When I was younger, I always thought very fondly of being able to sustain my lifestyle by earning “mailbox money.” I envisioned myself walking down to the end of my driveway (often in my pajamas) and pulling out an envelope with a check enclosed (with electronic payments, walking down the driveway is no longer required!). The dream of earning mailbox money sounds great, but unless a plan is put into place it remains just that: a dream. One piece of our puzzle to make mailbox money a reality involves rental real estate. While it hasn’t been quite as seamless as I had envisioned, I would consider our efforts somewhat successful so far.
2019 Real Estate Rental Figures
Even though we have been renting out the house for over three years, the financials look a bit skewed for two of those years. Since we were also living in the house for at least a portion of those years, we were only able to deduct a percentage of the expenses for tax purposes. Thankfully, the house was used as a rental property for all of 2019 and there is no need to make any adjustments to the figures. You can check out this previous blog post for a bit of background on our rental property. Without further ado, let’s dig into the numbers.
The rental property is a four-bedroom, two and one-half bathroom, single-family-home located in Auburn Hills about a mile from Oakland University. The house was purchased for $182,000 in December of 2016. We rented the house out to college/graduate students and young professionals on a room-by-room basis at a rate of $400 per month (I’ll explain later why we would probably do it differently if we had the chance). The total revenue generated by the rental in 2019 was $21,919. In addition to the monthly rent payments, the total revenues also included reimbursement for utilities (water, electricity, and natural gas). Since we didn’t know any better, we kept all the utilities in Nicole’s name and just had the renters reimburse us for the utilities on a monthly basis. Again, we will probably handle this differently and have the renters transfer the utilities into their name(s) in the future for both reduced liability and simplicity.
Between maintenance, repairs, supplies, property taxes, licensing, and utilities, the expenses for the house for 2019 were $7,271. Typically, two other major expenses associated with rental properties are landlord insurance policies and mortgages. We paid the annual premium for our insurance policy in 2018 so we could receive the tax deduction in 2018. The premium amount was $949, so let’s not forget to include that amount in our expense figure. Before completing a cash-out-refinance in late-October of 2019, we were fortunate enough to not have a mortgage associated with the rental for most of the year. Since we used some of the money from the cash-out-refinance to reduce the mortgage balance on our primary residence and the remainder for investment purposes, we don’t include the mortgage interest as a rental expense (and isn’t deductible against the rental income for tax purposes either).
In addition to the expenses noted above, we also had to have the hot-water-heater replaced in the middle of the winter. This expense wasn’t included with the others since it is treated differently for tax purposes, but I won’t get into that here. The cost of the hot-water-heater, some additional adjustments to bring the venting system up to code, and the associated labor was $2,141 (ouch)!
Therefore, before depreciation (I’ll explain this concept in a moment), the net cash flow provided by the rental was $11,558. Even though that may seem like a good sum of money, remember that this amount also has to compensate Nicole and me for the time we spend finding potential renters, making repairs, filing paperwork, completing the licensing process, communicating with renters, and all the accompanying stress.
Rental Real Estate Depreciation
While there are several areas of the tax code that look fondly upon rental real estate, one particular tax deduction that stands out is the depreciation deduction. Depreciation is an accounting concept that assumes certain assets become worn out and lose value over time. In practice, depreciation allows you to claim a tax deduction for a percentage of a rental property’s purchase price (the technical term is known as basis and it is often adjusted over time, but that’s beyond the scope of this post).
For 2019, we were able to take a depreciation deduction of $5,357. To be clear, we didn’t receive a payment of $5,357 and we didn’t have to pay that amount either. Depreciation just impacts the amount of taxes due. Since Nicole and I were in the 12% tax bracket in 2019, depreciation reduced our overall tax bill by about $643 ($5.357 x .12). Therefore, when the depreciation expense is included, the total net cash flow provided by the rental property was $12,201 ($11,558 + $643). Getting paid a little over a thousand dollars a month for owning an asset isn’t such a bad gig!
If you are interested in rental real estate, the question you need to ask yourself is do the benefits outweigh the headaches? While the numbers may look enticing, there is a lot of unseen work that goes into rental real estate (unless you are using a property manager).
If you have any questions or if you ever want to have a conversation about rental real estate, please use the Your Thoughts page to reach out.
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