Tax free income from rentals

[Jessica Pratt]

I've read several of the the Rich Dad Poor Dad books. He talks about taking out loans on the properties for your income because loans aren't taxable. Does this really work and how do you make the strategy viable? The only way in my head I can see to make this work is if you ladder the payoffs and loans. But that doesn't erase the fact that the rental income received is taxable. Is this is a viable strategy, is there a good resource to learn more about this?

[Natalie Kolodij]

Many rentals have losses on paper due to depreciation. 

The building value of the rental is written off across 27.5 years. So for example; if you pay $500k for a rental and $400k is building value. 

You likely only made a down payment of 3-20% ....but you still get to write it off on the full value across 27.5 years.

So 400k/27.5 = 14,000 ish a year of a write off where during the year you didn't need to incur an actual expense, no cash outflow. 

So your super basic P&L may look like: 

$30,000 Rents
-$3,000 insurance expense 
-$9,000 interest

-$3,000 taxes

-$8,000 operating expenses

-$14,000 depreciation 

---------------

-$7,000 loss on paper for the year  so negative taxable income 

But remember- $14k of that (depreciation) was something we didn't actually spend money on- so cash in bank at year end would be $7,000. 

So often rentals don't have taxable income; and once they do it's still not subject to the payroll taxes paid by W2 wages or on self employed income. 


But yes; if a rental generates net income after all expenses that is still taxable. 

What the concept you mentioned is talking about is leveraging equity to gain cash vs. selling essentially. 

It's not necessarily saying all of your income from rentals ever will be tax-free (though it could be). 

But if you have 10 rentals. And each go up in value annually. 

And after several years you start doing cash out refinances.....If you can refinance one property every 1-2 years and withdraw $200k of equity....that's not taxable. 

You can now live on that $200k if you want. 

If you wanted to earn $200k to live on at a W2 job....you'd need to earn significantly more because you'd have to pay income taxes, and payroll taxes on the income; where as taking on debt isn't taxable at all. 

Or if you wanted to sell a rental to make the $200k from selling- you'd have to pay capital gains, and unrecaptured depreciation tax and potentially depreciation recapture.