Decision Needed - How to Invest Rental Income?

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simpatico
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Decision Needed - How to Invest Rental Income?

Post by simpatico » Thu Nov 30, 2017 11:48 am

This year we bought a rental condo. Took $200K 30-year mortgage with 4% APR. We are receiving $18K for the upcoming rentals. Can't decide what would be the best investment strategy for the money: pay them towards the mortgage or to invest in mutual fund. And if to invest - then what fund to select??? Our AA is about 60/40 bonds/stocks...
Please help with some wisdom!!!

chevca
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Re: Decision Needed - How to Invest Rental Income?

Post by chevca » Thu Nov 30, 2017 11:51 am

Do you/will you get to make use of all the deductions owning a rental property, or is your income above the limit to do so?

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Meg77
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Re: Decision Needed - How to Invest Rental Income?

Post by Meg77 » Thu Nov 30, 2017 11:52 am

We'd need a lot more detail to help - like whether you're already saving, what your savings rate is, if you're maxing out retirement accounts, if you have other debt and what the rates are, etc.

In general though without any context, I'd tell you to keep that cash on hand for a year without doing anything. I have several rentals and have had them for years. Everything goes well for months or even a year or two, then you'll need a $8000 HVAC, or a tenant will move out and trash the place requiring all new paint and carpet etc, or you can't get somebody in for 3 months, or a plumbing leak flood the place...

In general here's the order of priorities for extra cash though:
Pay off high interest rate consumer debt (anything over 7%)
Contribute enough to get any 401k matches
Set aside 3-6 months emergency fund
Max out Roth IRAs
Max out HSA (if you have access to one)
Pay off low interest rate consumer debt (under 7%)
Max out 401ks

Now it gets tricky. You could arguably pay down mortgages or invest in taxable. I'd probably refi my home mortgage to a 15 year fixed to lower the rate instead of simply making extra payments - if you can lower the rate enough for this to make sense. If maxing out retirement means you're contributing 20% or more of your income for retirement, then after that I'd probably use extra cash to reduce your highest rate mortgage debt, which would be the rental. But if you have other goals - another rental, starting a business, putting kids through school - it's OK to invest in taxable to reach those instead.
Last edited by Meg77 on Thu Nov 30, 2017 12:20 pm, edited 1 time in total.
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rocket354
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Re: Decision Needed - How to Invest Rental Income?

Post by rocket354 » Thu Nov 30, 2017 11:57 am

I don't think where the money comes from is an important factor in deciding what to do with the money. And that depends on your overall financial picture. With any money, the approximate order of importance is:

1) Pay down high-interest debt (credit cards primarily)
2) Invest (stocks or more rental properties, depending on your risk tolerance and availability of profitable options)
3) Pay down mortgages and other low-interest debt (assuming most mortgages nowadays are low-interest)

Some people swap #2 and #3 for peace of mind. To each his own.

If the question is really "How quickly should I pay down my rental property mortgage?" then you'll get a variety of answers but I own a couple rental properties and I choose the above listed order. I do not pay them down as doing so reduces return. I'd rather invest the money either in index funds or another rental property than pay off a tax-deductible 4% interest mortgage. Others may disagree.
Last edited by rocket354 on Thu Nov 30, 2017 12:01 pm, edited 1 time in total.

TravelforFun
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Re: Decision Needed - How to Invest Rental Income?

Post by TravelforFun » Thu Nov 30, 2017 12:01 pm

rocket354 wrote:
Thu Nov 30, 2017 11:57 am
I don't think where the money comes from is an important factor in what to do with the money. And that depends on your overall financial picture. With any money, the approximate order of importance is:

1) Pay down high-interest debt (credit cards primarily)
2) Invest (stocks or more rental properties, depending on your risk tolerance and availability of profitable options)
3) Pay down mortgages and other low-interest debt (assuming most mortgages nowadays are low-interest)

Some people swap #2 and #3 for peace of mind. To each his own.

If the question is really "How quickly should I pay down my rental property mortgage?" then you'll get a variety of answers but I own a couple rental properties and I choose the above listed order. I do not pay them down as doing so reduces return. I'd rather invest the money either in index funds or another rental property than pay off a tax-deductible 4% interest mortgage. Others may disagree.
I would do 1, 3, and 2 because I wouldn't borrow money to invest which is what #2 is .

TravelforFun

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rocket354
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Re: Decision Needed - How to Invest Rental Income?

Post by rocket354 » Thu Nov 30, 2017 12:06 pm

TravelforFun wrote:
Thu Nov 30, 2017 12:01 pm
rocket354 wrote:
Thu Nov 30, 2017 11:57 am
I don't think where the money comes from is an important factor in what to do with the money. And that depends on your overall financial picture. With any money, the approximate order of importance is:

1) Pay down high-interest debt (credit cards primarily)
2) Invest (stocks or more rental properties, depending on your risk tolerance and availability of profitable options)
3) Pay down mortgages and other low-interest debt (assuming most mortgages nowadays are low-interest)

Some people swap #2 and #3 for peace of mind. To each his own.

If the question is really "How quickly should I pay down my rental property mortgage?" then you'll get a variety of answers but I own a couple rental properties and I choose the above listed order. I do not pay them down as doing so reduces return. I'd rather invest the money either in index funds or another rental property than pay off a tax-deductible 4% interest mortgage. Others may disagree.
I would do 1, 3, and 2 because I wouldn't borrow money to invest which is what #2 is .

TravelforFun
While I agree different people have different risk tolerances, I will also point out that most people who make such claims as you just did do not in fact abide by that order. Most people who have that opinion, for example, still max out their 401k and/or IRA and/or HSA space rather than put all that money into their mortgage. Or they save to the point of the maximum company match. So it's often just different points along a spectrum: how advantageous of an investment must it be before people will choose it over paying down mortgages or other low-interest debt? And that's strictly up to a person's comfort level.

chevca
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Re: Decision Needed - How to Invest Rental Income?

Post by chevca » Thu Nov 30, 2017 12:08 pm

Although, if they get to take all deductions, unlike a primary home they get to deduct all the mortgage interest on the rental. So, effectively they're borrowing at a lower rate and someone else is paying the interest anyway.
Last edited by chevca on Thu Nov 30, 2017 12:10 pm, edited 1 time in total.

guitarguy
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Re: Decision Needed - How to Invest Rental Income?

Post by guitarguy » Thu Nov 30, 2017 12:13 pm

chevca wrote:
Thu Nov 30, 2017 12:08 pm
Although, if they get to take all deductions, unlike a primary home they get to deduct all the mortgage interest on the rental. So, effectively they're borrowing at a lower rate and someone else is paying the interest anyway.
Side question for someone who eventually might become a landlord:

Mortgage interest, prop taxes, and any other expenses associated with maintaining the rental property...does that all simply get added up and deducted from rental income like what would be a regular sole proprietor schedule C calculation: 1099 income less all business expenses gives you taxable income?

Or are the tax benefits of owning a rental more complicated than that?

chevca
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Re: Decision Needed - How to Invest Rental Income?

Post by chevca » Thu Nov 30, 2017 12:17 pm

That's pretty much it. It all gets added up and reduces total income. But, you could look at it as reducing rental income first.

There are income limits to be able to use the deductions year to year, or delay them until later. When I was an accidental landlord, I was below the income limit. So, I'm not too sure on how the delayed part works.

There's also depreciation, and if you make major improvement/repairs you can depreciate those too. Those also reduce income.

Grt2bOutdoors
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Re: Decision Needed - How to Invest Rental Income?

Post by Grt2bOutdoors » Thu Nov 30, 2017 12:18 pm

guitarguy wrote:
Thu Nov 30, 2017 12:13 pm
chevca wrote:
Thu Nov 30, 2017 12:08 pm
Although, if they get to take all deductions, unlike a primary home they get to deduct all the mortgage interest on the rental. So, effectively they're borrowing at a lower rate and someone else is paying the interest anyway.
Side question for someone who eventually might become a landlord:

Mortgage interest, prop taxes, and any other expenses associated with maintaining the rental property...does that all simply get added up and deducted from rental income like what would be a regular sole proprietor schedule C calculation: 1099 income less all business expenses gives you taxable income?

Or are the tax benefits of owning a rental more complicated than that?
You use Schedule E for rentals. You must begin taking depreciation on the property in year you place into service as a rental. If you earn more than $125K in AGI, losses on property rental can be carried forward but not deductible against ordinary income.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

simpatico
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Re: Decision Needed - How to Invest Rental Income?

Post by simpatico » Thu Nov 30, 2017 12:50 pm

Sorry, was in a meeting and couldn't reply promptly. We don't have any other debts and we max out all retirement accounts and HSA. The rental income is about covering all the expenses, but our AGI is higher then $125K, so I am not sure if we can deduct anything...

simpatico
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Re: Decision Needed - How to Invest Rental Income?

Post by simpatico » Thu Nov 30, 2017 1:07 pm

You use Schedule E for rentals. You must begin taking depreciation on the property in year you place into service as a rental. If you earn more than $125K in AGI, losses on property rental can be carried forward but not deductible against ordinary income.
We are newbies as landlords - so we can't deduct the losses against our income? Does that mean that we definitely need to try to pay off the mortgage rather then invest the proceedings???

smackboy1
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Re: Decision Needed - How to Invest Rental Income?

Post by smackboy1 » Thu Nov 30, 2017 1:15 pm

Meg77 wrote:
Thu Nov 30, 2017 11:52 am
In general though without any context, I'd tell you to keep that cash on hand for a year without doing anything. I have several rentals and have had them for years. Everything goes well for months or even a year or two, then you'll need a $8000 HVAC, or a tenant will move out and trash the place requiring all new paint and carpet etc, or you can't get somebody in for 3 months, or a plumbing leak flood the place...
+1

The income property is a business. Some % of revenue needs to be set aside every month in a sinking fund to pay for anticipated future capital expenditures. For example:

Roof might need to be replaced every 25 years
HVAC: 10 years
Hot water heater: 10 years
Driveway: 20 years
Carpet and paint: 5 years
Exterior paint: 10 years

It does not mean that the $10,000 HVAC has to be replaced after 10 years. Plan on $1,000/year will go into the sinking fund for 10 years for that possibility. The sinking fund should not be invested similarly to an emergency fund i.e. nothing too volatile or illiquid.
Disclaimer: nothing written here should be taken as legal advice, but I did stay at a Holiday Inn Express last night.

avalpert
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Re: Decision Needed - How to Invest Rental Income?

Post by avalpert » Thu Nov 30, 2017 1:36 pm

As others said, need more detail to provide a specific answer.

As a general response, do not treat your rental income any differently than you would any other cash inflows - what is the optimal way to deploy your cash will be true regardless of the source.

simpatico
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Re: Decision Needed - How to Invest Rental Income?

Post by simpatico » Thu Nov 30, 2017 5:09 pm

We don't have any other debts and we max out all retirement accounts and HSA. The rental income is about covering all the expenses, but our AGI is higher then $125K, so I am not sure if we can deduct anything...
So what other details are needed? And it is a good point - it doesn't matter what is the source of the money. But I still am not sure whether to pay towards the mortgage or invest. And where to invest if so - a bond fund?

chevca
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Re: Decision Needed - How to Invest Rental Income?

Post by chevca » Thu Nov 30, 2017 5:17 pm

If you have a large taxable account, you may not need a specific rental reserve EF. You could just pull from taxable when things come up.

If the alternative would be a bond fund, I'd probably pay down the 4% mortgage.

You could always do both, half towards the mortgage and half to investments.

Grt2bOutdoors
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Re: Decision Needed - How to Invest Rental Income?

Post by Grt2bOutdoors » Thu Nov 30, 2017 6:11 pm

simpatico wrote:
Thu Nov 30, 2017 1:07 pm
You use Schedule E for rentals. You must begin taking depreciation on the property in year you place into service as a rental. If you earn more than $125K in AGI, losses on property rental can be carried forward but not deductible against ordinary income.
We are newbies as landlords - so we can't deduct the losses against our income? Does that mean that we definitely need to try to pay off the mortgage rather then invest the proceedings???
Not necessarily.
Let's say you have gross rental income of $15,000 and the combination of mortgage interest, simple repairs, maintenance expense and depreciation (using MACRS of property basis/26.5) your Schedule E shows a loss of $5,000. If your AGI is $125K or above, the loss will simply be carried over on Schedule E to the following year and so forth. Let's say you want to dispose of property, at the time of disposition, that loss can be used to offset the gain on sale. Remember, the taking of depreciation each year reduces the basis in your property value, so if you purchased property for $120K and now it's worth $150K but your basis is now $90K the gain could be $60K. But, you can then apply any losses to the gain including those carried over on Schedule E along with expenses of sale.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

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