(GCC: People read everything I’ve written about Real Estate and automatically assume that I believe owning real estate in any form is a terrible idea. That is understandable, but is only mostly true :) When consciously entered as a real business and with a compatible personality, rental real estate can be a capital friendly, cash flow friendly, and tax friendly path to Financial Independence. In fact, this is the approach I recommended to my own brother. Today, Coach Carson enhances our Never Pay Taxes Again series, paying no taxes with rental properties.)
Jeremy set the bar high for early retirees. While most of us aim to minimize or optimize our taxes, he wrote an article that took it to another level entirely. His crazy idea was to Never Pay Taxes Again!
After reading Jeremy’s article, I began to look more closely at my own tax returns. I realized that most years I also paid little or no income taxes. And it turns out I used the same core principles Jeremy explained, except I did it with real estate investing.
So, this is my turn to show how to never pay taxes again (or at least keep them to a minimum). I’ll build on the core principles you’ve learned from Jeremy. Then I’ll explain the nuances that make real estate both beneficial and challenging.
How to Eliminate Taxes in Early Retirement
In Jeremy’s original post, he shared 4 simple rules to eliminate taxes in early retirement:
- Choose leisure over labor
- Live well for less
- Leverage Roth IRA Conversions
- Harvest Capital Losses AND Capital Gains
I have nothing to add or improve here. Whatever investment vehicles you use, these principles are valuable.
When you choose to live off of investment income (leisure) instead of working a job (labor), you automatically reduce your taxes. Right or wrong, the tax system is built to benefit investors more than those still working.
And when you live well for less money, you give yourself “tax bracket space” to implement powerful tax-saving strategies. These include Roth IRA conversions and capital gain or loss harvesting.
But rental property investors do have a couple of wrinkles to add to this situation. I’ll share them next.
Rental Property Tax Saving Strategies
If you want to super-charge your tax savings, rental properties have a number of techniques to help. But for now, I want to show how you can eliminate taxes as a real estate early retiree using just two simple strategies:
- Rental income
- Depreciation
Rental income is not classified as earned income. So, it is not subject to social security or medicare taxes. This is a savings of up to 15.3% compared to earning the same income at a job.
Unfortunately rental income isn’t quite as good as qualified dividends or capital gains income. Those can be earned tax free within certain tax brackets. But the next benefit, depreciation, helps off-set that deficiency.
The IRS allows a depreciation expense because a building wears down over time (27.5 years in the case of residential property). But this is a “paper” expense because you never actually write a check for it. On your tax return, depreciation simply offsets income (in this case rental income) in order to reduce how much you pay in taxes.
When you combine these two rental property benefits with the lifestyle choices of frugality and early retirement, you can avoid paying income taxes. Let me show you how with an example.
An Optimal Real Estate Early Retirement Portfolio
As you’ve probably guessed by now, my own strategy to retire early involved rental properties. My particular situation is a little more complicated because it involves a 50:50 partner. But our general strategy could be summarized as a three legged-stool:
- Free and clear (no debt) rentals for steady, low-risk income
- Leveraged rentals (with safe debt) for growth and an inflation hedge
- Retirement accounts for tax optimization and long-term wealth
My retirement accounts currently own a mix of real estate (using self-directed accounts) and index funds. The real estate is in the form of private mortgages and limited partnership rentals. Over time I plan to invest a larger percentage of my retirement accounts into stock index funds for asset-class diversification.
And one category I didn’t mention is cash. Because our real estate is relatively illiquid, we like to hold a significant cash reserve for both opportunities and cash emergencies. It served us well in the 2008 – 2010 real estate down turn!
Now let’s look at some numbers to show how this real estate retirement strategy can also eliminate income taxes.
A $1 Million Early Retirement Example
Let’s assume that this example involves a 40 year old couple. They’ve already climbed the financial mountain, built wealth, and reached financial independence. The couple’s investment portfolio in this case is worth ~$1,000,000.
It’s divided into my same three categories:
- $600,000 = equity in five free-and-clear rental properties at a cost of $120,000 each
- $125,000 = down payments of $25,000 on five rental properties bought for $120,000 each
- $250,000 = retirement account balances invested in low-cost index funds
The couple’s living expenses are $40,000/year, and they pay for these expenses with rental income from their properties.
Each property rents for $1,200/month and has operating expenses (taxes, insurance, maintenance, management, etc) of $600/month. So, the five properties without a mortgage produce $600/month or $7,200/year in net income.
The properties with debt have 30-year mortgages at 5% with payments of $510/month. After deducting the mortgage payment, they produce $90/month or $1,080/year in net income.
Now let’s see what all of this rental income looks like put together.
Rental Income For Retirement
The total rental income before taxes looks like this:
Total Net Income – Rental Properties | |||
Property | Net Operating Income/Year | Mortgage Pmt/Year (Principal/Interest) | Net Income |
Rental #1 (No Debt) | $7,200 | $0 | $7,200 |
Rental #2 (No Debt) | $7,200 | $0 | $7,200 |
Rental #3 (No Debt) | $7,200 | $0 | $7,200 |
Rental #4 (No Debt) | $7,200 | $0 | $7,200 |
Rental #5 (No Debt) | $7,200 | $0 | $7,200 |
Rental #6 (Mortgage) | $7,200 | -$6,120 | $1,080 |
Rental #7 (Mortgage) | $7,200 | -$6,120 | $1,080 |
Rental #8 (Mortgage) | $7,200 | -$6,120 | $1,080 |
Rental #9 (Mortgage) | $7,200 | -$6,120 | $1,080 |
Rental #10 (Mortgage) | $7,200 | -$6,120 | $1,080 |
Total: | $72,000 | -$30,600 | $41,400 |
The taxable rental income is a little different. I’ll assume all properties have the same depreciation expense of $3,273/year. Here’s what the taxable income looks like:
Total Taxable Income – Rental Properties | ||||
Property | Net Operating Income/Year | Interest Expense (Year #1) | Depreciation Expense | Taxable Income |
Rental #1 (No Debt) | $7,200 | $0 | -$3,273 | $3,927 |
Rental #2 (No Debt) | $7,200 | $0 | -$3,273 | $3,927 |
Rental #3 (No Debt) | $7,200 | $0 | -$3,273 | $3,927 |
Rental #4 (No Debt) | $7,200 | $0 | -$3,273 | $3,927 |
Rental #5 (No Debt) | $7,200 | $0 | -$3,273 | $3,927 |
Rental #6 (Mortgage) | $7,200 | $4,718 | -$3,273 | -$791 |
Rental #7 (Mortgage) | $7,200 | $4,718 | -$3,273 | -$791 |
Rental #8 (Mortgage) | $7,200 | $4,718 | -$3,273 | -$791 |
Rental #9 (Mortgage) | $7,200 | $4,718 | -$3,273 | -$791 |
Rental #10 (Mortgage) | $7,200 | $4,718 | -$3,273 | -$791 |
Total: | $72,000 | -$23,590 | -$32,730 | $15,680 |
So, the rental income the couple actually collect covers their $40,000/year of living expenses very nicely. And only $15,680 of that is subject to income taxes.
Let’s look at how this all fits together to help you eliminate taxes in early retirement.
Tax Optimization to Eliminate Taxes
As a couple filing taxes jointly, they get a $24,000 standard deduction (as of 2018). So, the $15,680 of rental income not sheltered by depreciation is completely free from tax.
But the couple still has $8,320 of their $24,000 standard deduction available. So, they follow Jeremy’s advice and do an $8,320 Roth IRA conversion. This will permanently move retirement funds from pre-tax 401(k) to non-taxable Roth accounts.
So in the big picture, the couple has:
- paid their $40,000 of bills using $41,400 of rental income
- grown their net worth as rental values increase and their mortgage balances decrease
- set their 401(k) up to grow and become more tax optimized over time
- paid no income tax in the mean time!
This is a good situation, isn’t it? The couple could live off their rental income, travel the world (like I did for 17 months with my family in Ecuador), and enjoy their lives for years to come.
Carson Family on Horseback in Ecuador (photo credit: Coach Carson)
But in the spirit of the famous Go Curry Cracker passion obsession with tax reduction, there’s still more tax optimization left on the table. Let’s play around briefly with a few more tax optimizations this couple could do using real estate.
Short-Term Rental Ladder For 0% Capital Gains
One of the glaring opportunities with this couple’s situation is the extra $77,400 of tax bracket space that could be filled with 0% long-term capital gains. So, if I were them I would set up what I call a short-term rental ladder.
Basically this would start by purchasing one more property each year. This would likely be a higher price single family house that they could buy $30,000 to $75,000 below full value. Then 1 or 2 years later, they’d sell the property to their tenant who has been prescreened as a potential buyer.
How do you find this kind of deals? Hustle. Creativity. Networking. Looking for vacant houses during your jogs in neighborhoods. You can find good deals in any real estate market if you get serious.
The rental income would probably break-even at best. And the short 1 to 2 year holding time would nullify depreciation expense benefits with depreciation recapture tax of 25% at the time of sale.
But in the end, a gain of $30,000 to $75,000 would be added to the couple’s bank account for reinvestment. And the tax rate would be 0% because the couple would still be in the 10% or 12% tax brackets.
How’d you like that nitro added to the wealth building fire?
But the couple could still do more.
Live-In Flips For Massive Tax-Free Gains
Because the couple is out looking for real estate deals anyway, they might as well move into one of these good deals. This is what’s known to real estate nerds (like me) as a live-in flip. Carl and Mindy at 1500days.com have used this strategy better than anyone I know.
In the U.S. (and many other countries as well) the tax code gives the sweetest deal to homeowners who live in a property for at least two of the next five years. Even renters for life might choose to own a hot real estate deal in order to make a tax-free profit of up to $500,000 (for a couple)!
Even after short-term rental ladders and live-in flips, there is still more tax-free real estate fun this couple could have.
Use 1031-Exchange to Grow Income and Wealth
I admit that selling real estate isn’t always easy. And on top of the hassle and high costs of liquidation, Uncle Sam hits rental owners with a 25% depreciation recapture tax on all prior depreciation expenses (even if you are in lower tax-brackets for 0% capital gains).
So, a powerful strategy used by savvy real estate investors is something called a section-1031 tax-free exchange. Named after its section of the tax code, this type of property exchange allows you to defer all federal income taxes due at the time of the sale. You basically sell one property and move your equity to a new property without touching the funds yourself.
There are plenty of rules to follow and specialized intermediaries needed to help execute the transaction. So, study up if you plan to do one.
So, the couple in this example could sell some of their existing 10 rentals if they found properties that performed even better. In this way they could grow their income and wealth tax free over time.
But what happens if they need big chunks of cash during all of this long-term wealth building?
Tax-Free Borrowing For Cash Needs or Reinvestment
As I said in the previous section, selling real estate isn’t always easy. But if you own a good long-term property, selling isn’t always necessary.
Our couple’s equity in real estate will continue to grow over time as prices appreciate and their mortgages get paid down. That combination of equity building magic is how real estate fortunes are built.
At some point the couple may want to use this equity to fund their lifestyle or to reinvest somewhere else. But rather than selling, they could refinance their property and pull out funds tax-free. As long as the net rent covers all expenses (with a cushion!), it’s a reasonable thing to do.
This is actually how I plan to help pay for college for my two young daughters.
Die With Your Real Estate
Don’t laugh. When it comes to real estate investing, the tax code all but screams at you to keep your properties until you die.
Why? Because your heirs receive a stepped up basis when they inherit your properties. In regular language, this means they could sell your properties right away and avoid a big tax hit.
So after doing a few 1031 exchanges into comfortable, easy-to-manage long-term rentals, the couple in the example keeps their rentals for life. When they die, the properties pass on to their children or worthy charities.
Tax Optimization For Life
There you have it. A plan to invest and live tax-free for life using real estate.
Will you be able to use all of these strategies at once? Maybe…
I look at any tax optimization strategies like tools in a toolbox. You learn to use and apply a tool or two that apply to your life right now. Then you carry around your toolbox for the rest of your life and pull out the appropriate tool when needed.
I hope this article has filled up your head and your toolbox with new strategies to use now and in the future!
Have you used any of these real estate tax optimization strategies? How do you plan to eliminate or reduce your taxes?
Enjoyed this article? Check out these other great posts on taxes and real estate:
- Never Pay Taxes Again
- Never Pay Taxes Again by Moving Abroad
- Never Pay Taxes Again with an Overseas Corp
- Renters For Life
- How I Made $102k in Real Estate and Am Poorer For It
- The Rental From Hell
- Be the Bank
And BE SURE to check out Coach Carson’s NEW BOOK: Retire Early with Real Estate
hi, great article…could you give some ideas how one could manage that many properties while traveling?
Thanks Lawrence! The short answer is I have a small team back on the ground to help. I still stay involved paying bills, doing some bookkeeping, and brainstorming issues, if they arise, over messaging apps or phone. But that typically took an hour or two per week. You can see all the details of my team and the technology I use at https://www.coachcarson.com/landlording-101/
Coach Carson may have a small team in place, but for the rest of us mere mortals we can use Property Managers for a fee of 8-12%, which is what I do.
FYI, anytime Coach Carson says, types, etc. I shut up and listen.
Great article, btw!
Excellent job of summarizing the benefits, Coach! Rentals have been the fuel to our savings these past five years, for these very reasons.
Depreciation recapture is crummy, but to your point, if you can hang onto your properties and pass them on to heirs, you avoid the recapture penalty. I may take this route, but plenty of time to figure it all out. Gotta love real estate if you can get in while the market is low. Land is finite, and people continue to flock to urban areas.
Great to hear real estate has helped you too, Cubert! Buying real estate with reasonable numbers is key. Sometimes that means buying when the market is low. Other times, that means buying property that is distressed (i.e. needs a lot of work) or in a location that’s still up and coming. It takes some effort up front, but the long-term results can be worth it.
Articles like this leave me feeling warm and fuzzy about our decision to pursue rental properties as a way of generating income for an early retirement!
Interesting article, real estate investing is very popular right now. The combination of lower interest rates and higher appreciation have made rentals very appealing to some folks. While I welcome different strategies to gain/grow wealth, I think this article lacks the substance and detailed thought process that GCC has done for other strategies.
If I take one of the paid off houses for example, the return is 6%/yr ($7200 income on $120k house). This is very similar to the long term market average of 7%/yr, so financially they are more or less the same (All though I prefer 7% vs 6% compounded over time). The devil is in the details, real estate investing is not exactly a passive investment. As you stated above, you have to hustle, network, and be creative to be able to find the best investments. Avoiding taxes with a 1031 transfer is a great strategy, but it does take careful efforts to execute properly. This may be “fun” for some people but it is still more effort that putting in a buy order for an index fund.
The second problem is liquidity. Maintaining a rental house (or 10 houses) requires significant cash or liquid assets. Not only do you have the annual maintenance items, you will need to remodel kitchens, bathrooms, etc over time to get the maximum in rent. In many cases, these capital improvements can be done within the tax shelter of the rental property but it still requires cash. This is money that you are not investing elsewhere so there is an opportunity cost for your cash reserves.For the example of 10 houses in this article, you own a total of $1.2M, I will assume $20k in cash reserves and plan another $20k in capital improvements per year (Maybe you remodel one of your 10 houses every year). Take that $40k compounded over 20 years at 7% and you get $155k. You have essentially lost over $100k in potential returns. Index funds with low fees require no cash reserves.
Lastly, there is the problem of diversification. People tend to own rental properties closer to their own homes or at least in the same state or country. There are any number of events that could adversely effect a geographic area and put your housing capital at risk. Natural disasters such as floods, hurricanes, etc will at the very least interrupt your cash flow, assuming your insurance will make you whole again. Or there is the long term decay of urban areas that might erode your property values. I live near Detroit and there are many people who are still underwater from the 2008 collapse. You might be smart and avoid such pitfalls but again this is a strike against real estate investing in my book. Global index funds will literally spread the risk over the entire global market.
The only pro I can see from real estate is the leveraging effect of mortgages. I couldn’t get the bank to loan me money at 4% over 30 years to buy index funds, but they would be more than happy to loan me money for a house. Financial leverage can amplify your gains to where you might outperform the market for a period of time. For someone just starting out, this might help them grow wealth quicker than index funds. However leverage can also work the other way around and destroy wealth in a downturn. Since i can’t predict what might happen in the future, I prefer the passive, liquidity, and diversification of index investing.
Thanks for the feedback John. I’m not sure what you mean by “lack of substance and detailed thought process.” I guess I didn’t address all of the points you made in your comment? I’d love to write an encyclopedic post on real estate, but comprehensive 5,000 word articles to cover every point at one time aren’t always the best to introduce a topic.
In this example, 6% returns on a free and clear house is only from income. If there is any appreciation, which there typically is, that would be higher. Equities and stocks both have impressive long-term returns. But according to this Federal Reserve study of the “Rate of Return on Everything, 1870 to 2015” – real estate has actually been a little better long-term: https://www.frbsf.org/economic-research/publications/working-papers/2017/25/
And yes, real estate is not as passive as index funds. But you also have more control over your returns and the timing of early retirement (vs passively waiting for the market to give you its returns). It’s a trade-off I personally like. And real estate becomes much more passive over the long run. I spent 1-2 hours per week overseeing 90 properties while living abroad (with help of course). 10 properties with a 3rd party manager would be much easier.
I think you missed some things on cash reserves. The expenses in this example would include capital expense reserves. Sure, some kind of cash reserve would be prudent. But I think even pricing that in as part of your cost of capital, the benefits would be satisfactory.
I like leverage as well. But it’s not the only plus. It would be an outstanding asset class even without it.
Real estate isn’t perfect. Neither is index fund investing. To each his/her own! Just know the pluses and minuses going in.
I, for one, thought this post had exactly the right amount of substance and thought. Which one would expect, since it is basically your life.
I prefer the index fund approach as well (obviously) but appreciate the Real Estate Tycoon approach.
Real Estate only grows at the rate of inflation. The cost of replacement, i.e, building costs such as lumber, labor etc. Any studies that say otherwise are incorrect. Short-term anything is possible. Long-term it grows with the inflation rate. It is definitely not passive.
I have five properties in the SF Bay Area that say otherwise!
A home that’s been in the family in SF since 1972 has appreciated at 9+% a year for the past 46 years.
First of all thanks for this article. I have been waiting my whole life for an article like this! :D In this example the couple needed $750,000 to generate $40,000 a year. If you are investing in index funds you need to save up $1,000,000 to generate $40,000 a year (assuming a 4% withdrawal rate). So right there you have shaved off 25% of the money needed to generate $40,000 a year by using real estate instead of index funds.
Second, living off 4% of your 1 million dollar index fund fortune is great if you have already amassed the fortune (which presumably you worked 10+ years earning a 6 figure income to obtain) but what about people trying to reach that $1 million dollar mark? If you are investing in index funds to get there then a stock market crash / bear market will set you back 10 years or more as you are waiting for the market to recover. This is something I don’t think is discussed in the FIRE community enough, it will be interesting to see what happens to the FIRE community when the stock market has a big correction, which happens about every 10 years. Real estate has only crashed twice in the last 100 years, and like in a stock market correction, as long as you are a buy and hold real estate investor and you don’t sell in a down market then you are OK. During the great recession in 2008 the property values of my rentals dropped a little but my rental income cash flow increased because there were so many new renters in the market driving rents up. If the real estate market crashes again I will have increased cash flow and I will be able to buy more properties at a discount with that cash. If the stock market crashes because it does every decade or because Trump starts a trade war, etc. then I don’t care because I have my monthly cash flow coming in to pay my bills and I will be able to retire much earlier than someone who is relying on the stock market to reach financial freedom.
You mentioned leverage which is another way real estate can accelerate your financial freedom goal. I can buy a property with 3.5% down (there are some credit unions that have mortgages with 0% down) but yet use 100% of the asset. I can’t put 3.5% down on a stock and get 100% use of the asset. The article doesn’t go into appreciation which is a necessary part of building wealth with real estate, nor does it go into mortgage pay down which is the simplest method of becoming a millionaire with real estate. If you want the idiot’s way to becoming a millionaire then buy one million dollars worth of property with 15 year fixed mortgages (assuming you are putting 20% down then you will need $200,000, if you are putting 3.5% down then you only need $35,000) and make sure when you buy that the market rent will cover all your expenses and PITI and in 15 years your tenants will have paid off your mortgage and all the related expenses and you will have 1 million dollars in equity. If you are smart then you purchased properties in which the market rent is more than your expenses and PITI but this is the idiot’s route to being a millionaire so we don’t even need to cash flow on the properties. So any idiot can take $35,000 and turn it into one million dollars in equity in 15 years, and even faster than 15 years if you buy in appreciating markets. For me real estate is the fastest and safest way to reach financial freedom and the tax advantages outlined in this article make it even sweeter.
P.S. If liquidity is a problem, remember you are generating cash flow every month so there’s cash money coming in each month from rents (it’s like owning a stock that pays out massive dividends on a monthly basis) and as you build up equity in a property you can take out a HELOC and you will have instant access to that money in case of emergencies.
Great article! I especially like the dose of conservatism related to having a big portion of the overall portfolio being owned free and clear. And a question in that vein: what is the mathematical answer to the question of – do you buy one pay it off early – then buy another one? OR, do you buy more properties and just pay the monthly mortgage amounts? For those of us just thinking about starting out – there is a limited source of funding and it seems a lot safer to just do one at a time. But that is not what most real estate investors do – who use leverage to the full advantage. I’d like to see a clear mathematical answer that either Coach Carson or GCC could lay out?
Thanks again !
Hmmm … good future article idea on the comparison:) But without even doing fancy modeling, I do think it depends on your comfort level with debt and the availability of purchase opportunities. For example, in 2010-2012 there was an unusual abundance of deals on the market at great prices. In that case, it might make sense to buy several properties at once. But then it comes back to your goals and comfort level. I like to reach a plateau of rentals where the income could support my FI plans, then work to pay them off. My favorite method is the old Debt Snowball strategy applied to rentals: https://www.coachcarson.com/debt-snowball-plan/
I appreciate this article as an owner of 2 rentals. We are early retired and you are right that the depreciation makes them really tax advantaged. We have had one of our rentals for 31 years and it is fully depreciated. I have wondered if we did do a 1031 exchange, would we get to start depreciating that one or not?
Fun to hear your story, Susan! And interesting on your 31 year rental. If you bought a more expensive property with a 1031 (by investing new equity or using leverage), then you’d have some new depreciation on the increased basis. But I think there would still be no depreciation on the original basis from your old property.
Thank you for your feedback. That makes a lot of sense.
I think the key point is something you wrote right at the beginning. There is no one-size-fits-all approach to investing/early retirement goals/financial independence. You have to find the right fit for your personality. I like reading about approaches that are different from what I would do. My husband is a carpenter/draftsman so I thought having rental properties would be a perfect match for us. He knows the ins and outs of the physical side and would be able to do any repairs or renos himself. But he was not interested in doing the work, even though he has the knowledge. Luckily we figured that out while rental house hunting, not after buying a property! Know yourself and what works for you.
Great point! It’s fun to learn about all the different approaches, but it’s also fun to stick to what YOU’RE comfortable with. Definitely glad you all figured that out before buying!
A finer point I don’t often see made in FIRE community posts discussing RE, is that rentals generally come across as a negative number on the 1040 thus giving extra ‘ordinary income’ space that can be used to offset w2 wages, roth conversions, additional qualified dividends, etc.
Yep, it’s a beautiful thing!
For many people, the taxable income in this example may be $12,544 and not $15,680 once you apply the 20% pass-through deduction that came into effect on 1/1/2018 as part of the new tax law. This will leave room for $11,456 for Roth conversions instead of $8,320 as mentioned in the article.
Good point, Krishna. I didn’t get into the new pass through deduction and rentals because there seems to be some nuance in the types of landlords who can use it and who can’t. But if landlords can use it, it will just make this scenario even better.
Am i missing something here — In your example, you show the couple taking both the standard deduction AND deducting mortgage interest from their taxable income. In order to use the $24,000 standard deduction, you wouldn’t be able to also deduct the $23,590 in mortgage interest, correct?
Good question, Beau. Rental property deductions are separate from personal deductions. For example, I have an LLC that owns rentals and all the interest is deducted on the 1065 partnership return. Then the net number is reported on our personal tax return. It’s the same on schedule E if you don’t have an LLC.
Good rundown of the tax advantages of real estate. Did you mention being able to write off business expenses? That’s another huge advantage.
However, I don’t agree with so many houses free and clear. Those 4% mortgages were too good to pass up, and the inflation protection is really important. Also, I wouldn’t buy a rental that cash flows only $90 per month. Too slim a profit margin for me, demonstrating that prices in most markets are just too high right now. Valuation is important in real estate as well as paper assets, a lesson the FIRE cult refuses to learn. I’m afraid they’ll learn it the hard way.
Everyone has to choose their happy place for debt levels. But I am happy with half free and clear (deflation hedge) and half leveraged (inflation hedge). Risk mitigation is much more important once you reach FI.
I’m not sure $90/mo demonstrates prices are too high. Single family houses in good neighborhoods (A or B level) won’t always cash flow a lot at first.
In this example, you own $150,000 houses for $120,000 price, about 6% cap rate, and positive cash flow. That is solid for long term.
Very interesting strategy of leveraging tax benefits of real estate. I have a question on the increases going property taxes for rentals and how you manage that. This is really cutting into rental income. Any strategies?
I have noticed property taxes are much higher in some states and in some municipalities than others. So, if you haven’t bought already you can pick and choose locations that have better property tax rates.
GCC: would you please write about new 2018 tax change (what is 20% pass thru?…etc) and how we can estimate amount of Roth conversion before being bumped into next higher tax bracket?
Thanks
small FYI: The link to 1500days in the article goes to another webpage.
fixed. thanks for heads up.
Thanks for the wealth of information! The tax benefits of real estate are phenomenal, and I love the thought of getting my tax bill to ZERO!
You might add the “Real Estate Professional Status” tax benefit to this list. It doesn’t apply to everyone, but when it does, it is magical for tax sheltering active income.
Good point about professional status, Natasha. It is a great tool for some people (especially high earners where one or both spouses can work in real estate). I didn’t mention it because it’s a fairly high hurdle to become professional (a lot of hours working real estate) and I assumed most early retirees won’t want to work that much!
Awesome post – it follows moderately closely what my financial plans are. I have been saving cash for when the next downturn comes, but don’t expect to have quite enough to get to the $1M mark in my taxable portfolio. However I have a sizable amount in my 401k portfolio that would make up the difference, it’s just in the wrong classification for a real estate investment (it’s hard to give up free money from my employer!)
Any ideas on how to re-allocate from a 401k to a taxable account with minimal pain so that I can follow a model like this?
You could look into rolling some of your 401k into a self-directed solo 401(k). This assumes you have or could set up some kind of solo business venture. Then there are provisions to borrow from your 401k so that you could use it to buy real estate. This old forum thread on BiggerPockets might be helpful: https://www.biggerpockets.com/forums/51/topics/71819-self-directed-401k-loan—maximum-allowable-interest
In what markets are you getting houses at $120k with $1200/mo rent?
I’m paying $3500/mo rent for a house valued at $1.7 mil, but I’m also living in a stupid market.
The $120k house renting for $1200/mo example that Chad gives meets the basic “1% rule” that many real estate investors look for when purchasing rental homes (monthly rent gross income should be 1% of the home’s purchase price). Although it sounds impossible to those of us living on the east or west coast, you can find homes that have these numbers all over the Midwest and Southeast!
Good answer Ryan. You can also sometimes go an hour or two outside the big cities to find more reasonable rent/price ratios.
Chad, Excellent article! For those like me who have a diehard aversion towards being a landlord, what do you suggest as alternative to consider? Right now, I have a sizeable allocation to REITs but VNQ offers only 4.4% yield, but to be used within the overall limits of dividends and capital gains tax ceiling. What about real estate crowdsourcing investments from avenues like FundRise or RichUncles? Do they offer the same benefits as owning physical real estate directly?
Good question! I’m not an expert on REITS because I haven’t used them myself. And I’m just dabbling in crowdfunding, so I don’t have a strong opinion yet.
For an experienced investor like yourself, I like the idea of being the money partner for a trustworthy entrepreneur who doesn’t have enough capital. You could buy a rental property found by the entrepreneur (perhaps with leverage if you like). Then the entrepreneur could manage the property long term. You would split all rental income (and losses) plus all future gains.
You get a passive investment with the tax benefits of direct ownership. She/he gets 50% of a deal they never would have purchased because they didn’t have enough capital.
I did several deals like this early in my career as the entrepreneur and loved them. My money partner was very happy too.
Great article! My wife and I began our rental property investments 6 years ago and since have expanded to vacation rentals and apartment buildings. A few more comments:
*Depreciation & Cost Segregation – Make sure to capture all the assets in your rental (not all are 27.5 years) by hiring a cost segregation specialist.
*Track Travel and expenses for for tax write-offs
*Turnkey Real Estate Companies make this much easier to manage.
*Principal Paydown, Fixed Rate Mortgage as Hedge against inflation, leveraged appreciation, depreciation benefits, and rent increases are just fabulous reasons to hold rental properties!!
I do like this strategy, especially over stock market investing, but it’s a little misleading to say you’ll never pay taxes again this way.
I don’t think there are any municipalities where someone who owns property gets charged *no* property taxes, are there?
As an aspiring non-payer of taxes, I was hoping some way to avoid those that I’d never considered would be included here.
I’d rather pay my local community than the federal government, but with other strategies, I can avoid paying taxes to either one, and contribute voluntarily and directly to the people and orgs I know actually make the community better, instead of outsourcing that work to the government, which always seems to hold things back.