Tax strategy for paid off investment properties

Investor · Jacksonville, FL · Member since 2015 · 504 posts · 217 votes

What should we expect tax season if we paid off investment property this year, and how can we minimize the tax bill on the income of paid off rentals?

0 Reply

18 views

Most Popular Reply

Steve Vaughan

Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes

I don't see how paying off your rentals is detrimental to your tax burden. Opinions on the opportunity cost of the cash you used to pay it off aside, your tax position will BENEFIT.

I have 3 paid off places now and will have a 10-unit paid off in 2019. Here's what it did on 1 house as an example. I was paying $6,000 in interest per year. That was resulting in a tax reduction/ rebate of about $1500.

I was spending $6,000 to get back $1500. That's the reality of the 'tax benefits' of mortgage interest. Send me $6k and I will return $1500 to anyone any day. Twice on Sunday.

4 Reply

See this reply in the discussion

27 Replies

Jump to latestLatest

Sort by

Alex Deacon
Investor · Pittsburgh, PA · Member since 2015 · 1k+ posts · 1k+ votes
9y
@Carolyn Morales Carolyn first of all awesome for you to pay off your investments and if i am reading this correctly you just paid off your mortgages and you own the rental property free and clear. If thats the case first of all your rental income is considered passive so you will pay passive income tax rate. There is nothing you can do to minimize rental income other than buy more properties and reinvest. Or revert them somehow into a SDIRA (Self Directed IRA). You need to seek the advice of a good Accountant who knows real estate and possibly talk with a SDIRA company that will manage the IRA.
1 Reply
Lance LvovskyPro Member
Accountant · Fort Lauderdale, FL · Member since 2013 · 1k+ posts · 753 votes
9y
You should speak with a CPA who can review your prior tax returns and see if there are opportunities to further reduce your taxes. Of course one way is to do a cash out refinance but since you just paid off your property, you may not want debt again ok your rental. There are the common expenses such as real estate taxes, insurance, etc. But also the uncommon expenses that you may overlook, such as auto mileage, BP membership, etc.
3 Reply
Mike Dymski
Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
9y
Leverage and taxes are two of the greatest benefits of real estate versus other asset classes and two of the most misunderstood.
You can own one free and clear $100 property and receive $100 worth of depreciation expense or you can own four $100 properties leveraged and receive $400 worth of depreciation expense. It is important to calculate the after tax return on your investment alternatives and decisions.
Regarding leverage, assuming 3% appreciation per year, the single $100 property will be worth $181 after 20 years ($81 in added equity) versus the four $100 properties with a value of $722 ($322 in added equity).
4x the amount of depreciation and 4x the amount of appreciation is lost with the single property scenario. IMO, direct real estate investing is too much work to not realize these key benefits...and other investment alternatives become more attractive without them.
In the end, there are lots of ways to make money in real estate and investing is not a one size fits all game. There are also many places in between full leverage and no leverage that may be the sweet spot for some.
Lever up and reinvest (does not have to be in direct real estate) or loose the tax benefits. Or simply enjoy having a free and clear property and the ~5% returns on paying off the debt (whatever your interest rate on borrowing is).
Good question and keep us posted.
3 Reply
Bernard ReiszPro Member
CPA delivering RE Tax Tools: 1031 Exchange, SDIRA, 401(k), Cost Seg · New York City, NY · Member since 2017 · 581 posts · 563 votes
9y
@Carolyn Morales As @Lance Lvovsky suggests, the first step should be to consult an experienced tax advisor. Another option that should be considered as part of your tax and investing strategy is a Solo 401(k) Plan. A Solo 401(k) allows for high tax deductions, makes available a range of tax strategies, and enables you to use tax-advantaged retirement funds for RE investment.
To be eligible for a Solo 401(k) there must be self-employment income and no full time employees. There are some tax rules to be aware of when pursuing these strategies, but those are easily managed if you're aware of them and have whom to consult with when a question arises.
[email protected]
1 Reply
Thomas S.
Member since 2016 · 13k+ posts · 12k+ votes
9y
Best tax option is to pull all the cash you can from the properties. Based on the opportunity value of cash all your properties are now a liability, probably negative cash flow due to the cost of the dead cash in your properties. Leverage them all to the max to achieve maximum tax advantage and spread the money to as many new investments as possible. If you do not want to expand your property investments refinance and sit down with your financial advisor to determine the best income fund vehicle. This will create a greater return, combined with the leveraged properties, than you are presently achieving.
1 Reply
Carolyn Morales
OP
Investor · Jacksonville, FL · Member since 2015 · 504 posts · 217 votes
9y
Bernard Reisz, Lance Lvovsky, Mike Dimsky, Alex Deacon Thomas S
What banks will refinance a paid off investment property without hitting me with outrageous interest rates? Most local banks only loan on primary residences. That seems the best strategy is to refi, because we want to build on a paid off lot. I do have a CPA I have used since the 90s. I have borrowed most of my available portion of 401k and can not access the rest until 2021 retirement, I already checked into self directing.
0 Reply
Andy D.
Investor · Zürich, Zürich · Member since 2016 · 292 posts · 115 votes
9y
Originally posted by @Carolyn Morales:

Bernard Reisz, Lance Lvovsky, Mike Dimsky, Alex Deacon Thomas S
What banks will refinance a paid off investment property without hitting me with outrageous interest rates? Most local banks only loan on primary residences. That seems the best strategy is to refi, because we want to build on a paid off lot. I do have a CPA I have used since the 90s. I have borrowed most of my available portion of 401k and can not access the rest until 2021 retirement, I already checked into self directing.
I'm fairly confused by your above post especially in combination with your opening post. You seem to have a financed property and yet you say no bank will finance investment properties?! What do you think most people here on BP have (including yourself, apparently)? Also, "outrageous interest rates" at this point in time? Have you at all followed the market in the last few years??
As for properly tagging people: you need to add the "@" sign before their first name and then, if you wait a moment, a suggestion pop-up-window will appear where you can select the correct person.
1 Reply
Mike Dymski
Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
9y
Most lenders will refinance an investment property at reasonable terms (~0.50% higher than a primary residence, assuming good credit).
1 Reply
Paul Allen
Financial Advisor · Virginia Beach, VA · Member since 2017 · 502 posts · 508 votes
9y
@Carolyn Morales
Hopefully you had a discussion with your CPA about your tax strategy for after the property was paid off BEFORE the property was paid off. What did s/he recommend at that time?
1 Reply
Steve Vaughan
Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
9y
I don't see how paying off your rentals is detrimental to your tax burden. Opinions on the opportunity cost of the cash you used to pay it off aside, your tax position will BENEFIT.
I have 3 paid off places now and will have a 10-unit paid off in 2019. Here's what it did on 1 house as an example. I was paying $6,000 in interest per year. That was resulting in a tax reduction/ rebate of about $1500.
I was spending $6,000 to get back $1500. That's the reality of the 'tax benefits' of mortgage interest. Send me $6k and I will return $1500 to anyone any day. Twice on Sunday.
4 Reply
Carolyn Morales
OP
Investor · Jacksonville, FL · Member since 2015 · 504 posts · 217 votes
9y
Originally posted by @Andy D.:

Originally posted by @Carolyn Morales:
Bernard Reisz, Lance Lvovsky, Mike Dimsky, Alex Deacon Thomas S
What banks will refinance a paid off investment property without hitting me with outrageous interest rates? Most local banks only loan on primary residences. That seems the best strategy is to refi, because we want to build on a paid off lot. I do have a CPA I have used since the 90s. I have borrowed most of my available portion of 401k and can not access the rest until 2021 retirement, I already checked into self directing.
I'm fairly confused by your above post especially in combination with your opening post. You seem to have a financed property and yet you say no bank will finance investment properties?! What do you think most people here on BP have (including yourself, apparently)? Also, "outrageous interest rates" at this point in time? Have you at all followed the market in the last few years??
As for properly tagging people: you need to add the "@" sign before their first name and then, if you wait a moment, a suggestion pop-up-window will appear where you can select the correct person.
We have 3 of 5 paid off but 1 of the paid off is a vacant lot we want financing to build on. Locally ,I can only find primary residence financing that has a decent enough interest rate. I hope that is clear enough @Andy D. Thank you for your response.
0 Reply
Carolyn Morales
OP
Investor · Jacksonville, FL · Member since 2015 · 504 posts · 217 votes
9y
Originally posted by @Steve Vaughan:

I don't see how paying off your rentals is detrimental to your tax burden. Opinions on the opportunity cost of the cash you used to pay it off aside, your tax position will BENEFIT.
I have 3 paid off places now and will have a 10-unit paid off in 2019. Here's what it did on 1 house as an example. I was paying $6,000 in interest per year. That was resulting in a tax reduction/ rebate of about $1500.
I was spending $6,000 to get back $1500. That's the reality of the 'tax benefits' of mortgage interest. Send me $6k and I will return $1500 to anyone any day. Twice on Sunday.
@Steve Vaughan
This is what I am trying to find out, Thank You. Have you ever refinanced a paid off investment property ? If so, What financial institution and interest rate?
0 Reply
Carolyn Morales
OP
Investor · Jacksonville, FL · Member since 2015 · 504 posts · 217 votes
9y
@Paul Allen. 1 has been paid off since 2004 .Another we just paid off a small balance. We have never refinanced a rental property just wanting to know the ins and outs of it. Depreciation has helped the 1 paid off since 04. The 2nd pay off of occupied investment property makes it a bigger income stream.
0 Reply
Carolyn Morales
OP
Investor · Jacksonville, FL · Member since 2015 · 504 posts · 217 votes
9y
Originally posted by @Carolyn Morales:

@Bernard Reisz, @Lance Lvovsky, @Mike Dimsky, @Alex Deacon @Thomas S
What banks will refinance a paid off investment property without hitting me with outrageous interest rates? Most local banks only loan on primary residences. That seems the best strategy is to refi, because we want to build on a paid off lot. I do have a CPA I have used since the 90s. I have borrowed most of my available portion of 401k and can not access the rest until 2021 retirement, I already checked into self directing.
0 Reply
Carolyn Morales
OP
Investor · Jacksonville, FL · Member since 2015 · 504 posts · 217 votes
9y
@Andy D,
I reposted with @ included. I didn't say no banks will refinance rentals, I said it is difficult to find here locally and most only want to refinance primary residences. Thanks for your helpful information.
0 Reply
Carolyn Morales
OP
Investor · Jacksonville, FL · Member since 2015 · 504 posts · 217 votes
9y
@Alex Deacon 3 paid off of 5 , 1 we will occupy, 1 paid off ,is a vacant lot we want to build on.
0 Reply
Carolyn Morales
OP
Investor · Jacksonville, FL · Member since 2015 · 504 posts · 217 votes
9y
@Mike Dymski
Which lenders? Local banks I have dealt with only want to finance primary residences. Which a new build will eventually be a primary but not soon enough to pitch it as a primary to a lender. So,We would try to refi paid off property in order to build or wait.
0 Reply
Carolyn Morales
OP
Investor · Jacksonville, FL · Member since 2015 · 504 posts · 217 votes
9y
@Andy D, All of our properties were primary at one point. We buy and hold. All of our financing was primary residence.
0 Reply
Lesley Resnick
Real Estate Agent · Jacksonville, FL · Member since 2015 · 1k+ posts · 1k+ votes
9y
I believe leverage and tax advantage is why we invest.
There are a lot of people advocating paying everything off. For personal debt (car, credit card, etc) I agree. For investment, leverage is the way to go. The only exception is if you are retired on a fixed income and have no other means of income. I do not recommend being reckless and leveraging you last penny. I also recommend keeping cash reserves. You can have 4x as many properties using leverage, thus income, depreciation etc. on 4 properties. The fact is that a small portfolio is not going to get you where you want. The additional effort on a larger portfolio vs a smaller one is minimal. It is probably not worth it to only have one or two properties. The only way for most people to get there is though leverage, fannie mae loans or private money.
If you can qualify for a fannie mae loan, by all means it is a great loan. If not, you will have to look at the higher cost loans. It becomes a question of numbers, not weather or not the interest rate is high. If you can not get the money any other way and the deal still works, then the interest rate is just an expense and irrelevant. You will get some of that money back in taxes.
1 Reply
David Krulac
Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes
9y
@Carolyn Morales
It depends on you. If you want to buy more property or bigger properties, paying off mortgages can help that. Or if you don't want to buy more, then improvements to currently help property would be one avenue, keeping money available as a reserve or doing some other investment.
I've had 50 mortgages and at one point I decided that my biggest expense every month was paying those mortgages. I had already quit my full time job but felt like I was working for the banks. I stopped buying properties using financing, and went on an aggressive program of paying off mortgages. I sold some properties and used proceeds and excess rent to pay off other mortgages. I paid off almost of the mortgages and of the last 100+ property purchases only one involved a mortgage, which was such a good offer I could not refuse. I've upgrades other properties installing new gas furnaces, new heat pumps, central air, etc to upgrade the properties and the rents. And of course still have lots of depreciation for a tax deduction.
David Krulac
1 Reply
Andreas W.
Durham, NC · Member since 2013 · 502 posts · 215 votes
9y
@Carolyn Morales
We are in a time of historically low interest rates. If you want to take on fixed rate debt, now is the time. Should your local banks be uninterested in mortgaging your rentals, there are many national lenders out that happily will. They are a phone cal away.
1 Reply
Jim BlackburnBusiness Member
Lender · Florida Based (48 states Puerto Rico) · Member since 2017 · 321 posts · 121 votes
9y
Carolyn Morales - many investors lien to keep their properties financed to maintain the tax advantage, especially if still employed and earning high income, and leveraging that equity to accumulate more real estate while rates are still low. Both Fannie and Freddie will now allow up to 10 financed properties. Ask anything.
954-993-1625
Stairway Mortgage, a Division of NEXA Mortgage LLC597 Reviews
Website View Page
1 Reply
Carolyn Morales
OP
Investor · Jacksonville, FL · Member since 2015 · 504 posts · 217 votes
9y
@Jim Blackburn, Thank you for your kind response. Does your company refinance paid off investment properties in Florida? All of our buy and hold were primary residences at one point.
0 Reply
Steve Vaughan
Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
9y
Originally posted by @Carolyn Morales:

@Andy D, All of our properties were primary at one point. We buy and hold. All of our financing was primary residence.
For a tax strategy, we can sell our primary tax-free up to 3 years after we turn it into a rental. That's tax-free appreciation! How long since you turned your last primary into a rental?
Since you are seeking a new construction loan for your primary, that could be your focus. Probably easier than financing the rentals. My bro-in-law just got a construction loan for his house he is building. He 'celebrated' when it came through, so it may not be simple. But it is attainable. Good luck, Carolyn!
0 Reply
John Verduzco
Naples, FL · Member since 2016 · 37 posts · 25 votes
9y
I have used Quicken Loans, Flagstar, Stearns and Suntrust to finance (not cash out refinance) investment properties. We did our ten properties (including primary residence) which is the conventional loan max and we were happy with rates and terms on each one. Typically 80% LTV on the first four and 75% LTV on the next 6. Rates were between 4% and 5%. all are 30 year fixed. this was 2013 to 2015 so shouldn't have moved much since. credit scores will likely need to be 720 (middle score of 3 for both borrowers. good luck.
1 Reply

Join the conversationCreate a free account to reply, vote on answers and follow this thread.