Please explain the concept of imputed rent to me like I'm a 5 year old

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills.
Topic Author
crossbow
Posts: 365
Joined: Mon Nov 12, 2018 5:47 pm

Please explain the concept of imputed rent to me like I'm a 5 year old

Post by crossbow »

I don't understand it. I have a niggly feeling that including "imputed rent" in the argument for home ownership is double-counting opportunity costs. I own my car outright and have never considered "imputed lease payments" because I don't see the lease payments I don't pay adding to my bank balance. What am I missing? :confused
runninginvestor
Posts: 1796
Joined: Tue Sep 08, 2020 8:00 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by runninginvestor »

My understanding is as follows:

Say you are a renter, and you rent out an apartment for $1,000 a month for 1 year. You pay the landlord $12,000. The landlord has to report that as income.

Now let's say the next year you buy that place to live in. You no longer pay $12,000 a year to a landlord that has to report that as income. In fact, no one reports that as income. But it's kind of like you are the landlord to your own home, and you are paying and collecting $12,000 to live in your own home, but you don't have to report that. So it's as if that $12,000 disappears from national income reporting.

So the "imputing" comes from trying to calculate the potential income and subsequent tax break you are receiving as a homeowner for not being taxed on that income.

Edit: I didn't realize you were talking about it in terms of opportunity cost and homeownership. I'll leave my explanation of imputed rent up (for future searches) unless somebody comes wrong and says the general definition is wrong.

But I suppose you could use that as an owner to determine the opportunity cost of what you would receive if you were to rent out your house vs the value you receive from living there.
Last edited by runninginvestor on Tue May 04, 2021 1:53 pm, edited 2 times in total.
fabdog
Posts: 2543
Joined: Wed Jan 16, 2013 12:59 pm
Location: Williamsburg VA

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by fabdog »

Well, you have to live somewhere... or at least most of us do. So the concept of imputed rent says if I'm going to pay X dollars for a place to live... I count that when thinking about the value of the house. In most places, most of the time, the house at least holds its value over time. Cars not so much

Now in some places you can rent more cheaply than you can buy, and in other places the opposite, so it's not the main reason to buy.... just a consideration

Mike
MrJedi
Posts: 3540
Joined: Wed May 06, 2020 11:42 am

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by MrJedi »

crossbow wrote: Tue May 04, 2021 1:24 pm I don't understand it. I have a niggly feeling that including "imputed rent" in the argument for home ownership is double-counting opportunity costs. I own my car outright and have never considered "imputed lease payments" because I don't see the lease payments I don't pay adding to my bank balance. What am I missing? :confused
Instead of thinking it as adding to your bank account, it's actually less coming out of the bank account (after the upfront purchase). Less monthly expense, not more monthly income.
User avatar
vineviz
Posts: 14921
Joined: Tue May 15, 2018 1:55 pm
Location: Baltimore, MD

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by vineviz »

The concept of imputed rent is primarily useful in the "rent versus buy" decision, since imputed rent is simply the amount of money you'd be willing to pay in rent to live in your own house. Beyond that, it's not concept that most individuals have reason to make much use of.

Nonetheless, it's an important economic concept because of a difference in the way that different assets produce income.

Most investment assets produce their income primarily in the form of cash: stocks pay dividends, bonds pay interest, etc. This makes the income (relatively) easy to measure.

But some other asset produce their income primarily in the form of goods and services that you consume: the "income" produced by a television is entertainment, the "income" produced by a car is transportation, and the "income" produced by a house is primarily shelter.

Just like dividends + capital gains - expenses equals the total return of a stock, imputed rent + capital gains - expenses equals the total return of a home.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
User avatar
Ben Mathew
Posts: 2720
Joined: Tue Mar 13, 2018 11:41 am
Location: Seattle

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by Ben Mathew »

runninginvestor wrote: Tue May 04, 2021 1:43 pm My understanding is as follows:

Say you are a renter, and you rent out an apartment for $1,000 a month for 1 year. You pay the landlord $12,000. The landlord has to report that as income.

Now let's say the next year you buy that place to live in. You no longer pay $12,000 a year to a landlord that has to report that as income. In fact, no one reports that as income. But it's kind of like you are the landlord to your own home, and you are paying and collecting $12,000 to live in your own home, but you don't have to report that. So it's as if that $12,000 disappears from national income reporting.

So the "imputing" comes from trying to calculate the potential income and subsequent tax break you are receiving as a homeowner for not being taxed on that income.
Agree with this explanation.

The imputed rent and capital gains (upto a point) being tax free makes it equivalent to holding a rental property in a Roth IRA. (Sorry, that was not for a 5 year old!)
Total Portfolio Allocation and Withdrawal (TPAW)
User avatar
Ketawa
Posts: 2521
Joined: Mon Aug 22, 2011 1:11 am
Location: DC

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by Ketawa »

You own a home. You can either rent it out or live in it.

If you rent it out, you have income from the rents. You have separate rent expenses for another home, since you have to live somewhere else.

If you live in it, the income from the rents and your rent expenses are the same. You are consuming the imputed rent.

There is no double counting, because in both circumstances you can make money from capital gains when you sell the home.
KlangFool
Posts: 31526
Joined: Sat Oct 11, 2008 12:35 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by KlangFool »

OP,

Please note that this concept, "imputed rent", only works if the person actually choose to compare "rent versus buy" with the same or equivalent house. Many folks rents a smaller place versus what they choose to buy. Then, they use the "imputed rent" to justify their purchase of the bigger place.

KlangFool
30% VWENX | 16% VFWAX/VTIAX | 14.5% VTSAX | 19.5% VBTLX | 10% VSIAX/VTMSX/VSMAX | 10% VSIGX| 30% Wellington 50% 3-funds 20% Mini-Larry
KlangFool
Posts: 31526
Joined: Sat Oct 11, 2008 12:35 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by KlangFool »

OP,

Let's say that you can rent a house at $2,300 per month. If you buy the house, your monthly expense for the house is $1,800 per month. You saves $500 per month by buying the house. The "imputed rent" is $2,300 per month. You make/save money due to the imputed rent.

KlangFool
30% VWENX | 16% VFWAX/VTIAX | 14.5% VTSAX | 19.5% VBTLX | 10% VSIAX/VTMSX/VSMAX | 10% VSIGX| 30% Wellington 50% 3-funds 20% Mini-Larry
User avatar
Lee_WSP
Posts: 10402
Joined: Fri Apr 19, 2019 5:15 pm
Location: Arizona

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by Lee_WSP »

crossbow wrote: Tue May 04, 2021 1:24 pm I don't understand it. I have a niggly feeling that including "imputed rent" in the argument for home ownership is double-counting opportunity costs.
I actually agree with this statement. I don't even know why it ever comes up and generally ignore it when I see it.

There is no imputed rent in the rent vs buy calculation. It's quite simply the total cost to own vs (the cost to rent + investment gains/losses of any excess between rent payments & total monthly ownership costs (inclusive of down payment)) over the given timeframe of expected ownership/rental.
User avatar
vineviz
Posts: 14921
Joined: Tue May 15, 2018 1:55 pm
Location: Baltimore, MD

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by vineviz »

Lee_WSP wrote: Tue May 04, 2021 2:21 pm There is no imputed rent in the rent vs buy calculation. It's quite simply the total cost to own vs (the cost to rent + investment gains/losses of any excess between rent payments & total monthly ownership costs (inclusive of down payment)) over the given timeframe of expected ownership/rental.
That's effectively a calculation of imputed rent, FWIW.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
Admiral
Posts: 5039
Joined: Mon Oct 27, 2014 12:35 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by Admiral »

Here's another way of looking at it which is not directly applicable to imputed rent, but the way I see it.

When you rent a $2000 house, the $2k is a straight expense and you have no benefit from price appreciation.

Now let's say you buy the property and your mortgage payment is $2000 P+I, plus the taxes. The taxes and the interest are a straight expense. However (and this is esp true at low rates of interest) some portion of your $2000 is gains, in the form of equity, or forced savings. It's locked up in the house, but it's there. You can count it in your balance sheet if you so choose, at the very least as debt reduction. Each month, this savings grows larger, while your interest expense is reduced. If you're renting, your rent is likely to go up, because as taxes and other maintenance items are incurred, the owner will raise rent to pay for them. You get no benefit, and higher expenses. As an owner, you will also incur these expenses, but your actual monthly payment is fixed.

Now, whether you end up making money depends on a lot of factors: downpayment (and any opportunity cost you gave up), interest rate, market forces, maintenance, etc. For most people buying is more of a lifestyle choice, though with very low interest rates it's definitely more appealing, assuming you can find a property you can afford.

But as long as the amount you pay per month to buy is at least reasonably close to a rent expense, you are likely to do ok. The issue (if it is one) is that most people buy much more than they would rent.

My personal feeling is that having your (typically) largest monthly expense fixed, with little or no uncertainly about having to move, has tremendous value, and not just economically but emotionally and psychologically as well. A house is also a great interest rate hedge.
User avatar
Lee_WSP
Posts: 10402
Joined: Fri Apr 19, 2019 5:15 pm
Location: Arizona

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by Lee_WSP »

vineviz wrote: Tue May 04, 2021 2:31 pm
Lee_WSP wrote: Tue May 04, 2021 2:21 pm There is no imputed rent in the rent vs buy calculation. It's quite simply the total cost to own vs (the cost to rent + investment gains/losses of any excess between rent payments & total monthly ownership costs (inclusive of down payment)) over the given timeframe of expected ownership/rental.
That's effectively a calculation of imputed rent, FWIW.
How so? How are we defining this term? Maybe the term doesn't even have a great definition.

Here's what Wikipedia has to say:
https://en.wikipedia.org/wiki/Imputed_r ... %20tenants.

I think the concept is useful when you're thinking about *selling* the house you own or otherwise trying to put a value on it, but not when one is considering whether one should buy vs continue renting. So, maybe I need to add that caveat to my original "I don't get it" statement.
Topic Author
crossbow
Posts: 365
Joined: Mon Nov 12, 2018 5:47 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by crossbow »

vineviz wrote: Tue May 04, 2021 1:54 pm imputed rent + capital gains - expenses equals the total return of a home.
This is the formula I'm having trouble wrapping my head around and where I think the double counting occurs. Why wouldn't total return of a home be simply [capital gains - expenses]? Sure I don't pay rent when owning the house, but I have home ownership expenses like maintenance and mortgage interest... which is included in expenses.

Edit: Wouldn't the reverse be saying that one should consider "imputed home ownership savings" into monthly rent like maintenance, mortgage interest and property taxes?
User avatar
Ketawa
Posts: 2521
Joined: Mon Aug 22, 2011 1:11 am
Location: DC

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by Ketawa »

crossbow wrote: Tue May 04, 2021 2:54 pm
vineviz wrote: Tue May 04, 2021 1:54 pm imputed rent + capital gains - expenses equals the total return of a home.
This is the formula I'm having trouble wrapping my head around and where I think the double counting occurs. Why wouldn't total return of a home be simply [capital gains - expenses]? Sure I don't pay rent when owning the house, but I have home ownership expenses like maintenance and mortgage interest... which is included in expenses.

Edit: Wouldn't the reverse be saying that one should consider "imputed home ownership savings" into monthly rent like maintenance, mortgage interest and property taxes?
I haven't thought about this before, but I think including imputed rent in total return actually makes a lot of sense.

Suppose you owned a rental property, and you rented a place to live separately. You would count your rental income towards the home's total return. The rent for the place you live would be counted in a separate expenses column.

If you live in the home instead, its total return isn't suddenly dramatically lower. The imputed rental income should be counted towards the home's total return. It just happens to equal the imputed rental expenses in your expenses column.

Of course, total return is just a number. Use it for what you will. I don't really have a reason to calculate my home's total return. However, when I purchased it, I did estimate the rental cost that would make renting vs buying a break-even decision. The rental cost was much lower than I could find in the market, so purchasing was a good decision.
Last edited by Ketawa on Tue May 04, 2021 3:21 pm, edited 1 time in total.
rascott
Posts: 2957
Joined: Wed Apr 15, 2015 10:53 am

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by rascott »

crossbow wrote: Tue May 04, 2021 2:54 pm
vineviz wrote: Tue May 04, 2021 1:54 pm imputed rent + capital gains - expenses equals the total return of a home.
This is the formula I'm having trouble wrapping my head around and where I think the double counting occurs. Why wouldn't total return of a home be simply [capital gains - expenses]? Sure I don't pay rent when owning the house, but I have home ownership expenses like maintenance and mortgage interest... which is included in expenses.

Edit: Wouldn't the reverse be saying that one should consider "imputed home ownership savings" into monthly rent like maintenance, mortgage interest and property taxes?

Why is it double counting? You also are getting the benefit of the place to live.... you are consuming that as your housing expense and must look at what comparable rent would be for a comparable home for a valid rent vs buy comparison.

That's like saying your total compensation is only your cash pay.... ignoring other compensation items like health insurance.
Last edited by rascott on Tue May 04, 2021 3:24 pm, edited 2 times in total.
User avatar
vineviz
Posts: 14921
Joined: Tue May 15, 2018 1:55 pm
Location: Baltimore, MD

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by vineviz »

crossbow wrote: Tue May 04, 2021 2:54 pm
vineviz wrote: Tue May 04, 2021 1:54 pm imputed rent + capital gains - expenses equals the total return of a home.
This is the formula I'm having trouble wrapping my head around and where I think the double counting occurs. Why wouldn't total return of a home be simply [capital gains - expenses]? Sure I don't pay rent when owning the house, but I have home ownership expenses like maintenance and mortgage interest... which is included in expenses.
The total return of a home is not just [capital gains - expenses] because a home also provides you with an additional source of income: a place to live, which you otherwise would have to pay for in the form of cash. Just like the total return of a stock is not limited to just the capital gain - expenses, the total return of a home is not limited to just the capital gain - expenses.

If you're having trouble visualizing this, imagine you're hired by a company to work at a remote location where the only housing is owned by the company. They offer you two options for your pay package:

A) You get paid $100k/year and pay the company $1,000/month for your housing.
B) You get paid $88k/year and get your housing for free.

Clearly these are identical amounts of net income (ignoring the effect of taxes etc.). With both options you're receiving the same $100K in income and paying the same $12k in rent. The only difference is whether the rent takes the form of imputed income and imputed expense, or takes of the form of cash income and cash expense.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
User avatar
dodecahedron
Posts: 6607
Joined: Tue Nov 12, 2013 11:28 am

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by dodecahedron »

crossbow wrote: Tue May 04, 2021 1:24 pm I own my car outright and have never considered "imputed lease payments" because I don't see the lease payments I don't pay adding to my bank balance.
Economists do recognize that *theoretically* consumer durables (e.g., cars, furniture, household appliances, etc.) also yield imputed income, but (as a practical matter) imputed income from such acquisitions are not included in our national income accounts.

https://www.oxfordreference.com/view/10 ... &result=16

I agree that imputed income is a tricky theoretical concept to wrap one's head around, having tried to teach about it for decades in the context of tax policy classes.

Here is a simple example that I have used in a classroom setting to make things concrete. Suppose you do not own your own washer and dryer, so you are spending $5 per week (in quarters!) in coin-ops. If you buy your own washer and dryer, that is effectively an "investment" with a return of $5 per week in imputed income (money saved at the laundromat) over the lifetime of the appliances.

Farmers whose families eat some of the farm's produce also have (theoretical) imputed income. The value of childcare, eldercare, and housekeeping services provided by family members for free is also imputed income.

For most practical purposes, imputed income is a (largely) theoretical concept almost entirely disregarded by our tax system. (For example, farmers do not need to declare as income the value of the produce their family eats.). The practical considerations for measuring it are often a challenge.

However, in some cases imputed income is taxable to the person receiving it. For example, if your employer owns a home and allows you to live in it without paying rent, you will need to pay tax on the imputed income associated with living there rent-free (i.e., the fair-market rental value of the home.). There are exceptions (for example, if living in employer-provided housing is a condition of the job, "for the convenience of the employer," it may be excluded from taxable compensation. So a live-in building superintendent who is on-call 24 hours a day may not have to include imputed rent for his free apartment onsite in his income subject to taxation. But a college that provides free (or even just below-market rent) on college-owned housing to faculty as a perk to attract them to teach there may be required to report the imputed rent as income.

With pretty narrow and specifically delineated exceptions, most in-kind goods or services that are provided to you by an employer would be considered taxable imputed income and would be subject to reporting on a W-2.

https://www.patriotsoftware.com/blog/pa ... ed-income/

But outside of employment/commercial relationships, imputed income is largely a theoretical construct, worth noting when we consider the flaws and limitations in our operational definitions of GDP, for example.
User avatar
vineviz
Posts: 14921
Joined: Tue May 15, 2018 1:55 pm
Location: Baltimore, MD

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by vineviz »

dodecahedron wrote: Tue May 04, 2021 3:24 pm However, in some cases imputed income is taxable to the person receiving it. For example, if your employer owns a home and allows you to live in it without paying rent, you will need to pay tax on the imputed income associated with living there rent-free (i.e., the fair-market rental value of the home.). There are exceptions (for example, if living in employer-provided housing is a condition of the job, "for the convenience of the employer," it may be excluded from taxable compensation. So a live-in building superintendent who is on-call 24 hours a day may not have to include imputed rent for his free apartment onsite in his income subject to taxation. But a college that provides free (or even just below-market rent) on college-owned housing to faculty as a perk to attract them to teach there may be required to report the imputed rent as income.
Another example that comes to mind of imputed income being taxable in the US is a “below-market loan”.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
User avatar
Lee_WSP
Posts: 10402
Joined: Fri Apr 19, 2019 5:15 pm
Location: Arizona

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by Lee_WSP »

crossbow wrote: Tue May 04, 2021 2:54 pm
vineviz wrote: Tue May 04, 2021 1:54 pm imputed rent + capital gains - expenses equals the total return of a home.
This is the formula I'm having trouble wrapping my head around and where I think the double counting occurs. Why wouldn't total return of a home be simply [capital gains - expenses]? Sure I don't pay rent when owning the house, but I have home ownership expenses like maintenance and mortgage interest... which is included in expenses.

Edit: Wouldn't the reverse be saying that one should consider "imputed home ownership savings" into monthly rent like maintenance, mortgage interest and property taxes?
Living somewhere has value. I don't personally consider it income like vineviz, but apart from that definition change (replace income with value), I agree with his response to you.

I also agree with your edit question, however, the more in depth calculators do have inputs for those items. They all typically include PITI.
knowledge
Posts: 489
Joined: Wed Mar 02, 2011 4:44 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by knowledge »

Say Person A and Person B each own home a home and decide to rent it out to one another. Let's say they each rent it out for $1k/mo. That $12k/year is income and should be reported. If they wise up, they realize they can be in the same situation by just living in their "rental" properties. Now there are no payments, and that reported income goes away.

The only time this comes up is if your government decided to tax imputed rent. Crazily enough, it's been done before! I can't even begin to imagine how a politician would go about trying to explain the concept to the general public - let alone try sell that they're going to tax it.
Topic Author
crossbow
Posts: 365
Joined: Mon Nov 12, 2018 5:47 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by crossbow »

vineviz wrote: Tue May 04, 2021 3:23 pm
crossbow wrote: Tue May 04, 2021 2:54 pm
vineviz wrote: Tue May 04, 2021 1:54 pm imputed rent + capital gains - expenses equals the total return of a home.
This is the formula I'm having trouble wrapping my head around and where I think the double counting occurs. Why wouldn't total return of a home be simply [capital gains - expenses]? Sure I don't pay rent when owning the house, but I have home ownership expenses like maintenance and mortgage interest... which is included in expenses.
The total return of a home is not just [capital gains - expenses] because a home also provides you with an additional source of income: a place to live, which you otherwise would have to pay for in the form of cash. Just like the total return of a stock is not limited to just the capital gain - expenses, the total return of a home is not limited to just the capital gain - expenses.

If you're having trouble visualizing this, imagine you're hired by a company to work at a remote location where the only housing is owned by the company. They offer you two options for your pay package:

A) You get paid $100k/year and pay the company $1,000/month for your housing.
B) You get paid $88k/year and get your housing for free.

Clearly these are identical amounts of net income (ignoring the effect of taxes etc.). With both options you're receiving the same $100K in income and paying the same $12k in rent. The only difference is whether the rent takes the form of imputed income and imputed expense, or takes of the form of cash income and cash expense.
Hey vineviz, thanks for the detailed explanation and I follow your total return example. However, I don't see why one would account for the value of living in a purchased home but disregard this value if it was rented.

True, I get utility from living in the house I purchase. But, I get that same value from renting a home... So following this logic, shouldn't I add the "income" (a.k.a utility or value) from living in a rented home to my rent expense, effectively making it zero?
Topic Author
crossbow
Posts: 365
Joined: Mon Nov 12, 2018 5:47 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by crossbow »

rascott wrote: Tue May 04, 2021 3:20 pm
crossbow wrote: Tue May 04, 2021 2:54 pm
vineviz wrote: Tue May 04, 2021 1:54 pm imputed rent + capital gains - expenses equals the total return of a home.
This is the formula I'm having trouble wrapping my head around and where I think the double counting occurs. Why wouldn't total return of a home be simply [capital gains - expenses]? Sure I don't pay rent when owning the house, but I have home ownership expenses like maintenance and mortgage interest... which is included in expenses.

Edit: Wouldn't the reverse be saying that one should consider "imputed home ownership savings" into monthly rent like maintenance, mortgage interest and property taxes?

Why is it double counting? You also are getting the benefit of the place to live.... you are consuming that as your housing expense and must look at what comparable rent would be for a comparable home for a valid rent vs buy comparison.

That's like saying your total compensation is only your cash pay.... ignoring other compensation items like health insurance.
Don't I also get a place to live when I rent a place? Why would I consider this a "benefit" of a purchased home - that's why I think it is double counting. What am I missing? :confused
User avatar
vineviz
Posts: 14921
Joined: Tue May 15, 2018 1:55 pm
Location: Baltimore, MD

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by vineviz »

crossbow wrote: Tue May 04, 2021 4:31 pm
Hey vineviz, thanks for the detailed explanation and I follow your total return example. However, I don't see why one would account for the value of living in a purchased home but disregard this value if it was rented.
The value isn’t disregarded when you rent from someone else.

Go back to ketawa’s sample earlier: when you lease a house from someone else, the rent shows up as an expense for you and as income for them

When you own your own house instead, the (imputed) rent is both an expense AND income for you.

The value of having shelter is the same in both cases, and the concept of imputed rent just let’s you account for transfer of that value when ther is just one party in the “transaction” instead of two.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
Topic Author
crossbow
Posts: 365
Joined: Mon Nov 12, 2018 5:47 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by crossbow »

vineviz wrote: Tue May 04, 2021 5:08 pm
crossbow wrote: Tue May 04, 2021 4:31 pm
Hey vineviz, thanks for the detailed explanation and I follow your total return example. However, I don't see why one would account for the value of living in a purchased home but disregard this value if it was rented.
The value isn’t disregarded when you rent from someone else.

Go back to ketawa’s sample earlier: when you lease a house from someone else, the rent shows up as an expense for you and as income for them

When you own your own house instead, the (imputed) rent is both an expense AND income for you.

The value of having shelter is the same in both cases, and the concept of imputed rent just let’s you account for transfer of that value when ther is just one party in the “transaction” instead of two.
I get ketawa's example (I think). My understanding from that is that we should not add inputed rent to a home's "total" return because we consume the benefit if we live in it.

Going back to your earlier formula, if imputed rent nets itself off by being an equal amount of income and expense by way of consumption, why would it be included in the total return of a home? Unless by "imputed rent" you mean "imputed rent income + imputed rent expense". If so, I think we are on the same page. I just always thought it meant only "imputed rent income", which may be where the disconnect is.
imputed rent + capital gains - expenses equals the total return of a home
MindBogler
Posts: 1446
Joined: Wed Apr 17, 2013 12:05 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by MindBogler »

I prefer to think of the monthly cost of a home in these terms:

P - principal
I - interest
T - taxes
I - insurance
M - maintenance

Payments to P are a forced savings which, barring egregious market crashes, can be recouped by a cash-out refi, sale, or equity credit lines. Interest is a decreasing function of the (ITI), compounding negatively at the mortgage rate. Taxes are typically increasing, but the magnitude is highly specific to geography. Insurance is likely increasing as well, albeit at a much lower rate. Maintenance I have traditionally fixed at 1% of the purchase price per year. I've owned two homes over 20 years and that has worked out well.

Due to principal being forced saving, I tend to ignore principal paydown in a rent vs buy calculation. It is likely as a tenant that a portion of your rent is going into the landlord's pocket. I'm not saying that there aren't homes rented with poor cashflow, but the likelihood that landlords are doing so, in the aggregate, can be disproven with simple intuition. Given two equivalent homes, rent would need to be less than ITIM above in order for me to consider it (or extenuating circumstances, like the need for mobility, would have to outweigh these concerns).

This is just the way I think about and choose to make these decisions. I once rented a home in a new geography for a year to ensure I wanted to live there prior to buying. That was a poor financial choice but it made me feel better. YMMV
cbeck
Posts: 640
Joined: Sun Jun 24, 2012 1:28 am

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by cbeck »

One of the best arguments in favor of home ownership is that imputed rent is not taxable. If you didn't own a home, but instead had $300,000 in T-bills and used the income to rent a place to live, then that income would be taxed.

I understand that at one point the IRS did have a plan to tax imputed rent, but dropped the idea probably because of the taxpayer revolt that would have ensued.
Topic Author
crossbow
Posts: 365
Joined: Mon Nov 12, 2018 5:47 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by crossbow »

MindBogler wrote: Tue May 04, 2021 5:32 pm I prefer to think of the monthly cost of a home in these terms:

P - principal
I - interest
T - taxes
I - insurance
M - maintenance

Payments to P are a forced savings which, barring egregious market crashes, can be recouped by a cash-out refi, sale, or equity credit lines. Interest is a decreasing function of the (ITI), compounding negatively at the mortgage rate. Taxes are typically increasing, but the magnitude is highly specific to geography. Insurance is likely increasing as well, albeit at a much lower rate. Maintenance I have traditionally fixed at 1% of the purchase price per year. I've owned two homes over 20 years and that has worked out well.

Due to principal being forced saving, I tend to ignore principal paydown in a rent vs buy calculation. It is likely as a tenant that a portion of your rent is going into the landlord's pocket. I'm not saying that there aren't homes rented with poor cashflow, but the likelihood that landlords are doing so, in the aggregate, can be disproven with simple intuition. Given two equivalent homes, rent would need to be less than ITIM above in order for me to consider it (or extenuating circumstances, like the need for mobility, would have to outweigh these concerns).

This is just the way I think about and choose to make these decisions. I once rented a home in a new geography for a year to ensure I wanted to live there prior to buying. That was a poor financial choice but it made me feel better. YMMV
Great thank you. My personal high level rent vs buy is similar in but I also consider the OCD (Opportunity Cost of Downpayment) in addition to ITIM like you mentioned above. I tend to shoot for a 4% return on 20% of house price, a prudent post-tax and post-inflation return on VTSAX.

Now I'm trying to find out if I'm missing an input called "Imputed Rent" and if I need to consider it in addition to ITIM + OCD.
MindBogler
Posts: 1446
Joined: Wed Apr 17, 2013 12:05 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by MindBogler »

crossbow wrote: Tue May 04, 2021 5:47 pm Great thank you. My personal high level rent vs buy is similar in but I also consider the OCD (Opportunity Cost of Downpayment) in addition to ITIM like you mentioned above. I tend to shoot for a 4% return on 20% of house price, a prudent post-tax and post-inflation return on VTSAX.

Now I'm trying to find out if I'm missing an input called "Imputed Rent" and if I need to consider it in addition to ITIM + OCD.
That's a great input for certain.
Topic Author
crossbow
Posts: 365
Joined: Mon Nov 12, 2018 5:47 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by crossbow »

cbeck wrote: Tue May 04, 2021 5:43 pm One of the best arguments in favor of home ownership is that imputed rent is not taxable. If you didn't own a home, but instead had $300,000 in T-bills and used the income to rent a place to live, then that income would be taxed.
Which is preferable - paying property tax or saving tax via "imputed rent" (btw, still trying to wrap my head around this concept)?
cbeck wrote: Tue May 04, 2021 5:43 pm I understand that at one point the IRS did have a plan to tax imputed rent, but dropped the idea probably because of the taxpayer revolt that would have ensued.
Probably!
cbeck
Posts: 640
Joined: Sun Jun 24, 2012 1:28 am

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by cbeck »

crossbow wrote: Tue May 04, 2021 6:03 pm
cbeck wrote: Tue May 04, 2021 5:43 pm One of the best arguments in favor of home ownership is that imputed rent is not taxable. If you didn't own a home, but instead had $300,000 in T-bills and used the income to rent a place to live, then that income would be taxed.
Which is preferable - paying property tax or saving tax via "imputed rent" (btw, still trying to wrap my head around this concept)?
cbeck wrote: Tue May 04, 2021 5:43 pm I understand that at one point the IRS did have a plan to tax imputed rent, but dropped the idea probably because of the taxpayer revolt that would have ensued.
Probably!
Rent covers the property tax or else the landlord would be losing money.

Imputed rent is just the market value of the housing (service) that the home provides to the owner who occupies it. By contrast, the owner who rents out the place gets the same value in actual rent dollars.

Imputed rent is no more abstract than opportunity cost, which nevertheless escapes some people. I frequently read opinions of home owners who think their housing is free, because they don't understand opportunity costs.
MindBogler
Posts: 1446
Joined: Wed Apr 17, 2013 12:05 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by MindBogler »

cbeck wrote: Tue May 04, 2021 6:13 pm Imputed rent is no more abstract than opportunity cost, which nevertheless escapes some people. I frequently read opinions of home owners who think their housing is free, because they don't understand opportunity costs.
And it's never really free due to property tax and insurance, which in some cases can be a substantial yearly sum.
cbeck
Posts: 640
Joined: Sun Jun 24, 2012 1:28 am

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by cbeck »

MindBogler wrote: Tue May 04, 2021 6:16 pm
cbeck wrote: Tue May 04, 2021 6:13 pm Imputed rent is no more abstract than opportunity cost, which nevertheless escapes some people. I frequently read opinions of home owners who think their housing is free, because they don't understand opportunity costs.
And it's never really free due to property tax and insurance, which in some cases can be a substantial yearly sum.
But property tax at 1% to 3% is insignificant compared to the 100% market value tied up in a property with no mortgage.
MindBogler
Posts: 1446
Joined: Wed Apr 17, 2013 12:05 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by MindBogler »

cbeck wrote: Tue May 04, 2021 6:20 pm
MindBogler wrote: Tue May 04, 2021 6:16 pm
cbeck wrote: Tue May 04, 2021 6:13 pm Imputed rent is no more abstract than opportunity cost, which nevertheless escapes some people. I frequently read opinions of home owners who think their housing is free, because they don't understand opportunity costs.
And it's never really free due to property tax and insurance, which in some cases can be a substantial yearly sum.
But property tax at 1% to 3% is insignificant compared to the 100% market value tied up in a property with no mortgage.
No dispute from me. I'm merely pointing out that something with an ongoing cost cannot, by definition, be free.

:sharebeer
international001
Posts: 2748
Joined: Thu Feb 15, 2018 6:31 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by international001 »

If I cook a fancy meal for myself, isn't that also imputed income? I should give some money to the IRS (or part of the meal)

Fortunately/unfortunately, IRS can only tax when there is money exchange associated to an increase of utility. With the exception of some big items like housing. In US, I suspect you get much more of money exchanged than other countries (going out to dinner, etc).
Topic Author
crossbow
Posts: 365
Joined: Mon Nov 12, 2018 5:47 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by crossbow »

cbeck wrote: Tue May 04, 2021 6:13 pm Rent covers the property tax or else the landlord would be losing money.
In my VHCOL area, landlords are often willing to rent for less than ITIM (see MindBogler's definition above) by betting that the house value will rise quickly and they can make a profit off the capital gain.
This is true of my current rental unit.
While our decision to rent is based on non-financial factors, it's a bonus that I can pay market rent and invest the difference in VTSAX. My landlord is betting that the property market here will beat VTSAX; I am betting the opposite.
:sharebeer
Topic Author
crossbow
Posts: 365
Joined: Mon Nov 12, 2018 5:47 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by crossbow »

international001 wrote: Tue May 04, 2021 6:36 pm If I cook a fancy meal for myself, isn't that also imputed income? I should give some money to the IRS (or part of the meal)

Fortunately/unfortunately, IRS can only tax when there is money exchange associated to an increase of utility. With the exception of some big items like housing. In US, I suspect you get much more of money exchanged than other countries (going out to dinner, etc).
That's exactly what I find hard to understand about considering an imputed rent variable in Buy vs Rent. In your analogy, it is akin to concluding that not only your meal at home costs less overall, but you also save on paying the chef and tipping the server.
cbeck
Posts: 640
Joined: Sun Jun 24, 2012 1:28 am

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by cbeck »

crossbow wrote: Tue May 04, 2021 6:51 pm
cbeck wrote: Tue May 04, 2021 6:13 pm Rent covers the property tax or else the landlord would be losing money.
In my VHCOL area, landlords are often willing to rent for less than ITIM (see MindBogler's definition above) by betting that the house value will rise quickly and they can make a profit off the capital gain.
This is true of my current rental unit.
While our decision to rent is based on non-financial factors, it's a bonus that I can pay market rent and invest the difference in VTSAX. My landlord is betting that the property market here will beat VTSAX; I am betting the opposite.
:sharebeer
Sounds like a symptom of another bubble.
Northern Flicker
Posts: 15365
Joined: Fri Apr 10, 2015 12:29 am

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by Northern Flicker »

Imputed rent is a piece of calculating return on investment of a home you live in. Robert Schiller has argued that over sufficiently long periods, single family home prices track the inflation rate. If this is correct, then the real (inflation-adjusted) return on home ownership is the imputed rent minus expenses. (If a mortgage is used, the calculation is more complex).

When making a rent vs buy decision, you are comparing the cost of purchase to cost of renting, which does not have to be the same home, so you may drop imputed rent and use actual rent where you would live as a renter instead. Both should not be counted.
Last edited by Northern Flicker on Tue May 04, 2021 11:29 pm, edited 1 time in total.
Afty
Posts: 2390
Joined: Sun Sep 07, 2014 5:31 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by Afty »

international001 wrote: Tue May 04, 2021 6:36 pm If I cook a fancy meal for myself, isn't that also imputed income? I should give some money to the IRS (or part of the meal)
Yes it is — see https://en.wikipedia.org/wiki/Imputed_i ... l_services. Whether or not you should be taxed on it is up to the tax code though.
Katietsu
Posts: 7677
Joined: Sun Sep 22, 2013 1:48 am

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by Katietsu »

crossbow wrote: Tue May 04, 2021 6:56 pm
That's exactly what I find hard to understand about considering an imputed rent variable in Buy vs Rent. In your analogy, it is akin to concluding that not only your meal at home costs less overall, but you also save on paying the chef and tipping the server.
I think I agree with you here. The way a traditional buy vs rent calculator works, you want not use imputed rent. You are essentially comparing the change to your net worth over a given time period if you owned for X years vs rented for the same time period. For me, the concept of imputed rent comes up when someone discusses how they lost money on home ownership when the sales proceed are slightly less than the purchase price plus expenses. If they moved out of a similar house that they could have lived in rent free then, yeah, they lost money on the house ownership. But you need to add the value of imputed rent to get a real picture of ownership.
Tingting1013
Posts: 1594
Joined: Mon Aug 24, 2020 5:44 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by Tingting1013 »

crossbow wrote: Tue May 04, 2021 6:51 pm
cbeck wrote: Tue May 04, 2021 6:13 pm Rent covers the property tax or else the landlord would be losing money.
In my VHCOL area, landlords are often willing to rent for less than ITIM (see MindBogler's definition above) by betting that the house value will rise quickly and they can make a profit off the capital gain.
This is true of my current rental unit.
While our decision to rent is based on non-financial factors, it's a bonus that I can pay market rent and invest the difference in VTSAX. My landlord is betting that the property market here will beat VTSAX; I am betting the opposite.
:sharebeer
There is a flaw in your logic.

Assume that LCOL and VHCOL are both appreciating at an equal CAGR.

How many $200k SFHs in LCOL do you need to own to generate a reliable $100k/yr increase in net worth?

How many $2M SFHs in VHCOL do you need to own to generate the same $100k/yr?

Take into account the headaches of owning multiple properties, vacancy risk, job market risk, etc. Not to mention the clearly false assumption I started with. Are VHCOL landlords really just gamblers? Or are they rational decision makers like everyone else?
international001
Posts: 2748
Joined: Thu Feb 15, 2018 6:31 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by international001 »

crossbow wrote: Tue May 04, 2021 6:56 pm
international001 wrote: Tue May 04, 2021 6:36 pm If I cook a fancy meal for myself, isn't that also imputed income? I should give some money to the IRS (or part of the meal)

Fortunately/unfortunately, IRS can only tax when there is money exchange associated to an increase of utility. With the exception of some big items like housing. In US, I suspect you get much more of money exchanged than other countries (going out to dinner, etc).
That's exactly what I find hard to understand about considering an imputed rent variable in Buy vs Rent. In your analogy, it is akin to concluding that not only your meal at home costs less overall, but you also save on paying the chef and tipping the server.
No.. you are paying yourself (the chef) for your work with the meal. And the utility is positive (i.e. the value of the meal is higher than the work of the cooking). What you are saving is on taxes.

Imagine you cook a meal for $10 (assume ingredients are free) you sell to your friend for $10, and your friend cooks a meal for $10 that it sells to you. At 20% tax rate, this would be $4 for uncle Sam.

The corollary is that taxes are high, the more likely you are to cook for yourself (or do barter trading), instead of having a formal economy, and the official GDP diminishes (respect the total amount of values produced).
international001
Posts: 2748
Joined: Thu Feb 15, 2018 6:31 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by international001 »

Lee_WSP wrote: Tue May 04, 2021 2:49 pm
vineviz wrote: Tue May 04, 2021 2:31 pm
Lee_WSP wrote: Tue May 04, 2021 2:21 pm There is no imputed rent in the rent vs buy calculation. It's quite simply the total cost to own vs (the cost to rent + investment gains/losses of any excess between rent payments & total monthly ownership costs (inclusive of down payment)) over the given timeframe of expected ownership/rental.
That's effectively a calculation of imputed rent, FWIW.
How so? How are we defining this term? Maybe the term doesn't even have a great definition.

Here's what Wikipedia has to say:
https://en.wikipedia.org/wiki/Imputed_r ... %20tenants.

I think the concept is useful when you're thinking about *selling* the house you own or otherwise trying to put a value on it, but not when one is considering whether one should buy vs continue renting. So, maybe I need to add that caveat to my original "I don't get it" statement.

So according to law, you cannot tax rent imputed income as taxable income.
US, unlike other countries, found a workaround for that. Just have a high property tax.
If your property tax is taxed at 1%, and the return of your home is 6% (long term average). Then the effective rate would be about 17% flat rate on imputed income.

It's a similar concept like some countries don't tax investment income but they have a wealth tax instead (in this case there is actual $$ involved)

It's funny how laws and economy intersect.
jackbeagle
Posts: 157
Joined: Sat Mar 06, 2021 4:22 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by jackbeagle »

fabdog wrote: Tue May 04, 2021 1:44 pm Well, you have to live somewhere... or at least most of us do. So the concept of imputed rent says if I'm going to pay X dollars for a place to live... I count that when thinking about the value of the house. In most places, most of the time, the house at least holds its value over time. Cars not so much

Now in some places you can rent more cheaply than you can buy, and in other places the opposite, so it's not the main reason to buy.... just a consideration

Mike
I think the imputed rent is more of an accounting function to show where opportunity lies, not necessarily ding you for not renting out every piece of real estate you own and living in your car. If you care about that sort of thing and want to live in the property with the absolute lowest opportunity cost, the metric can help you as something you want to MINIMIZE, but most traditional living situations won't be able to eliminate the opportunity cost entirely.
Topic Author
crossbow
Posts: 365
Joined: Mon Nov 12, 2018 5:47 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by crossbow »

international001 wrote: Wed May 05, 2021 12:26 pm
crossbow wrote: Tue May 04, 2021 6:56 pm
international001 wrote: Tue May 04, 2021 6:36 pm If I cook a fancy meal for myself, isn't that also imputed income? I should give some money to the IRS (or part of the meal)

Fortunately/unfortunately, IRS can only tax when there is money exchange associated to an increase of utility. With the exception of some big items like housing. In US, I suspect you get much more of money exchanged than other countries (going out to dinner, etc).
That's exactly what I find hard to understand about considering an imputed rent variable in Buy vs Rent. In your analogy, it is akin to concluding that not only your meal at home costs less overall, but you also save on paying the chef and tipping the server.
No.. you are paying yourself (the chef) for your work with the meal. And the utility is positive (i.e. the value of the meal is higher than the work of the cooking). What you are saving is on taxes.

Imagine you cook a meal for $10 (assume ingredients are free) you sell to your friend for $10, and your friend cooks a meal for $10 that it sells to you. At 20% tax rate, this would be $4 for uncle Sam.

The corollary is that taxes are high, the more likely you are to cook for yourself (or do barter trading), instead of having a formal economy, and the official GDP diminishes (respect the total amount of values produced).
Still as confused as when I first started this thread seeking clarification. Are you saying that imputed rent is a thought concept associated with real estate taxation, and is not a thought concept for a Rent vs Buy comparison? If so, I follow. If not, )(*@#*&@(#*$^(@#^$&*@#(*$&@(#*%)(*!@(*$(^
User avatar
vineviz
Posts: 14921
Joined: Tue May 15, 2018 1:55 pm
Location: Baltimore, MD

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by vineviz »

crossbow wrote: Wed May 05, 2021 2:46 pm Still as confused as when I first started this thread seeking clarification. Are you saying that imputed rent is a thought concept associated with real estate taxation, and is not a thought concept for a Rent vs Buy comparison? If so, I follow. If not, )(*@#*&@(#*$^(@#^$&*@#(*$&@(#*%)(*!@(*$(^
I wish I understood what about the concept of imputed rent us making the concept confusing.

It’s just a way to put a value on the service that your house provides to you.

If you rented your house from someone else, you’d pay them in cash. Because instead you effectively rent your house from yourself there is no cash transaction. Imputed rent just captures the same value in a different form.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
mbasherp
Posts: 735
Joined: Mon Jun 26, 2017 8:48 am

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by mbasherp »

crossbow wrote: Wed May 05, 2021 2:46 pm
Still as confused as when I first started this thread seeking clarification. Are you saying that imputed rent is a thought concept associated with real estate taxation, and is not a thought concept for a Rent vs Buy comparison?
I know you didn't ask me this, but the answer is that it's #1... because otherwise GDP numbers don't make sense. But because it exists via #1, it is useful for #2 as well.

Here's a thread I started several years ago where I learned about imputed rent, which I intuited as a new homeowner but didn't know it was a "thing." Perhaps it will help?

viewtopic.php?f=2&t=226205&p=3502681&hi ... t#p3502681
TheBeanCounter
Posts: 118
Joined: Thu Sep 03, 2020 2:57 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by TheBeanCounter »

Next summer you will be six.
Topic Author
crossbow
Posts: 365
Joined: Mon Nov 12, 2018 5:47 pm

Re: Please explain the concept of imputed rent to me like I'm a 5 year old

Post by crossbow »

mbasherp wrote: Wed May 05, 2021 3:16 pm
crossbow wrote: Wed May 05, 2021 2:46 pm
Still as confused as when I first started this thread seeking clarification. Are you saying that imputed rent is a thought concept associated with real estate taxation, and is not a thought concept for a Rent vs Buy comparison?
I know you didn't ask me this, but the answer is that it's #1... because otherwise GDP numbers don't make sense. But because it exists via #1, it is useful for #2 as well.

Here's a thread I started several years ago where I learned about imputed rent, which I intuited as a new homeowner but didn't know it was a "thing." Perhaps it will help?

viewtopic.php?f=2&t=226205&p=3502681&hi ... t#p3502681
It did help - thanks much. I just read through the entire thing. Now I wonder when the next thread on this concept will come up, not sure if it's a trend to have this come up every few years. :D
Post Reply