“Most people don’t know that I am an accomplished dramatic actor… But I’ve performed in several Shakespeare productions including Hamlet, except in this version, Hamlet lives in an apartment with two women, and has to pretend he’s gay so that the landlord won’t evict him.”
A man mentioned to his landlord about the tenants in the apartment over his. “Many a night they stamp on the floor and shout till midnight.”
When the landlord asked if it bothered him, he replied, “Not really, for I usually stay up and practice my trumpet till about that time most every night anyway.”
First off, the disclaimer.
I am not a CPA. Check with your accountant before trying this yourself. I did some reasonable calculations and used calculators to come to what seem to be pretty good approximations. However, pretty good approximations and reasonable to assume conclusions are not the same as professional tax help. This is directionally correct, meaning it’s in the ballpark, but your numbers may vary.
Currently, we have health insurance through my wife’s employer, but when we retire, we’re going to need to account for our own health insurance.
Up until the Affordable Care Act passed, we were figuring on having to go to the marketplace and purchase an individual policy, which wasn’t going to be cheap. At our age, a high deductible health plan would cost us around $522 a month (see “HDHP: Not a Medical Condition, But It May Reduce Your Medical Expenses” for more).
However, now that the ACA has been affirmed by the Supreme Court, if we’re intelligent about how we manage our income in PIRE, we should be eligible for an Obamacare subsidy (I use ACA and Obamacare interchangeably in this article).
Let’s look at an example of a couple our age who hits PIRE with just their rental real estate. We’ll make some assumptions:
- 8% vacancy. I know this is lower than some people like to project. You could project 16% vacancy, which will lower the income even further. 8% is about what we’re seeing with our rental properties.
- 14.1% cash on cash gross income for rental properties fully paid in cash. Again, your mileage may vary; that’s what we are getting in our properties.
- 48.9% non-depreciation expenses. Again, this is what we’re getting in our rental properties. That’s insurance, repairs, property management, etc.
- Land is 20% of the total value of properties. This is high compared to our assessments, but it allows for a more conservative case, as land cannot be depreciated.
- Married couple, no dependents. No other sources of income. Standard deductions and exemptions. They max out HSA contributions at $6,650. This is important because HSA contributions are not modified adjusted gross income (MAGI) adjustments from your Adjusted Gross Income (AGI).
This couple has $1,273,812.12 in basis on their properties, which, if fully rented, would provide $15,000 a month in rental income. Given the vacancy rate, that translates into $13,800/month in rental income.
After expenses, this couple brings home $6,748.20. They should be setting aside some of that money for a rainy day fund for their properties, for funding their HSAs, and for taxes, so let’s give them $5,000 a month to live on.
Most people can live pretty well on $5,000 a month.
But what about health care? What about taxes?
Taxes, Landlords, and Obamacare Credits
Rental property income is calculated on an IRS Form 1040 Schedule E. It incorporates income, expenses, and a non-cash expense called depreciation.
Depreciation is, in simple terms, the devaluation of a property over time. The IRS believes that real estate has a lifespan of 27.5 years and allows you to count that devaluation as an expense over time.
Therefore, in filing a 1040 Schedule E for our sample couple, we find that the couple earned $165,600 in gross rents, paid $81,403.21 in non-depreciation expenses, and had $37,056.35 in depreciation. That led to net rental income of $47500.44. You can see the Schedule E here.
Once we take out the HSA contributions from their income, they have an adjusted gross income of $40,850, which according to the U.S. government, is at 260% of the poverty level for a family of 2.
According to the Kaiser Family Foundation calculator, this family would have to pay, after a $3,665 annual tax credit, $285 a month for a Silver Obamacare plan, or, as I would choose, $129 a month for a Bronze ACA plan.
According to Bankrate’s quickie 1040 calculator, this couple would owe about $2,108 in taxes. Of course, there are other ways to reduce that taxable income which would both reduce the tax and reduce the out-of-pocket cost of health insurance, but that’s beyond the scope of what I’m demonstrating here.
I realize that there are still some hiccups with going with an Obamacare plan. Some of my clients have reported difficulties in finding doctors who would take the Obamacare Bronze plan coverage (surprising given that it’s a high deductible plan, meaning that they’ll get up front cash most of the time). The memory of the healthcare.gov debacle is still fresh in many people’s minds.
There is also plenty of room for income growth to still be eligible for a tax credit. Even though the credit isn’t as large, the income would be much higher. According to the KFF calculator, even at a $62,800 MAGI, the couple would still receive a $1,084 tax credit for enrolling in Obamacare, making the cost of Silver $500/month and Bronze $344/month. Based on straight line increases in rental income/expenses, this couple could bring home a little over $8,900 per month in net rental income after expenses and still be eligible for the tax credit.
Again, this is all illustrative, but it’s powerful to show that a couple with no kids who don’t smoke could bring home roughly $8,900 a month in spendable income – although, again, I’d put some aside for a rainy day fund for the properties, to fund the HSAs, and to pay income taxes, so let’s call it $6,500 a month in spendable income – and still be eligible for a tax credit that allows them to pay $344/month for health insurance.
Not everyone is cut out to be a landlord and not everyone should invest in real estate. After all, if we all invested in real estate, where would the tenants come from? This does show, though, that because of depreciation expenses, people who invest in real estate can bring home more after-tax cash with a lower MAGI, which may, for full-time investors who are living off of their portfolios, make them eligible for Obamacare tax credits.
By the way, you could probably accomplish the same thing, or get an even better result, using taxable investments and tax loss harvesting with them. There are many ways to skin a cat.