What's the next move? Needing advice...

[Elle Scott]

Hi Everyone,

Would love some advice from those of you who have been in my shoes before. I'm new to this and cramming education quickly. Im a young corporate sales professional with a large income (which we all know means "taxed to death" lol ) only a small mortgage and a car payment for debt. In July of last year I purchased a home out of state where my parents live so they could remodel it (which is their specialty and darn good at it) I needed the tax write off desperately and every mentor said it was a must. Why I didn't buy a primary home is because San Diego is mad expensive and I'd rather use my debt to income ratio on rentals or flips rather than a 500k mortgage.

After learning more about REI, I now want to work my way to changing my income source. So what's the next move?

I bought the home in Coeur D Alene ID  for 15k under asking price, 20% down, put about 10k in materials and 20k of labor -rough numbers as I'm still tallying up everything- Come July the status of the home is eligible to change from being second home to whatever I want and I'm researching whether or not to sell it, rent it or hold it longer. I'd rather utilize the investment for cash flow as I'm currently paying the mortgage on top of the rent I pay here in SD. It's tough to completely say without knowing my specifics and lifestyle, so I completely understand not getting straight forward advice. I expect to make a similar income this year and need a write off while I'm still a wage earner.

Should I sell the place, do a 1031 and purchase a MF for cashflow or another flip? Just hold on to it, continue paying the mortgage until I have a larger amount of capital to do a proper investment? I'm ready to start taking some risks and create cashflow :)  Thanks all! 

[Brandon Hall]

@Elle Scott Your questions are great questions, just very difficult to give any sort of helpful advice because I don't know anything about your financial position. 

So let's make assumptions. 

 - Your income subject to federal tax (after 401k) is $120k/yr

 - Your second home's interest payment is $9k/yr

 - Your second home can rent for $20k/yr gross

 - Your second home has operating expenses of $9k

 - Your second home can claim depreciation and amortization of $3700/yr

 - You are single and have no dependents

 - Your itemized deductions, not including anything from your second home, are $30k

Scenario 1 - you do not rent the second home

In this scenario, your AGI will be $120k and your taxable income will be $77,050 ($120k - $30k - $9k from interest - $3,950 for exemption). This puts you in the 25% tax bracket and your total tax will be $15,119. 

Scenario 2 - you rent your second home

In this scenario, you lose the ability to itemize your interest deduction, however you are also no longer paying for the interest as your tenants are, so you can save an extra $9k per year. First we want to figure out the net income (loss) from your new rental property. The net income after operating expenses will be $11k ($20k - 9k). We then subtract the interest applicable to the loan and we are left with $2k ($11k - 9k). We then subtract depreciation/amortization and we are left with a loss of $1,700. Note, this is a paper loss. Your real income on the property was $2k, however it's sheltered by depreciation. 

Your AGI will be $120k and your taxable income will be $86,050 ($120k - 30k - 3,950). You are still in the 25% tax bracket and your total tax will be $17,369.

You may think scenario 1 is better as it results in less tax, however let's look at the real net difference. 

The tax difference is $2,250 ($17,369 - 15,119) however in scenario 2, you are no longer paying interest out of your pocket and your net income is $2k tax free. So scenario 2 gives you an "income" of $11k. Subtract the difference between scenario 1 and 2 and your real gain by choosing scenario 2 is: $8,750 ($11k - 2,250).

Obviously this is high-level, but these are the scenarios you will want to run with a CPA.