Impossible to profit on Vacation Rentals with a Mortgage?

[Chase Cline]

Hey Everyone!

Sorry for the clickbait title... 

I own a successful vacation rental (successful meaning it pays for itself) and close on another one at the end of this month. We also bought another one in August of this year that we will be moving out of in March and it will become our 3rd vacation rental.

So I use QuickBooks self-employed to track my first rental and I have a bank account dedicated only to that property. At the end of this year I saw a $1,000 profit which means the property was "successful" in that it fully pays for itself, which is the goal while there is still a mortgage on the property, right?

(by the way we paid $4,000 in extra mortgage payments throughout the year so we could have had $5k profit, but my point still exists)

Well, I met with my new accountant for the first time two days ago and a bomb was dropped on me that I hadn't thought about it. I was expecting to be taxed ONLY on the ~$1,000 profit I showed, but apparently that's not how it works (I'm not a newbie, but this was a newbie mistake that I only became aware of because I finally started using a real accountant and not H&R block). I am taxed on the Net Income which does NOT include any mortgage principal payments. So this took my taxable income on the property from what I thought was ~$1,000 up closer to $8k. Getting taxed on that amount will just about eat up most of the profit. 

Are all of you dealing with the same issue? This was a very shocking realization and is making me re-think having a mortgage on vacation rentals. How are all of you handling this?

What are your monetary profit goals on VRs that still have a mortgage?? Even without making extra mortgage payments this year we will be left with maybe $1k profit after taxes. Is the work of managing these places worth a $1k profit every year?  

Thanks for any feedback!

Chase

[Tim Schroeder]

Personally, I disagree with your definition of a "successful vacation rental". A successful vacation rental is NOT something that "pays for itself", it's something that makes a ton of money.

A property that makes you 1,000 per year before taxes is, at best, a free second home. But it's not really that even. What are you going to do when it needs a $2,000 refrigerator, a $5,000 furnace, or a $15,000 roof?  If what you want is a 2nd home for yourself -- a place to go sit in the sun and relax -- great. Good for you. You MIGHT just break even, until that furnace goes out anyway.

I have two properties mortgaged to the hilt, and they net me a disgusting amount of money. The mortgage isn't your problem, your property is. Do the ROI math on a mortgaged property vs a non-mortgaged property. Often, when you look at the profit numbers on a non-mortgaged property, you'll see much higher profit and you'll get excited. But divide that number by the capital you invested to buy the property outright and you'll see your ROI is terrible, because in order to get that profit up to an exciting level, you had to invest too much capital. And for most people, capital is the limiting factor for further investing. Personally, I would not be interested in an CoC ROI under 20%. Hell, historically I can get 8% in stock market index funds with less risk (over time) and zero effort.

Do the numbers for what you have now, then re-run them pretending you paid off the mortgage. Compare the ROI. Choose the scenario that yields a higher ROI. Consider sharing the results if you like. People here love talking about this stuff.

Then call your agent and put that thing up for sale and invest the proceeds in a better money-maker.  :)