Part 2 (Part 1 can be found here): In this post, we will take a look into the typical returns between traditional stocks and rental properties. The numbers used for this analysis will be industry acceptable values. Your returns, and expenses will vary. We will also assume the rental property is leveraged as most real estate investor utilize leverage for their investments. The example below is based on a $20,000 investment utilizing historic returns of the S&P 500 compared to a $100,000 dollar rental property purchased with $20,000 dollars down payment and an $80,000 loan. We will compare taxes of both investments based on a single filer making less than $90,750. State taxes are excluded as they vary with some states having no income taxes.
The median return of the S&P 500 since 1970 is 12.6%. 3.4% of the total returns comes in the form of dividends. Currently, the tax rate for both long term gains (the investment is considered long term gains if held for longer than 12 months) and dividends is 15% for single filers making less than $90,750.
Stock Investment Calculation
$20,000 investment x 12.6% (median S&P returns) = $2520 gains
Taxes – $2520 x 15% = $378
After tax gains = $2142 or 10.7 percent.
Rental calculation parameters:
Yearly Rent = 12% of property value ($100,000) = $12,000
Property Appreciation = 3% of property value ($100,000) = $3,000
Maintenance – 1% of property value ($100,000) = $1,000
Property taxes – 1% of property value ($100,000) = $1,000
Insurance – .5% of property value ($100,000) = $500
Interest – 4% of loan note ($80,000) = $3200
Loan principle – 1.25% of note ($80,000) = $1000
Property depreciation – The IRS allow the building value (not including property value) to be depreciated over 27 1/3 years and this amount is deducted from our taxable income. It is important to note, when selling a property you will be subject to a 25% recapture tax (in another post we will discuss ways to avoid this recapture tax). In our example we will assume the building value is $80,000. $80,000 divided by 27.333 = $2,926 yearly depreciation.
Rental Property Calculation
Total rents $12,000 minus costs (property taxes, maintenance, interest and insurance) $5,700 = $6,300 returns – $2,926 depreciation = $3374 total taxable income.
These returns are subject to ordinary income taxes rates. FICA taxes are not included in this calculation as most investors aren’t considered a real estate professional per IRS guidelines. Individuals who work more than 15 hours per week can qualify as a real estate profession, which changes taxes and tax deductions. We will discuss the advantages and disadvantages of a real estate professional in another post. The tax rate for single fliers making less than 490,750 is 25%.
Taxable income $3374 x 25% = $843 total taxes paid
Total Investment Gains
After tax gains = $5,457
Property appreciation gains – $3,000 -$450 (capital gain taxes) = $2550.
Principle reduction = $1,000
Total gains = $9,007 or a 45 percent gain on our original $20,000.