invest in taxable account vs pay off mortgage on rental property

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Topic Author
vanpan
Posts: 23
Joined: Thu Aug 03, 2017 5:52 pm

invest in taxable account vs pay off mortgage on rental property

Post by vanpan » Sat Aug 01, 2020 1:03 pm

I am a little confused and need advice. I will soon (in the next month) receive about 300K after my RSU's vest and tax is payed off. I am currently thinking of 2 options.

Option1 : Reduce balance on mortgage of rental property from 420K to 100K
Option2 : Buy fskax in my taxable account

Some background :

Rental property : My rent is 4050 a month and my mortgage payment is around 3200 (15 year fixed mortgage). When i add property tax and HOA, I am bout -ve 400 every month. I currently pay no tax on this income as depreciation + property tax + maintenance is greater than income from rent.

Financial background:
Cash : 200K
Taxable portfolio : 900K (60% in fskax and 40% in FANG, Mcdonalds)
Retirement portfolio(401K + small IRA backdoor) - 600K
Primary Home : 1.3 M ( paid off)

Would love to hear your thoughts ? Any options i am not thinking off ?

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FiveK
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Re: invest in taxable account vs pay off mortgage on rental property

Post by FiveK » Sat Aug 01, 2020 1:27 pm

vanpan wrote:
Sat Aug 01, 2020 1:03 pm
I currently pay no tax on this income as depreciation + property tax + maintenance is greater than income from rent.
Are you able to deduct your rental "loss" from other income?

If so it's a choice between what is probably a lower but more certain after-tax return on paying down the mortgage, vs. a higher expected but less certain after-tax return on your 100% stock (if your 401k is similarly invested). No way to know in advance which will be better.

Topic Author
vanpan
Posts: 23
Joined: Thu Aug 03, 2017 5:52 pm

Re: invest in taxable account vs pay off mortgage on rental property

Post by vanpan » Sat Aug 01, 2020 3:02 pm

Thanks. I unfortunately can not deduct rental loss from other income.

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FiveK
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Re: invest in taxable account vs pay off mortgage on rental property

Post by FiveK » Sat Aug 01, 2020 3:07 pm

vanpan wrote:
Sat Aug 01, 2020 3:02 pm
Thanks. I unfortunately can not deduct rental loss from other income.
Then the after-tax interest rate on the mortgage is the stated rate. The choice remains....

petulant
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Re: invest in taxable account vs pay off mortgage on rental property

Post by petulant » Sat Aug 01, 2020 3:16 pm

You are asking about paying down the mortgage or investing in equities. These have very different properties: equities are volatile, risky, but have a high return over time. The mortgage debt has a fixed, nominal interest cost, and if you pay it down, your value is stuck in an illiquid asset (the house). On an expected value basis, it is probable that the high expected return of equities makes them a better bet than paying down the mortgage debt.

However, as you age, you may become more concerned about the volatility of stocks. If you would be transitioning some equities to bonds in the next 5 or so years, it would be more effective to pay down the mortgage rather than paying down the bonds since the cost of debt on the mortgage is probably higher than the return on bonds.

When you think about the risk and return, it's important to keep in mind that the cost of debt on the rental property's mortgage may be relatively high. For example, using the equity risk premium model, we might expect forward-looking stock returns of 6-7%. And bonds are earning .5-2% depending on the term and borrower. So stocks are a lot better than bonds. But the rental mortgage might be 4-5%, and you're not deducting all of the losses each year (carrying them forward, but losing the time value of money on them). That 4-5% isn't a whole lot less than the expected 6-7% on stocks, and with a lot less volatility to boot. So even if the return on equities is better, it might not be so much better that they really beat paying down the mortgage after considering risk.

So it really depends on your risk/reward preferences. In your shoes I would look closely at using the windfall to pay down the mortgage.

Good luck!

LeeMKE
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Re: invest in taxable account vs pay off mortgage on rental property

Post by LeeMKE » Sat Aug 01, 2020 3:18 pm

IMHO it looks like you have enough in taxable right now.

I'd pay down the mortgage as that is a certain gain, of the percent interest rate you are now paying, plus the additional principal payoff from your next payments. Hard to know what will happen with the stock market, but it might not beat your mortgage rate. Depending on the terms of your mortgage, the remaining balance will pay off quickly if your payments remain the same. Time to start thinking about what you want to do when that property is free and clear.
The mightiest Oak is just a nut who stayed the course.

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grabiner
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Re: invest in taxable account vs pay off mortgage on rental property

Post by grabiner » Sun Aug 02, 2020 9:54 am

vanpan wrote:
Sat Aug 01, 2020 3:02 pm
Thanks. I unfortunately can not deduct rental loss from other income.
You will deduct it eventually, either when you sell the rental, or when you have gains from the rental and can offset them with past disallowed losses.

Therefore, the after-tax return on a mortgage paydown is less than the pre-tax return. The adjustment should be somewhat less than the tax rate; paying down a 4% mortgage in a 24% bracket costs you 0.96% in taxes in a future year rather than this year.

It's still likely to be attractive to pay down the mortgage, because this is a risk-free return. If the mortgage rate is 4%, even a risk-free 3.04% is a very good deal with today's interest rates.
Wiki David Grabiner

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