Commercial Property Tax Revenues
I am going to present a brief financial analysis of a home that my wife and I purchased in January 2007 and sold in September 2008. The property was located in Belton, Missouri, a suburb of Kansas City. The property is a two-level, three-bedroom, two-car garage home. It is what I consider a “bread and butter” home. However, it is in a marginal location, although not a bad one. We purchased the house as a closed offer with Missouri VA. The purchase price was $68,900 and the down payment and fees were only $1,403.
We were able to rent the property for $725 per month during the rental period, with the exception of the last month. We receive a total of $21,750 during the rental period, or approximately $713 per month. During the same period, our expenses (taxes, insurance, interest, repairs, supplies, etc.) totaled $15,983, or approximately $524 per month. Therefore, our net cash flow per month was approximately $189 per month for a total of $5,767.
After fixing it up and renting it out for over two years, our tenants could no longer pay and we parted ways. By listing the services of a local real estate agent, we were able to sell the property in less than 30 days. The gross sales price was $80,000. If we stop here, as some books want you to, you’ll think we made a fortune on our initial investment of $1,403. But let’s take a look at reality. First, I had to pay real estate agent fees, mechanical repair costs, taxes, and other fees. Our actual sales price was $73,210 and our closing cash was $6,790. Still, that’s not bad. The actual appreciation of the house was $4,310 ($73,210 minus $68,900). Principal As we diligently paid off the mortgage each month, a small fraction went directly to the principal payment. Remember, our sales price was $68,900 minus the $700 down payment. Our 30-year loan was $68,200. At closing, the actual mortgage payment was $67,103. Therefore, our equity was $1,097.
The rental tax game is quite an interesting one. We bought a nice “bread and butter” income house knowing full well that it would go up in value, however at the end of each year the IRS allowed us to depreciate it over a specified period of time (27.5 years) and using a particular method they have approved (modified accelerated cost recovery) [MACRs]). Wow, what’s the catch here? For one, land is not a depreciable item, so only the value of the home can depreciate. Of course, you are free to calculate the value of the land against the property. Any improvements, fixtures, appliances, and other items may be depreciated. The other problem is that when you sell the property, the government wants your temporary loan back. In other words, you pay taxes on depreciated property at your tax rate. During the rental period we depreciated a total of $5,801 in property, appliances, etc. Certain depreciable items, such as the electric stove we purchased, were sold as part of the house and therefore the remaining value was reduced to zero, so these items represented a small tax loss.
The long-term capital gains tax was 20 percent (it’s now 15 percent), and ordinary gains are taxed at my personal tax rate. After running the numbers through my tax program, the entire sale resulted in a tax charge of $1,768. If we take the deferred taxes saved over the 30.5-month period ($5,801) and multiply it by my tax rate (28 percent), the result is a tax savings of $1,624 over the period of ownership of the property. Ultimately, because I paid $1,768, I almost broke even, but lost $144. My advice here is not to rely on tax advantages when evaluating a property. However, once you purchase a property, save all your receipts, monitor your mileage, and try to be as tax efficient as possible. Be prepared for April 15 when you sell a rental property.