Should you buy a rental property for the tax benefits?

May, 08 2014 by Eric Linden

I have a good friend who owns two rental homes here in California. The tales he tells regarding these “assets” are not for the faint of heart. Most recently, on a particularly active St. Patty’s Day, a drunken reveler decided to drive his stomper truck through a bedroom of one of his units. No one was hurt, thankfully, but as you can imagine, my friend had a mess on his hands. This is one of the many stories I have heard regarding these investments, and I have come to the conclusion that there had better be a nice payday in exchange for this madness. Mind you, not all rental properties produce the same carnage, but it still would be nice to see a decent ROI (Return on Investment) in exchange for “May I please speak with Mr. Larson? This is. Mr. Larsen, this is the Los Angeles Police Department.”

A co-worker of mine has owned a rental property since 1977 (and, yes, he is very old now). He pointed out that the laws about rentals have changed drastically, and as long as Congress is still breathing, the laws are subject to change, daily!  He states that while the existing law has limits to current allowable deductions for losses on rental real estate, it is still a valuable asset to many people.  His rental shows a nice profit each year and his main asset (the rental home and the land it sits on) continues to grow in value.  When he sells it, he will still be able to only pay capital gains rate for the majority of the gain.

Are rentals the panacea for all to “beat the tax man?”  Clearly, the answer to that is no.  Someone who has no stomach for the possible headaches and hassles, lacks the handy man gene, makes over $150,000 (a current limitation number to be able to take a current loss instead of carrying the loss forward until disposing of the asset), and does not live near the rental unit would probably not be a good candidate for being a landlord. The ideal candidate would be a retired contractor who lives next door to the rental unit and makes $80,000 from retirement.  Those two examples are the outer limits, while most of the rest of us fall somewhere in between.

You put a dollar in the bank in your savings account and it is safe, but is it sound?  In two or three years at the current interest rate, your $1.00 is now worth $1.02, maybe.  Will you be able to live like Donald Trump?  Is there a better way?  Maybe for some but when the rewards are higher, so is the risk.  The bottom line is each individual situation is different. Each person is different. A good rule of thumb is to not invest in anything purely due to tax benefits. There are so many other factors to consider and being cognizant of that is a smart move.

Enjoy your investing and tax planning for 2014!