Real Estate Agent · Oakland, CA · Member since 2017 · 60 posts · 25 votes
This is a hypothetical situation. Billy has a day job earning $100,000 per year in California. He wants to build a real estate empire in his local market as the king of residential real estate (1-4 units). What value of real estate holdings would he need to have enough depreciation to offset $100,000 of gross income (assuming he does not buy commercial real estate)?
Investor · Clairemont, CA · Member since 2011 · 3k+ posts · 2k+ votes
5y
This would depend on the rent return etc...ignoring that for a second....
If he has 100K in W-2, and needs 100K in depreciation...then he needs 100K*27.5 years is 2.75 Million in improvements, or 3.925 (2.75M/70%) in asset value. Of course that increases by however much rental income is also being brought in and eating away at the depreciation already....
Obviously an over simplified response, but that's your answer.
Real Estate Consultant · Denver, CO · Member since 2021 · 661 posts · 389 votes
5y
@David Lao When discussing depreciation, residential rentals are considered commercial property. If you have a W2 job, you will not likely qualify as a RE Professional to be able to take advantage of making your commercial investments "active". Therefore, you cannot use the depreciation to offset the W2 income. On the other hand, if you have a spouse who does not have a W2 income, this may be an asset.
@David Lao When discussing depreciation, residential rentals are considered commercial property. If you have a W2 job, you will not likely qualify as a RE Professional to be able to take advantage of making your commercial investments "active". Therefore, you cannot use the depreciation to offset the W2 income. On the other hand, if you have a spouse who does not have a W2 income, this may be an asset.
Bonnie, thanks for the insights. So what value of real estate holdings would Billy need to have enough depreciation to offset $100,000 of gross income assuming that he or his wife meets the IRS's definition of a RE professional? We can assume that 70% of the asset value are improvements for this hypothetical situation.
Investor · Clairemont, CA · Member since 2011 · 3k+ posts · 2k+ votes
5y
This would depend on the rent return etc...ignoring that for a second....
If he has 100K in W-2, and needs 100K in depreciation...then he needs 100K*27.5 years is 2.75 Million in improvements, or 3.925 (2.75M/70%) in asset value. Of course that increases by however much rental income is also being brought in and eating away at the depreciation already....
Obviously an over simplified response, but that's your answer.
Real Estate Consultant · Denver, CO · Member since 2021 · 661 posts · 389 votes
5y
@David Lao There are many complex calculations that go into coming up with the appropriate number for you. In general, you can estimate that about 30-40% of the purchase price can be depreciated up-front. Of course, it depends on the type of property. A warehouse with 20% office space is going to be quite different than the same amount of footage in an office building or residential rental. I can go over the specific numbers with you if you are interested...no cost. Rough estimate: Maybe about $350k+ in purchase price.
@David Lao When discussing depreciation, residential rentals are considered commercial property. If you have a W2 job, you will not likely qualify as a RE Professional to be able to take advantage of making your commercial investments "active". Therefore, you cannot use the depreciation to offset the W2 income. On the other hand, if you have a spouse who does not have a W2 income, this may be an asset.
Hi Bonnie could accelerated depreciation/loss be used to offset capital gains/ short term capital gains?
Real Estate Consultant · Denver, CO · Member since 2021 · 661 posts · 389 votes
4y
@Will F. The best way to avoid capital gains on the sale of a property is to do a 1031 exchange into a new property. Once you have secured the new property you can accelerate the depreciation on the new depreciable basis. Of course, you will want to discuss this with your CPA/tax professional.
Real Estate Investor · Tempe, AZ · Member since 2012 · 874 posts · 648 votes
4y
He can't. A $100K "day job" is bound to disqualify him from being a real estate professional according to IRS rules. If his income (MAGI, actually) is $100K and not a penny more, he could take a passive loss of $25K, max.
The depreciation generated needs to first offset any profits in the properties (we do still like profits, right?), and then post a passive loss.
The 1986 tax act is calling to remind people that offsetting active income with passive losses is extremely difficult.
@Will F. The best way to avoid capital gains on the sale of a property is to do a 1031 exchange into a new property. Once you have secured the new property you can accelerate the depreciation on the new depreciable basis. Of course, you will want to discuss this with your CPA/tax professional.
I was wondering if the accelerated depreciation can offset short term or long term capital gains from other assets -- stock sales and cryptocurrency sales?
Cost Segregation Expert and Investor · Lakewood, NJ · Member since 2017 · 1k+ posts · 1k+ votes
4y
@Will F. as we discussed in another thread, only if you are a real estate professional. If not, unfortunately you cant use the depreciation to offset the capital gain from other assets.
@Will F. as we discussed in another thread, only if you are a real estate professional. If not, unfortunately you cant use the depreciation to offset the capital gain from other assets.
That's good. I do REI and prop management full time
Real Estate Syndicator · Phoenix, AZ · Member since 2018 · 903 posts · 1k+ votes
4y
@David Lao Quite simply, if you make a 100k, you are paying 30-40k taxes on a typical W-2 salary. To achieve this, you need to be married or file jointly with a real estate professional and thus have 30-40k in depreciation, not 100k. This is doable, it just takes one person filing taxes to qualify as a real estate professional and find some investment that provides 30-40k in losses from the investment.
This is entirely doable. If of course, your life and personal situation complies :) I have done this for three years now.
@David Lao Quite simply, if you make a 100k, you are paying 30-40k taxes on a typical W-2 salary. To achieve this, you need to be married or file jointly with a real estate professional and thus have 30-40k in depreciation, not 100k. This is doable, it just takes one person filing taxes to qualify as a real estate professional and find some investment that provides 30-40k in losses from the investment.
This is entirely doable. If of course, your life and personal situation complies :) I have done this for three years now.
For this thought exercise, let's assume the RE professional requirement has been met, and that the net rental income (excluding depreciation) equals $0.
Isn't 100K of gross taxable income less 30K of depreciation equal to 70K of taxable income (i.e., 100K-30K=70K)?
Going back to the original question, "What value of real estate holdings would he need to have enough depreciation to offset $100,000 of gross income (assuming he does not buy commercial real estate)?", 30K of depreciation (assuming the depreciation is not front-loaded via cost segregation), could be obtained from 825K of improvement value (or 1.18M of real estate investments assuming a 70% improvement value). This seems unusually low, but maybe I misunderstood. Thoughts?
Residential real estate is depreciated on a straight line 27.5 yr basis. Right, avoiding cost segregration blah blah which usually isn't worth it in residential properties, AND assuming your other costs equal the rents, AND your legal spouse can qualify as a Real Estate Professional (according to the IRS definition) so that you don't ahve to worry about the passive activity loss rules that start phasing out the $25k limit at $100k and finish at $150k...
1Mil of improvements (remember you can't depreciate land) gives you $36.363k of depreciation annually. I do agree above that $100k of gross taxable income should equate to some smaller number of taxable income after standard deduction, etc.. But, you can easily scale from here given all the other assumptions, which I assuming that is what you are asking with this hypothetical question. Again, its not the value of the real estate he has to hold, its the value of the improvements portion of the real estate that he holds.
Residential real estate is depreciated on a straight line 27.5 yr basis. Right, avoiding cost segregration blah blah which usually isn't worth it in residential properties, AND assuming your other costs equal the rents, AND your legal spouse can qualify as a Real Estate Professional (according to the IRS definition) so that you don't ahve to worry about the passive activity loss rules that start phasing out the $25k limit at $100k and finish at $150k...
1Mil of improvements (remember you can't depreciate land) gives you $36.363k of depreciation annually. I do agree above that $100k of gross taxable income should equate to some smaller number of taxable income after standard deduction, etc.. But, you can easily scale from here given all the other assumptions, which I assuming that is what you are asking with this hypothetical question. Again, its not the value of the real estate he has to hold, its the value of the improvements portion of the real estate that he holds.
I was hoping my question would lead to an interesting thread, haha. So based on what you wrote, 2.75M of improvement value can wipe out 100K of taxable income (assumptions: RE professional designation, net rental income of zero excluding depreciation, & "straight-line" depreciation over 27.5 years). Does that sound about right to you? Thumbs up if you agree, or comment if you disagree~
In broad strokes... and you had written in your OP that it was residential only. Otherwise, commercial (which is 5 or more living units) is depreciated on a 39yr basis).
Don't forget, unless you 1031 you'll be paying all that back with depreciation unrecapture when you sell.
In broad strokes... and you had written in your OP that it was residential only. Otherwise, commercial (which is 5 or more living units) is depreciated on a 39yr basis).
Don't forget, unless you 1031 you'll be paying all that back with depreciation unrecapture when you sell.
I had read that residential 27.5 years is any residential or multifamily buildings?
Correct. Residential properties are defined legally as 1-4 family units. Anything with more than 4 are considered commercial property.
Not sure what is your question from that statement.
I think the confusion many people have is that from a lending perspective anything over 4 units is considered commercial, but that is not the case when it comes to depreciation. All residential dwellings including multifamily (even 300 units building etc.) are all considered residential and depreciate over 27.5 year period, even though from a lending perspective it's considered commercial.
Oh, is that what is going on? Yes, is a legal issue too as residential and commercial property transactions are handled differently. But your IRS tax treatment is different.
Correct. Residential properties are defined legally as 1-4 family units. Anything with more than 4 are considered commercial property.
Not sure what is your question from that statement.
I think the confusion many people have is that from a lending perspective anything over 4 units is considered commercial, but that is not the case when it comes to depreciation. All residential dwellings including multifamily (even 300 units building etc.) are all considered residential and depreciate over 27.5 year period, even though from a lending perspective it's considered commercial.
Oops yes I was typing quickly @David
I meant to say that I thought that any multifamily can get the 27.5 depreciation period i had thought. sounds like Yonah confirmed that for depreciation 27.5 years is correct for Multis
Real Estate Consultant · Denver, CO · Member since 2021 · 661 posts · 389 votes
4y
@Will F. Yohan is almost correct. The exception is that if the residential rental(s) (small or large) is a short-term rental (less than 30 days) it has to be on a 39-year depreciation schedule like any hotel or transient use. 27.5 year depreciation is for residential rentals of any size that are leasing for 30-days or more. Unfortunately, you will have to pay the capital gains taxes unless you are doing a 1031 exchange of one property for another within the IRS' time frames.
And, as @David M. said, if you are occupying one of the units, it is more complicated. You can only depreciate or accelerate the portion of the property that you do not occupy.
@David Lao As you can see by the mix of answers to your original question, there too many variables to be answered on a forum like this. When it comes to improvements to a property there are many many additional questions that have to be asked. Just some questions are 1. When were the improvements done versus the date the property was purchased? 2. The improvements could be items that must be capitalized and some must be expensed according to the 2014 Tangible Property Regulations. 3. Are the properties actually active versus passive? There is a material participation requirement that MUST be well documented. And, 4. There are other commercial properties that are owner-occupied and should be active but are filed as passive to the owner's detriment.
I also noticed that a few people are confused about Gross Income versus Net Income. Net Income is your taxable income after deductions. Gross Income is the total income you have earned. Accelerating your investment property's depreciation reduces the amount of taxes you have to pay by lowing your taxable income and therefore increasing your cash flow.
Real Estate Syndicator · Phoenix, AZ · Member since 2018 · 903 posts · 1k+ votes
4y
@David Lao I see what you are trying to accomplish. However, unless you can purchase that property yourself, it seems like a mute point. What is more often the case for those seeking large depreciation, is investing into a larger deal 20+ million giving 50-100% bonus deprecation on 100k investment. Meaning in year one, someone receives 50-100k in depreciation. This is a much easier feat and very much doable if depreciation is your goal. That same 100k wouldn't even tap into a 1 million dollar property with value-add. Simplify, simplify, simplify, I say. Just depends on what your end goal is out of the investment.
@David Lao I see what you are trying to accomplish. However, unless you can purchase that property yourself, it seems like a mute point. What is more often the case for those seeking large depreciation, is investing into a larger deal 20+ million giving 50-100% bonus deprecation on 100k investment. Meaning in year one, someone receives 50-100k in depreciation. This is a much easier feat and very much doable if depreciation is your goal. That same 100k wouldn't even tap into a 1 million dollar property with value-add. Simplify, simplify, simplify, I say. Just depends on what your end goal is out of the investment.
Thanks Chris for the reply, and the goal is tax efficiency (for example, so that a spouses's W2 would have little-to-no federal income tax until retirement). I thought about these multi-million syndication deals before, and probably have a surface level understanding of them compared to you. Although being a limited partner on a large syndication could lead to a lot of depreciation in the beginning, a lot of these syndications have exit strategies that don't involve 1031s (at least as far as I understand), so the depreciation usually gets recaptured in a few years when the property is sold. There's still the time-value of money aspect benefit, but I was looking into these non-syndication deals where I'd have full control of deferring taxes via 1031s until death (assuming 1031s still exist in the future). For this reason, I find that the compounding effect for syndications is inferior. I definitely have the impression that being an LP in a syndication would be the path of least resistance though. Please feel free to tell me that I'm crazy and disagree with everything that I wrote. :P