Rental Property ROI Calculator

Only if it pays clearly more than the same equity would earn in safe bonds, after you allow for repairs, vacancies and your own time. That is the test this calculator is built around. A rental produces income that tends to rise with inflation and can be held until death, when the tax on it disappears. It also concentrates a large share of wealth in one building, in one town, with one tenant, and it takes work that becomes less welcome at 75 than at 60.

Most readers come to this question in one of two ways: they already own a rental, often a former home, and are deciding whether to keep it; or they have cash from a downsizing or an inheritance and are wondering whether to buy one. The arithmetic is the same. For an owner, use today's value, not the original price: the question is what the equity earns now.

With the calculator's defaults, a paid-off house worth $450,000 renting for $2,900 a month pays $1,697 a month, $20,360 a year, after a 5% vacancy allowance, $12,700 of running costs and reserves. That is a 4.52% cap rate. The same equity in Treasuries at 4% would pay $18,000. The owner earns about $2,360 a year more for 96 hours of work, and would earn less than the Treasuries after hiring a manager.

Rent, less vacancy and running costs, is net operating income; less any mortgage payment, it is cash flow.

• Vacancy. Five percent is about two and a half weeks a year. A turnover with cleaning and repainting often costs more than the lost rent.
• Running costs. Property tax, insurance, any HOA fee, routine repairs, and a manager's fee if you use one.
• The reserve. A monthly set-aside for items that wear out on a schedule: roof, heating and cooling, water heater, appliances, flooring. Leaving it out makes every rental look better than it is.
• The mortgage. Only cash flow counts it. Cap rate leaves it out, so you can compare properties however they are financed.

Cash flow here is before income tax. The tax section of the calculator shows how depreciation shelters much of it.

A single well-kept house with a long-term tenant may take a few hours a month; a turnover, a dispute or a major repair can take weeks. Enter a realistic monthly average. The calculator divides the manager's fee you avoid by those hours to show what your time earns. At the defaults, 8 hours a month earns about $31 an hour.

Whether that is worth it depends on whether you enjoy the work, and on what happens when you cannot do it. Travel, a spell of illness or a move to be near grandchildren all make remote management harder. Plan who would take over: a manager you have already interviewed, or a spouse or adult child with the lease files, the keys and the authority to act under a durable power of attorney. Switching the calculator to a property manager shows whether the rental still beats bonds once your time is no longer free.

The depreciation you deduct while you own the rental is taxed when you sell, at your ordinary rate but no more than 25%. Residential rental buildings are depreciated straight-line over 27.5 years; land is not depreciated (IRS Publication 527). Each year's deduction lowers your basis, so it reappears as gain at the sale, and that part of the gain, unrecaptured section 1250 gain, is taxed at a maximum 25% rate (IRS Topic 409).

Three rules matter most late in life. First, the tax applies to depreciation you were allowed to take, whether or not you claimed it. Second, a former home keeps its recapture: if you move back in to use the home-sale exclusion, depreciation after May 6, 1997 cannot be excluded, and rental years after 2008 can reduce the exclusion (IRS Publication 523). Third, heirs receive the property with a basis equal to its value at death (IRS Publication 551), which removes the recapture and the capital gain together. For a rental you have owned for decades, that last rule often decides the question of whether to sell.

• Ordinary income, after depreciation. Net rent less mortgage interest and depreciation is taxed at your regular rates. At the defaults, $11,636 of depreciation shelters about half of the $22,760 of net rent before the replacement reserve, which is not deductible until it is spent and depreciated.
• Losses are limited. Up to $25,000 of rental losses can offset other income if you actively participate, phasing out between $100,000 and $150,000 of modified adjusted gross income (IRS Publication 527). Above that, losses carry forward.
• Net investment income tax. A 3.8% tax applies to rental income when modified adjusted gross income exceeds $250,000 for married couples filing jointly or $200,000 for single filers (IRS).
• Not earnings for Social Security. Rent from real estate generally does not count toward the earnings test that can withhold benefits before full retirement age (SSA).
• But it counts for Medicare. Net rental income is part of the income that sets IRMAA surcharges two years later. A large gain in the year you sell can raise premiums for a year; the Medicare and IRMAA guide explains the brackets.

Selling in a year when other income is low, such as before required minimum distributions begin at 73, or 75 if born in 1960 or later, can keep more of the gain in lower brackets. It competes for the same room as Roth conversions, so plan the two together.

Only with money you will not need for years, at a price that beats bonds on day one. Buying for cash avoids a mortgage payment in retirement but puts a large sum into one illiquid asset; a sale takes months and costs several percent of the price. A mortgage keeps cash in the portfolio but adds a fixed payment and interest-rate risk, and cash-on-cash return then depends on the loan terms. Enter the loan balance to see both.

Keep the share of your wealth in one property modest, so that a bad tenant, an uninsured repair or a local downturn does not change your retirement. If what you want is property income without the work, publicly traded real estate funds offer it with daily liquidity, though without the depreciation deductions of owning a building directly. And if you are selling a home to downsize, remember that the home-sale exclusion requires you to have owned and lived in the home for at least two of the five years before the sale (IRS Publication 523), so renting the old house out for more than three years can forfeit it. The downsizing guide covers the move itself.

• Growth. Rent, costs and value are held level. In practice rent and costs both tend to rise; property tax and insurance have risen faster than rent in many places.
• Selling costs and the capital gain above cost. Only the depreciation part of the tax at sale is shown.
• State tax. Most states tax rental income and gains; a few do not.
• The tax on the alternative. Treasury interest is taxed federally but exempt from state income tax, while rent sheltered by depreciation is taxed lightly now and more at sale.