patrick.net

"Home will add another 300k+ of debt, but will still cost about what we would pay for rent for the home."

Have you done all the math on this, including maintenance, insurance, taxes, etc. when comparing to rent?

"Adding expenses, but also adding greater deductions (for the primary and the rental)."

If you make more than $150K, you will not get any deductions for the rental. If you make less than that, you may get some, but it is capped because of the passive activity rules. Make sure you discuss this with your accountant before jumping in head-first and assuming the rental will give you big deductions.

I think you are putting way too much emphasis on taxes. If the capitalization rate is good on the rental, it may be worth doing the rental for that reason, but most Bay Area rentals do not pencil out, especially when they are underwater as your house. If you're not making an adequate return, why take on the additional risk in order to save a relatively low amount on taxes?

Rental income/expense goes on schedule E, which is unrelated to standard deduction. The value is based on your federal and state tax bracket and not being phased out. In your case, if you make around 130-140K MAGI, you get the benefit of a higher tax bracket and not get diluted by passive and itemized deduction.

For passive rental activity. 150K Modified AGI is where it is 100% phased out. From your fact, since the rent covers the morgage and the mortgage includes principle, your rental and income are pretty neutral. The difference is the non-cash depreciation which may reduce your tax bill (about 5K deduction). Then there are all the phantom deductions like phone bill, cars, appliances that always are stuffed in SCH E as well.

For most people even if you're frugal, the biggest item on the Schedule A, itemized deduction is CA state income tax, CA personal property tax, SDI. Those are things you can't avoid anyway. If you make about 140K with no kids, you'll be paying about 8K in CA taxes, CA SDI anyway. The other big piece of course is mortgage interest and property tax.

Of course, you shouldn't buy on tax reasons alone, but it does/should figure into the analysis.

We want to buy another house because we want to live in another house, we have wanted to do so for a while. We want to keep the current house as a rental mainly because in the big picture 30k underwater isn't a concern since mortgage payment is $1500/month and property taxes are $2k a year (on a house that has been completely rebuilt basically, and fixers in the neighborhood are selling in a day). My 30k underwater estimate is based on the neighborhood being back to 1998/99 prices. Looking 15-20 years out walking away would be IMO a enormous mistake. I would be more apt to walk away from the more expensive home in the future...

So it sounds like the only tax benefits would be the sizable increase in interest/tax deductions on the new primary property, and only the depreciation and expenses on the rental? FYI we do make less than 150k a year, although not by that much.

Any recommendations for good accountants?

Tude, you don't need a CPA yet, I can run some analysis for you with a little more fact:

Of the 1,500 a month, how much is the current interest. or better yet loan terms and where you are with the loan (years in).

When you say a little less than 150K is that gross or AGI. Do you have investment income and income expectation for the future?

You likely not need to worry about walking away from your future home as the banks will ask for 30% down payment.

expected rent : $1500-1600

27 years left, refi'd before it was underwater for 5.375%, $1,168.17 paid for Oct Interest
Property tax bill is actually $2400, property assessment is about $170k as we bought it from FIL at a profit to him!

AGI is usually between 130k-140k depending on how much I put in retirement and if I have furloughs! No investment income as all savings is cash making zero interest. Not a lot of chance I will be making any more money any time soon, husband would most likely have to take a pay cut if he changed jobs but I am pretty close now to the bottom of pay for what I do.

Ok, your rental income and cash expense less principle is pretty much neutral. The thing that would push your Sch E to a loss is the depreciation and perhaps pushing for more pre-tax expenses on Sch E.

On a 170K property, I would imagine your land value is around 40K so 130K is depreciable or over 27.5 years or 4800 a year or 400 a month. This is worth about $1500 bucks a year in tax savings and $$ in your pocket based on your tax bracket.

So currently, you have a little bit of cash flow, but you wouldn’t feel it since 350 or so goes into principle repayment. The cash flow will increase over time.

At 130K AGI with no kids and standard deduction, you’re in the 25% federal bracket and 9.3% state bracket. You are paying about 7K in state income tax, and about 1K in state SDI alone. The standard deduction is 11,500 or so. So the first 3,500 of property tax and mortgage interest is worthless, everything after that is worth about 30% in tax savings.

A 300K 4.375% mortgage would translate into 13K in annual interest and 5K in Annual principle starting off. Property tax would be around 4K. In effect your tax savings is 13K or so times 30 percent or 4K annually.

4K benefit from new home (which about washes your property tax)
1.5K benefit from rental

The PITI net of principle and tax savings are around 1,200. I bet the place you have in mind rents for around 2K.

The caveat is the lender wants 30% down payment.

SFAce thanks. Your numbers are just a little off on the new place. Purchase price would be 375k with 10% down. We are pre-approved for this just in the past couple weeks with our income and 800 credit scores. The property taxes on the new property would be closer to 6k.

That said, I am trying to talk my husband into buying another much cheaper fixer that has the 2 car garage and second bathroom (but he doesn't want to do any work again!)

As for the depreciation, I am still a little confused about the home value calculation - do the just use the tax assessment (which is artificially low since we inherited it?). Our sales price and mortgage are 100k higher.

If you will need a mortgage to purchase the new property, you may find that your purchasing power is greatly diminished due to the rental property causing your back end debt load to go to too high. I have a rental property that makes a $500 profit each month, but even so this caused my debt load to go higher than most loans will qualify me for (only other debt being a normal sized car payment). Also be aware that in terms of income lenders will only allow 75% of the rental income to qualify, so you take another hit to qualify on a future home there if you are not making large amounts of profit each month.

If you are making 150k then look very carefully at AMT and how it will figure into you calculations. It wouldn't take much more income to get into the AMT schedules which can really hose you.

robertoaribas, we are pre-approved as of 2 weeks ago. All we can do is make an offer based on our pre-approval letter/amounts and see what happens. We have no other debt except our small mortgage payment and my $250/month student loan payment, everything else we own outright. Worse case scenario funding falls through and we stay put a while longer. I am just curious investment wise whether it is a good idea or not.

It was a pretty rigorous pre-approval process, I had to provide all my bank statements, retirement, pay stubs, tax returns.

We are just saving cash now, so obviously as prices either stagnate or fall our down-payment will be getting larger. That said, we are approved for a conventional with 10% down, and FHA with 3.5% down (but of course all the BS fees and insurance which pretty much makes it nearly 10% down anyway, we just qualify for 25k more in mortgage with FHA).