Tax savings and a rental property

Question: I am 23 years old and work in public accounting. I make 50k a year and am currently living with my boyfriend and paying him rent. I am trying to decide if buying a house would be a good decision. If I don't buy a house I'm worried that I will lose a lot of money on taxes because I'm single with no significant tax deductions to take. But, I'm not in the situation where I would be moving into this house. I plan on staying with my boyfriend and continuing to rent from him, so this would be a rental property. Is owning a rental home and being able to get the interest deduction and home buyer credit a good decision for me? Jolene, Asheville, NC

Answer: I'm worried that in an attempt to lower your tax bill you'll end up in financial trouble. It would be far better to save your money for now.

If you aren't doing it already (and you probably are) you can get some tax shelter by participating in the retirement savings plan at work. You can open up an IRA if your company doesn't offer one.

But the purchase of a house or condo to rent out could end up being very costly. For one thing, the value of the home mortgage deduction and other tax breaks associated with owning a home is greatly exaggerated. The tax breaks are dwarfed by the cost of paying interest on the mortgage, as well as maintenance on the home and property.

For another, being a homeowner and being a landlord are very different. The value of a home comes from building up equity over time as the mortgage is paid down and, hopefully, you enjoy some price appreciation. A home is an investment, a lifestyle, and a community.

You're a small business entrepreneur if you own rental property. Like any business, you'll get some extra advantages from owning the business, such as deductions tied to the repair and maintenance of the rental property. But as a landlord there are also many laws and regulations you'll have to abide by. Your bookkeeping will be more complicated. Insurance policies will cost more. You'll need to know how to make emergency repairs or have the money to pay someone else to do them for you.

Perhaps most important, the cash flow of the business is highly dependent on the quality of your tenants. The difference between good tenants and bad tenants is the difference between a money-making venture and a money-losing business. You'll have to compete on rental price, depending on the market. Landlords are sued more than any other group of business owners in the country.

Don't get me wrong: Owning rental property can be a great business. It has been a good way to build wealth over the years for those with the urge to be a landlord and a business plan. I just want you to be sure that it's the kind of entrepreneurial endeavor you want to embrace. That's why I am highligting the risks.

About the author

Chris Farrell is the economics editor of Marketplace Money.

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