Tax Savings ROI Through Net Loss

[Kyle R.]

Hi BP I am running through some scenarios for a first rental property which will be out of state using a PM. The scenarios range from a couple hundred cash flow positive per month to a break even per month. I have read a lot about the deprecation factor along with the other write offs and expenses (mortgage interest, PM expense) Cash wise we can make a profit per year whether large or small, but by being allowed to depreciate the prop over 27.5 years and deducting the other expenses we show a paper net loss for tax purposes. Say net loses for the year equal 10k, as a single member pass through LLC, I understand that 10k can be deducted from personal W2 salary under 100k. At a 25% tax rate that 10k of lowered taxable income will save personal taxes $2500. Even though the $2500 aren’t considered business income would I‎t be reasonable to count that onto income earned per year from the property for cash on cash return purposes? Say initial investment was 30k, can you add the hidden 2500$ saved in taxes to whatever the income earned on the property was to find the ROI for analytical purposes?

[Ben Zimmerman]

Originally posted by @Jon Crosby:

@Kyle R.  My accountant has always told me it's next to impossible to qualify for any type of 'active' management of your property.  Basically it's impossible to have any other job and claim active status. 

I would fire your accountant immediately and hire someone who actually deals with real estate taxes on a regular basis.  Even if you hire a management company you are still classified as actively managing it.

From the IRS Pubs: 

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Active participation.

You actively participated in a rental real estate activity if you (and your spouse) owned at least 10% of the rental property and you made management decisions or arranged for others to provide services (such as repairs) in a significant and bona fide sense. Management decisions that may count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and other similar decisions.

Example.

Mike is single and had the following income and losses during the tax year:

	Salary	$42,300
	Dividends	300
	Interest	1,400
	Rental loss	(4,000)

The rental loss was from the rental of a house Mike owned. Mike had advertised and rented the house to the current tenant himself. He also collected the rents, which usually came by mail. All repairs were either made or contracted out by Mike.

Although the rental loss is from a passive activity, because Mike actively participated in the rental property management he can use the entire $4,000 loss to offset his other income.

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However back to the OP's question, no I wouldn't count it towards a cash on cash calculation.  Don't overcomplicate things just to make the numbers sound more appealing than they are.