from which you can pay down the loan principal), then you'll have a profit from a cash-flow standpoint. (In such case your profit doesn't materialize in the form of an increasing checkbook balance, but rather in the form of a decreasing debt obligation, which is an increase of your net worth all the same.) However, you'll also be allowed to deduct depreciation on the property for income tax purposes, and so whether your tax return will show a taxable profit or a loss on the rental property's bottom line will depend on the size of the depreciation deductions vs. the amount by which your rental income exceeds your mortgage interest and other operating expenses.

Residential rental property is depreciated straight-line over 27 years, so take the cost of your property (100K), apportion that in a reasonable manner between land and building, then divide the building cost (land is not depreciable) by 27.5 to get an idea of your annual depreciation deduction. (In your first year you'll have roughly half a year of depreciation, but also only half a year of income and expenses, so adjust accordingly.)

sfskseg
06-12-2012, 04:58 PM
Thanks ArcSine. A couple clarifications...what would constitute operating expenses? I assume things like lawn care expenses. What about property taxes and home owners insurance?

And when you say to apportion in a reasonable manner between land and building, how do I determine what a reasonable manner is? Is there some some sort of resource for this?

Thanks!

sfskseg
06-12-2012, 05:11 PM
And one more question....what about the initial 40k down payment? Is that deductible as an investment?

Evan
06-12-2012, 06:32 PM
1. My first question is should I create an LLC? I assume the answer is yes. If so, should the title be in my name or the name of the LLC? Can that even be done? If I plan to close July 10, do I even have time to form an LLC? Is there anything else I should know about this?

That is going to be a personal decision, there are certainly legal reasons for forming an LLC. If you *do* go down thsi path, the title should be in the name of the LLC, and even the insurance, etc. should be in the name of the LLC. The important thing to make sure is that there is no local requirements that businesses (commercial) cannot own residential property. For example, there are generally zoning laws, so you are not buying a house in a residential area, and converting it to a commercial property if it's not "zoned" for that. (So you can't buy a large home in Dallas, knock it down and open a Subway sandwich shop, without the proper zoning permits, etc.) You may just wish to verify that you acquiring it as an LLC is not going to create any "additional" problems with the transaction. It shouldn't, but you should just confirm this.


2. How will taxes work? Specifically, I don't plan to make a cent of profit until the house is paid off. I am going to put the entire rental income towards the mortgage every month. That being the case, will I be paying taxes on anything as I have not made any profit (until the house is paid off)?

As a single-member LLC, you'd be filing Schedule E and could deduct the interest on the mortgage against the rental payments. Additionally, you can deduct depreciation of the house (27-1/2 years), but only the building (not land portion). To determine the value of the land, I'd guestimate approximately 20% of the purchase price, but I'd also look at the property tax assessment as well to determine this as well.


3. Finally, how do I treat my initial 40k investment when tax season comes around?
That's just your investment. It isn't deductible at all. The $40K cash plus $60K mortgage equal your purchase price, for which the building portion can be deducted (as described above). Beyond that, you won't get any other benefit. Now let's say you decide to sell the property after 10 years and you paid $20K on your mortgage. You'll have to pay back $40K on the mortgage ($60K original - $20K of payments = $40K). Now if you sold it for $115K, you'll receive $115K cash, with the $40K going to pay the mortgage, and the rest going in your pocket.



Re the timeline, check out the TX SOS website here (http://www.sos.state.tx.us/)for info on getting the LLC established; you might even give 'em a call and ask how quickly it can be done. Many states have so-called "expedited filing" options which are analogous to the grocery store express lane for setting up LLCs (although usually for a fee, natch).

As time is of the essence, I'd pay to expedite the filing if you go this route. You'll probably also have a minimum business tax in TX to pay as well.


What would constitute operating expenses? I assume things like lawn care expenses. What about property taxes and home owners insurance?
Yes, lawn care expenses (assuming you pay for those of your tenant), property taxes and homeowners insurance (absolutely). If you provide utilities for "free" (included in rent), then those are deductible. Costs to advertise your place for sale would be deductible. If you evict a tenant, those legal costs. Accounting fees as a result of having this new entity/property. Plus you can deduct any annual fees that TX may assess on your LLC.

sfskseg
06-13-2012, 06:07 AM
Evan,
Thanks for the detailed and helpful response. I forgot to ask about costs associated with getting the mortgage. Such as origination fees, points, etc. Are those operating expenses?

And assuming I do form an llc, but it is after I have paid certain expenses. For example i'm paying an inspector tomorrow. Can i claim these expenses anywhere?

Evan
06-17-2012, 02:29 PM
Evan,
Thanks for the detailed and helpful response. I forgot to ask about costs associated with getting the mortgage. Such as origination fees, points, etc. Are those operating expenses?

And assuming I do form an llc, but it is after I have paid certain expenses. For example i'm paying an inspector tomorrow. Can i claim these expenses anywhere?

Some costs may be instantly deductible, others will be capitalized and amortized. For example, if you're paying legal fees, or the inspector fees, those could be deductible in the current year as those are benefiting you now. Origination fees/points; however, generally benefit you for the life of the loan and are amortized over its life. So if you have a 30 year mortgage and loan origination fees are $4,000... That $4,000 is amortized over 30 years. Also, if you close this year, you only get a partial year (one year is January-December. If you close in July, then you get it from that point going forward.)

BP Writer
06-20-2012, 06:40 PM
If you do go the LLC route, I would love to know how you worked out the mortgage "wrinkle" ArcSine mentioned.

Just a couple of notes:

- You will need a landlord policy which is more expensive than a regular homeowner policy - and you might not be able to get that in the name of the LLC (if that's the case, you would get it in your name and list the LLC as an additional insured).

- If you actually live in Texas then obviously you don't have to worry about state taxes, but if you are living outside of Texas in a state with an income tax you have to report the profit/loss for this property on your state taxes.

- I assume your loan is of the "investment property" variety, as opposed to "owner occupied" -- otherwise, well, that would bring up more issues

Evan
06-25-2012, 01:04 AM
If you do go the LLC route, I would love to know how you worked out the mortgage "wrinkle" ArcSine mentioned.

- You will need a landlord policy which is more expensive than a regular homeowner policy - and you might not be able to get that in the name of the LLC (if that's the case, you would get it in your name and list the LLC as an additional insured).

- If you actually live in Texas then obviously you don't have to worry about state taxes, but if you are living outside of Texas in a state with an income tax you have to report the profit/loss for this property on your state taxes.

- I assume your loan is of the "investment property" variety, as opposed to "owner occupied" -- otherwise, well, that would bring up more issues

For tax purposes, the mortgage "wrinkle" won't matter much, though it'd be important for legal reasons.

In Texas, there may be no income tax; however, there is a franchise tax for businesses, and that will need to be paid (as applicable).

BP Writer
06-25-2012, 05:46 PM
In Texas, there may be no income tax; however, there is a franchise tax for businesses, and that will need to be paid (as applicable).
I guess the key to that is "as applicable" - I don't think the Texas franchise tax kicks in until annual revenues hit $1 million.