Taxes on Paid Off Rental Property

[Bruce L.]

Hi Guys,

I have one more payment in December of this year and one of my rental properties will be paid off.

What things do I need to plan on in the future now that the property is paid off?

How will this affect my taxes? I believe passive income will be treated as ordinary income. I currently have a regular 9-5 job and in 25% tax bracket.

Is there anything I could do to be better prepared?

Would you buy more properties so you have the interest deductions to offset the passive income?

Thanks.

[Account Closed]

Net rental income is taxed at ordinary income tax rates regardless of the amount owed or not owed on a property. You quite likely though still have depreciation deductions even though the property is paid off so that will continue to reduce taxable income.

Your deductible mortgage interest expense in 2012 is not going to be very much compared to years past, so 2013 is not going to be that much different. The main difference is that you will no longer be making principle payments. Your principle payments have been a cash expense with no deduction. That means in 2013 you will have more money in the bank and your actual taxable income won't change that much.

You might benefit from purchasing additional real estate, but it makes no sense to do this only to create a new mortgage interest expense. Far more important would be the return on investment for taking on new debt.