debate whether to mortgage rental properties or get them with cash. With record low interest rates and ever-increasing difficulty of accumulating cash, mortgaging seems to be the only option for most of us. Using figures from one of my properties. I will demonstrate the differences between the two sides. I will also throw in a quick scenario to highlight the risk levels associated too.
To make things easier, I will scale up the mortgage on the property to $1000.
With a paid property, assuming this property remains rented all 12 months of the year, you would be taxed on $11504 income generated. At a 30% rate you would pay the government $3451 and pocket the remaining $8053.
With a mortgaged property, assuming its rented all 12 months of the year, you would be taxed on 4800 in income. At a 30% rate you would pay the government $1440 and keep the remaining $3360.
With my experience I can tell you two things: 1)Your rental investments will rarely be filled every month of the year, and 2)Things go wrong. Yes you do pay less in taxes at the end of the year, but I would much rather give the government 30 cents than to just hand over the banks a dollar.... Plus if you are worried about making too much money on the property re-invest in the house through major improvements. You could do this with good cash-flow, but you wouldn't make enough if you were barely breaking even.
Lets apply this way of thinking to a possible real-life scenario:
Your property is rented the majority of the year, but is vacant during the months of July, August and September due to lack of tenants in the market and your flooring needs replaced... The floor job requires $3,000 to tile your property.
Looking at the data above you will now see the danger due to lack of free cash flow from the investment property. Writing off the 2400 dollar loss on your taxes is always a plus, but paying $1291 in taxes and pocketing $3013 is better any day. There are numerous tax advantages to acquiring losses with rental investments, that you cannot claim with other investment vehicles. But the piece of mind and profits you get from having 'paid-for' real-estate outweigh the "tax advantages."
Disclaimer: I am not a financial planner, advisor, or accountant. The financial actions mentioned were only suited for my own risk tolerance, strategy, and ideas. Copying another's financial moves can lead to large losses. Each person needs to do their due diligence in researching and planning their own actions in the financial markets.