Investors & landlords

The IRS has no clear definition of what constitutes profit or not for profit. It's all focused on intent, not results.

It is rare for residential rental real estate to actually show a profit *on paper* each year; especially if there's a mortgage on the property. But there are several factors that do come into play with the major factor being *intent*.  For example:

 - Are you renting at fair market value?

 - Are you renting to family?

Even those don't really have any clear cut definition either. What is fair market value? Even the IRS can't define that down to a definitive dollar figure.

Fair Market Rental Value – Usually abbreviated as FMRV. This is a rather vague figure that can be difficult to substantiate. Not only can it be difficult for you to prove you rented or are renting the property for it’s FMRV, it can also be just as hard for the IRS or anyone else to prove that you are not. Case in point:

I have a 3 bedroom, 1 ½ bath that I rent for $1000 a month. I also have a 2 bedroom 1 bath that I rent out for $1350 a month.  You’d think those rent amounts would be reversed. But there’s a reason they’re not. You see, the 2 BR/$1350 house is located in a gated community that offers residents the use of a community swimming pool, workout room, weight room, tennis courts, and a few other things. The 3BR/$1000 house is located in a non-gated subdivision that offers nothing of the sort to its residents. Therefore the smaller house is actually worth more to a renter who is preferring those amenities.

The fact that you may be renting at less than your mortgage payments has nothing to do with the FMRV what-so-ever. Back in 2009-10 when the economy was really tanked, the best I could get for the 2BR house was $700 a month. My mortgage payments were just over $800. So was I renting at the FMRV? You bet! With all the unemployment, I was lucky to get “anything” for that property. Those who did have a job and needed a place to live, were working hourly wage jobs anywhere they could find them – even if only part time. I was lucky as all git-out to find a tenant that could actually afford to pay $700 a month. Most of the landlords I know around here had tenants that were roomies together in a 1 bedroom place, just so they could afford to have a roof over their head with them both working and leading their own individual lives just trying to survive through those tough economic times. One landlord friend of mine actually had two families renting one of his 3 bedroom places together for two years. That’s the only way they could afford a roof over their heads.

So based on the above, the best definition I can come up with for Fair Market Rental Value, is this:

WHAT THE CONSUMER IS WILLING TO PAY.

As for profit, you most likely do make a profit which is more commonly referred to in this industry as "cash flow". But chances are not one penny of that profit is actually taxable income. When you add up all the deductible rental expenses they will more than likely exceed your rental income. Once those deductible rental expenses get your taxable rental income to zero, that's it. All remaining expenses are carried over to the next year where than can be deducted, provided of course you have the rental income to deduct them from.

You'll probably find that the depreciation you are required to take by law along with the mortgage interest deduction and other deductible rental expenses will exceed the rental income very year - meaning that the carry over expenses just increase with each passing year. (That's how it's worked for me until a few years after I actually paid off the mortgage on one of my rentals. But that's a whole 'nother story.)

So just looking at the mortage alone, If your payments are $800/mo and you're only getting $700/mo for rent, guess what? There's a profit in there. Remember, the only part of your mortgage payment that is deductible is the mortgage interest. The principle part of your mortgage is not deductible and is considered profit. But the taxability of that profit is then offset by the depreciation you are required to take by law. So in the end, it's somewhat rare for any residential rental property to actually show a taxable profit *on paper*, even though you may be pocketing a cash flow of a few hundred a month.