The ability to network and negotiate is sometimes all it takes to find a much cheaper rental agreement for housing. Specifically, by sitting down with an individual to discuss renting out their residential property, it might be possible to come to an agreement that helps the would-be landlord to save some money on their taxes through careful asset allocation, and pass some of those savings onto us as the tenant. The end result is a situation where both parties save money on the agreement, even though the tenant is entering into a rental contract that is actually below the market cost of rent for the area. Sounds appealing right? Here’s one of the easiest ways to start the process.
In order for this strategy to work, we need to find a landlord that rents out a residential property as an individual (or perhaps as a small corporation), and lives on a separate residential property that is their primary residence. Ideally, they will then only have a mortgage on one property, while the other is mostly paid off free and clear (if not entirely so). This latter point is where we can find out wiggle room, because that is where the landlord is able to juggle around their equity to save some money on their taxes.
The most common scenario in which we will see this is when a landlord previously lived in an apartment or townhouse, and has moved on to a different property without selling the apartment. In this situation, we usually find that the first property (the one which we would like to rent) is paid off free and clear, and the second will have a mortgage on it as a recent purchase. From here, we can continue the example to illustrate the point.
If the landlord owned an apartment that cost $600,000, and we were to rent it from them directly, we would likely need to pay $2,276 in rent per month (enough to cover out the landlord’s mortgage). From there, all of that money goes towards servicing their mortgage on their primary property, and the landlord is still taxed on the rental income in a way that restricts their cash flows even further beyond their actual mortgage payment.
Essentially, the landlord is being double charged on their mortgage by the amount of tax costs applied to their incomes because of the way in which they have no way to write-off the debt as being associated with their rental property. They are using business income to pay a personal mortgage, and paying way too much tax as a result. However, by making some adjustments with the help of an accountant and personal banker, the landlord can juggle their assets around to reduce the tax implications of their incomes.
If the landlord in our example were to mortgage their rental property, and use the proceeds to pay off the mortgage on their primary residence, the end result is a situation where the debt is being used to finance a property that is producing an income stream. In this situation, the interest costs of the mortgage are often tax deductible. This creates a situation where the interest rate of the mortgage is actually reduced by the tax costs of the interest payments (ie. interest payments times tax rate).
In our example with the $600,000 property, the landlord immediately saves about $420/month in taxes on the property (assuming a tax rate of about 35%). This means that the landlord now has an incentive to reduce the cost of rent down to as low as $1,860/month, so as to reduce their nominal payment obligation at the end of the year.
The end result is a situation where we can see how it is that landlords will actually have an incentive to charge as little rent as possible so as to avoid taxation. If we can help them to understand this point with the help of some simple tax math, it can pay off pretty well.