Tax / Debt Strategy on Rental Income from Investment Properties

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grkmec
Posts: 255
Joined: Wed Jun 22, 2016 8:46 am

Tax / Debt Strategy on Rental Income from Investment Properties

Post by grkmec »

So I have 2 rental properties that generate a fair amount of rent (~185k / yr combined). Both properties have mortgages:

Property 1: 1.43mm mortgage, 115% LTV, 1mL+110 bps, interest only until July 2021
Property 2: 1.12mm mortgage, 70% LTV, 1mL+125 bps, interest only until Oct 2020

Even though these properties are highly levered, they generated 91k in cash flow in 2016 and 83k in cash flow in 2017. In 2016, back when 1mL was sub 1%, my rental taxable income on Property 2 was barely positive - call it $3k. Property 2 generated a loss of (15k). With the rise in interest rates, rental taxable income has fallen to below zero for both properties and I am beginning to build a balance of unallowed losses. So in my current situation I am not really getting a current benefit from the interest expense tax shields.

So my plan is to pay down a signification amount of this debt as I maintain high levels of liquidity in short duration assets (money market munis, short term bonds, fixed income alternatives, etc.) I was actually thinking of paying down 620k on property 2 to get mortgage down to 500k. This saves me approx. 20k in annual interest expense. I chose property 2 because it has a slightly higher rate and the interest only period expires sooner.

That being said, I wanted to double check that rental income between properties can be netted for tax purposes. Meaning if Property 1 generates a big loss due to its leverage profile, and Property 2 generates a positive rental taxable income, one property can offset the other.

I am also hesitating to pay down any of these mortgages given these rates are no longer achievable. I had a special relationship with a private bank and my banker (no longer w/ bank), moved heaven and earth to get this kind of pricing. So having a 110-125 bps spread to 1mL locked in for nearly 30 years is attractive long term financing. That being said, if my marginal cost of debt is 3.125% and likely going higher near term, and some of it is not utilizable as a tax shield, that is not very tax efficient thing to do.

Any advice would be appreciated.
Clemblack
Posts: 112
Joined: Sun Jan 21, 2018 12:19 pm

Re: Tax / Debt Strategy on Rental Income from Investment Properties

Post by Clemblack »

grkmec wrote: Sat Apr 21, 2018 7:43 am So I have 2 rental properties that generate a fair amount of rent (~185k / yr combined). Both properties have mortgages:

Property 1: 1.43mm mortgage, 115% LTV, 1mL+110 bps, interest only until July 2021
Property 2: 1.12mm mortgage, 70% LTV, 1mL+125 bps, interest only until Oct 2020

Even though these properties are highly levered, they generated 91k in cash flow in 2016 and 83k in cash flow in 2017. In 2016, back when 1mL was sub 1%, my rental taxable income on Property 2 was barely positive - call it $3k. Property 2 generated a loss of (15k). With the rise in interest rates, rental taxable income has fallen to below zero for both properties and I am beginning to build a balance of unallowed losses. So in my current situation I am not really getting a current benefit from the interest expense tax shields.

So my plan is to pay down a signification amount of this debt as I maintain high levels of liquidity in short duration assets (money market munis, short term bonds, fixed income alternatives, etc.) I was actually thinking of paying down 620k on property 2 to get mortgage down to 500k. This saves me approx. 20k in annual interest expense. I chose property 2 because it has a slightly higher rate and the interest only period expires sooner.

That being said, I wanted to double check that rental income between properties can be netted for tax purposes. Meaning if Property 1 generates a big loss due to its leverage profile, and Property 2 generates a positive rental taxable income, one property can offset the other.

I am also hesitating to pay down any of these mortgages given these rates are no longer achievable. I had a special relationship with a private bank and my banker (no longer w/ bank), moved heaven and earth to get this kind of pricing. So having a 110-125 bps spread to 1mL locked in for nearly 30 years is attractive long term financing. That being said, if my marginal cost of debt is 3.125% and likely going higher near term, and some of it is not utilizable as a tax shield, that is not very tax efficient thing to do.

Any advice would be appreciated.

The answer to the only question I could find is "yes."
riverguy
Posts: 507
Joined: Sun May 23, 2010 10:33 pm

Re: Tax / Debt Strategy on Rental Income from Investment Properties

Post by riverguy »

Yes they net. Seems crazy that someone with $2.5m of specially acquired debt would not know this?
Topic Author
grkmec
Posts: 255
Joined: Wed Jun 22, 2016 8:46 am

Re: Tax / Debt Strategy on Rental Income from Investment Properties

Post by grkmec »

I emailed my accountant last week with this question but he never responded. I think I knew the answer and spent the whole morning doing web searches reading about Form 8582. Before making such a big move I wanted to confirm with multiple sources.

Thank you
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