For 50+ MF, how common is it to show a loss after depreciation?
Dasmariñas, Calabarzon · Member since 2017 · 8 posts · 3 votes
For 50+ MF, how common is it to show a loss after depreciation?
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Developer · Houston, TX · Member since 2017 · 161 posts · 134 votes
9yRyan White at 150 units and assuming 40k/unit, the lender would require a net worth of $6m and liquidity of 600k, that's after the Downpayment. For your first deal, you are looking at 70% leverage (30%down). You might find some lenders go to 75, but I would underwrite at 70. For me, I did my first deal at 65%, full recourse on 26 units.
If you buy by the end of the year, they prorate the depreciation. It would only be a few months and you would probably show a positive agi.
It takes us 6-9 months to find and close on a property. It's a long journey.
I recommend you find a syndicator in your market for your first deal. Let them show you the ropes. Maybe you are the only investor in the deal and can negotiate better compensation terms. The difference in return that you make as a passive vs a sponsor is maybe 3-5% on cashflow and only 2-4% on IRR. HOWEVER, the security and risk mitigation you receive is priceless. There are just as many sharks in multifamily as there are in single family except they bite harder in multifamily. You risk losing a lot more money if you don't know what you are doing in multifamily vs single family.
25 Replies
- Rental Property Investor · Greenwich, CT · Member since 2015 · 4k+ posts · 2k+ votes9y
@Account Closed, I'm not a CPA or tax lawyer, but as I understand it you can't offset earned income over a certain point (I think $125-150k/year, not positive).
It's unlikely that you would be showing a loss on a 50-unit, unless it's in a high-demand/low-cap rate market, where you're really getting appreciation and not a lot of relative cashflow.
That being said, you don't do get to "hold on to" your RE losses. Say your show $10k of RE losses in 2017 and then $15k of RE profits in 2018. You can carry the losses forward and apply them towards your 2018 taxes.
- Dasmariñas, Calabarzon · Member since 2017 · 8 posts · 3 votes9y
Thanks for the reply @Jaysen Medhurst!
According to the IRS rules, if you spend at least 750 hours on your real estate business, and more time than any other job or business, you are considered a "real estate professional" and can deduct the losses as active losses against active income. See this article:
Have you read Tax Free Wealth by Tom Wheelright? He talks about how you can take almost DOUBLE the depreciation on each rental if you do something called cost segregation. Did you factor that in when you said it's probably not common to see a loss on a 50-unit? Thanks so much. Have a great weekend!
- Developer · Houston, TX · Member since 2017 · 161 posts · 134 votes9y
@Account Closed welcome to BP. I am also rather new to BP, in my 3rd week but investing in strictly MF since 2010. great questions. I remember the year i switched from my corporate job at Exxon to being a "real estate professional" i wrote off over $100k in AGI in rental losses and depreciation.I got a huge tax refund that year and it was awesome! The 750 hours is easy to hit. There are several "either or" criteria you can hit to meet the requirement. I met by hours and also by "directly managing the investment". Talk with a CPA but if this is your property, then I have no doubt you will qualify as a RE Pro
In regards to Cost Segregation, this applies to your "non structural" items like carpets, appliances, floors, hardware packages, etc. They need to all be newly installed by you since in order to apply for this, you need to have ever invoice for your cost to install it. We do this a lot. The general scenario is, we buy a property, spend 5-10k per unit renovating it, provide all of our invoices for the interior work to a special firm that specializes in Cost segs. They then sum all of our Soft Cost from the rehab and depreciate all of it over 5 years. So you get accelerate depreciation for most of your interior rehab. This is one of the ways we keep our AGI so low. But, it requires that we continually buy properties so that we can continually renovate and do cost segs otherwise, at the end of 5 years, the deprecation write off drops and our AGI goes back up.
Also, one tip, try to buy a 150 unit. 50 is too small and hard to manage. Believe it or not, the bigger the property, the easier it is, until you get over 400 units.
Hope this helps.
- Dasmariñas, Calabarzon · Member since 2017 · 8 posts · 3 votes9y
@Joseph Bramante, thanks, that helps a lot. And thanks for the tip to start with a 150 unit. That makes a lot more sense for the deductions we need this year. If we purchased it by the end of 2017, would we get to take depreciation for it starting in 2017? Is purchasing a 150 unit by the end of 2017 unrealistic, with it being our first deal? We have been reading books and doing research, but no boots on the ground yet, so we have no idea on the time frame.
We will only have enough for a 5% down payment for a 150 unit by the end of the year. Do you have any tips for who to contact for lending, or creative funding? We have zero bad debt and 800 on credit scores, but maybe that doesn't matter for these kind of purchases?
- Developer · Houston, TX · Member since 2017 · 161 posts · 134 votes9yRyan White at 150 units and assuming 40k/unit, the lender would require a net worth of $6m and liquidity of 600k, that's after the Downpayment. For your first deal, you are looking at 70% leverage (30%down). You might find some lenders go to 75, but I would underwrite at 70. For me, I did my first deal at 65%, full recourse on 26 units. If you buy by the end of the year, they prorate the depreciation. It would only be a few months and you would probably show a positive agi. It takes us 6-9 months to find and close on a property. It's a long journey. I recommend you find a syndicator in your market for your first deal. Let them show you the ropes. Maybe you are the only investor in the deal and can negotiate better compensation terms. The difference in return that you make as a passive vs a sponsor is maybe 3-5% on cashflow and only 2-4% on IRR. HOWEVER, the security and risk mitigation you receive is priceless. There are just as many sharks in multifamily as there are in single family except they bite harder in multifamily. You risk losing a lot more money if you don't know what you are doing in multifamily vs single family.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes9y
Hi Ryan,
It list your location as in the Philippines?
Are you a U.S. citizen and the business is in the Philippines?
Things get complicated with tax treaties and also withholding on investment properties if you are overseas.
No way would I touch rentals for MF at 40k a unit. Those tend to be lower end tenants and managing from afar is a nightmare. It's a good way to lose your shirt. Tax write off is one component of investing but it is NOT the only reason you buy a property. The property itself needs to be fundamentally sound as well.
How do you know you have 5% down for a 150 unit if you do not list price per door? You need to decide on what type of tenant and area you want to invest in and how new the property is. That can make the difference between a 40k per door property and a 125,000 a door property.
With the online retail business a lender will want to look at how stable the cash flow has been year over year. Example have you done 200k profit the last 2 years and this current year is just a really great year at 800k? They will want to see trending and averaging of your business. Unlike other asset classes like commercial retail with corporate backed tenants on the leases you will be (feeding the beast) in multifamily if a tenant does not pay. One benefit of multifamily is great break even occupancy factor over other asset types. One downside is as mentioned by others to truly be passive you need a high quality product and lots of doors which can be very expensive.
As an example let's say you need 100 doors to be passive at 80k a door for a nice product. That is 8,000,000 in price. Highest LTV I have seen on a first note is 80% ltv. So minimum you need 1,600,000 down plus all the reserves and closing costs. More realistically 70 to 75% ltv so 2 million to 2.4 million or so down payment.
One of the benefits to commercial retail is that you can get passive at a much lower price point. For example an Aspen Dental, T-Mobile, and a Starbucks 3 tenant center at around 3 million for 30% down is 900,000. They all have 10 year primary term leases backed by tens of thousands of stores with corporate guarantee. They go up 10% every 5 years etc.
There are also single tenant properties such as a Dollar store or a Walgreens with very long primary lease terms and investment grade tenants NNN. You do nothing but collect a check and have tax depreciation based on your individual situation. If you are overseas you need to talk to a cross border tax attorney who is familiar with those situations.
You could also possibly invest with a sponsor. You have to look at it if your main goal is tax depreciation, cash flow today, or equity growth on the back end? It can be a mix of the 2 or 3 combined but there is usually one that stands out above the rest as the driving factor. With the sponsor you need to be careful how the operating agreement is set up. Some take most of the depreciation so structure is important.
No legal advice given.
- Investor · Des Moines, IA · Member since 2015 · 380 posts · 201 votes9y
Hello Ryan,
I am in a similar boat, but unfortunately, unless you have huge capital reserves, it'll be hard to buy enough to offset that much income, at least in a short amount of time.
Example, I have a $4.25m multifamily, 72 unit under contract. Even at a 20 year amort loan, it cashflows about $45k/yr. My depreciation expense would be about $116k/yr, that's assuming just taking building value over 27.5 yrs. There may be ways to accelerate something like that. But using that as an average scenario, I'm offsetting about $70k in other income.
Extrapolating that over $700k in income, I'd have to buy $42.5m in multifamily.
Even in an area where cap rates are really compressed and you're making $0 cash flow, it'd take about $25m in RE purchases to offset that. Assuming 20-30% down, you'd have to have a minimum of $5-7.5m in capital available to purchase this much.
These are my assumptions so if someone else has any thoughts on why my math is not correct, feel free to correct :)
- Dasmariñas, Calabarzon · Member since 2017 · 8 posts · 3 votes9y
@Chase Gochnauer thanks for the realistic numbers, that really helps. I guess we were optimistic and somewhat mislead by the book Tax Free Wealth.
- Dasmariñas, Calabarzon · Member since 2017 · 8 posts · 3 votes9y
@Joseph Bramante thanks for the reality check on the amount of capital needed for a purchase of that size. We listened to a few of Robert Kiyosaki's books and he made it sound like we could do no money down be being a little creative, and we could also do non recourse loans and we assumed that meant the bank wouldn't require huge capital reserves. Ignorance on our part. How big do you have to go before lenders will give you non recourse loans? Is it just a matter of having a good track record, and it doesn't matter how big the loan is? We didn't know about the prorating for depreciation, that helps a lot. Thanks for the recommendation for finding a syndicator. Will definitely look into that.
- Dasmariñas, Calabarzon · Member since 2017 · 8 posts · 3 votes9y
@Joel Owens we live in the US, we entered a zip code from Texas and not sure why it says philippines. For commercial retail, we are interested in it, but we read an article that said you're basically paying double per square foot than regular market value, and it's more an investment in the company and good faith that they will continue to stay in business in that location. We are still definitely interested and will continue to learn more about it. Thanks so much for the reply!
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes9y
You analyze market rents comparable to the lease.Developers like to build in TI into the leases which can sometimes push rents higher. I focus on internet resistant tenants.
- Developer · Houston, TX · Member since 2017 · 161 posts · 134 votes9y
Originally posted by @Account Closed:
@Joseph Bramante thanks for the reality check on the amount of capital needed for a purchase of that size. We listened to a few of Robert Kiyosaki's books and he made it sound like we could do no money down be being a little creative, and we could also do non recourse loans and we assumed that meant the bank wouldn't require huge capital reserves. Ignorance on our part. How big do you have to go before lenders will give you non recourse loans? Is it just a matter of having a good track record, and it doesn't matter how big the loan is? We didn't know about the prorating for depreciation, that helps a lot. Thanks for the recommendation for finding a syndicator. Will definitely look into that.
In general, you need a $5M loan. I have one that is 2M and non recourse, but it is the exception.
Be sure to check the copyright date for Mr Kiyosakis books. I'm assuming most were written in the 90's before the real estate crash. None of that stuff applies any more.
- Investor · Des Moines, IA · Member since 2015 · 380 posts · 201 votes9y
@Account Closed There could be worse problems to have, then the problem of paying too much in taxes. :) Section 179 is a good accelerated depreciation for vehicles/equipment. Not sure if you're eligible for the 10% domestic production writeoff but that's a good one too.
- Unit count is generally irrelevant for this question. The more important question is cap rate and capital cost. With an A paper loan and a cap rate 6 or 7 or below then you should be able to write off all the income plus some. As others have mentioned when your building gets big enough a cost seg can pencil and accelerate the depreciation and increase the write offs further. We do it on buildings over 3M which is 12-14 unit here.
- Rental Property Investor · Doylestown, PA · Member since 2008 · 1k+ posts · 1k+ votes9y
The Rich Dad books are good for motivation and that's it. He's about as accurate as a broken watch when it comes to details. Btw- @Account Closed... you're looking to offset your earned income from your online business... Why don't you look for more deductions within that business so your earned income isn't as high to start with. I'm sure if you talked to a tax professional and a financial advisor they could tell you what to do.
- Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes9y
Originally posted by @Joseph Bramante:
@Account Closed welcome to BP. I am also rather new to BP, in my 3rd week but investing in strictly MF since 2010. great questions. I remember the year i switched from my corporate job at Exxon to being a "real estate professional" i wrote off over $100k in AGI in rental losses and depreciation.I got a huge tax refund that year and it was awesome! The 750 hours is easy to hit. There are several "either or" criteria you can hit to meet the requirement. I met by hours and also by "directly managing the investment". Talk with a CPA but if this is your property, then I have no doubt you will qualify as a RE Pro
In regards to Cost Segregation, this applies to your "non structural" items like carpets, appliances, floors, hardware packages, etc. They need to all be newly installed by you since in order to apply for this, you need to have ever invoice for your cost to install it. We do this a lot. The general scenario is, we buy a property, spend 5-10k per unit renovating it, provide all of our invoices for the interior work to a special firm that specializes in Cost segs. They then sum all of our Soft Cost from the rehab and depreciate all of it over 5 years. So you get accelerate depreciation for most of your interior rehab. This is one of the ways we keep our AGI so low. But, it requires that we continually buy properties so that we can continually renovate and do cost segs otherwise, at the end of 5 years, the deprecation write off drops and our AGI goes back up.
Also, one tip, try to buy a 150 unit. 50 is too small and hard to manage. Believe it or not, the bigger the property, the easier it is, until you get over 400 units.
Hope this helps.
Hey Joseph. I'd recommend talking with your CPA and if they are having you spend money on cost segregation to depreciate carpeting, appliances, hardware packages, etc. that you have installed for items under the $2,500 de minimis safe harbor, you should switch CPAs. Those items are currently deductible and, in addition, not subject to depreciation recapture later on.
Ryan, it is common for CRE investors to use cost segregation to eliminate passive income and not uncommon to use it to offset earned income for those with the real estate professional status that you mentioned.
- Developer · Houston, TX · Member since 2017 · 161 posts · 134 votes9y
@Mike Dymski According to the IRS, the person completing the cost segregation study needs to be familiar with the construction processes. They can not be a normal CPA. You will need to use a firm that specializes in Cost segregation studies. I have done this twice already with a 3rd planned. It is typically best for big value add projects, not small 3k/unit rehabs since the survey itself cost you a few thousand bucks.
- Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes9y
Originally posted by @Joseph Bramante:
@Mike Dymski According to the IRS, the person completing the cost segregation study needs to be familiar with the construction processes. They can not be a normal CPA. You will need to use a firm that specializes in Cost segregation studies. I have done this twice already with a 3rd planned. It is typically best for big value add projects, not small 3k/unit rehabs since the survey itself cost you a few thousand bucks.
I was referring to capitalizing and depreciating rehab items below the $2500 de minimis safe harbor and then also having to pay depreciation recapture on those items later. If your CPA or cost segregation firm are doing that for these interior rehab items, that is a poor tax treatment. For example, if you are putting in new appliances and each of those appliances cost less than $2500, they are fully deductible in the current year. They do not need to be capitalized, depreciated through a cost segregation study, and then depreciation recapture taxes paid at sale of the property.
- Developer · Houston, TX · Member since 2017 · 161 posts · 134 votes9y
@Mike Dymski Sorry, yes obviously any competent CPA will be depreciating expense below 2500. But that is not a "cost segregation" A cost segregation is a 20-30 page document that gets included with the properties taxes that is requires an engineers approval. It is important not to confuse the two since they are two different things.
- Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes9y
Originally posted by @Joseph Bramante:
@Mike Dymski Sorry, yes obviously any competent CPA will be depreciating expense below 2500. But that is not a "cost segregation" A cost segregation is a 20-30 page document that gets included with the properties taxes that is requires an engineers approval. It is important not to confuse the two since they are two different things.
You wrote about a typical scenario where you go in and perform interior rehab...carpets, appliances, hardware packages and provide receipts to a cost segregation firm. I am trying to help you and the other members understand that is not the typical scenario for cost segregation and if your CPA or cost segregation firm are doing that, you should take them to the carpet on it.
- Dasmariñas, Calabarzon · Member since 2017 · 8 posts · 3 votes9y
@Mike Dymski thanks for hopping on. In Tax Free Wealth by Tom Wheelright, he talks about doing cost segregation for all of the pre-existing stuff like cabinets, appliances, floor coverings, parking lots, fences, landscaping, etc. No rehab required. Is that totally wrong?
- Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes9y
Originally posted by @Account Closed:
@Mike Dymski thanks for hopping on. In Tax Free Wealth by Tom Wheelright, he talks about doing cost segregation for all of the pre-existing stuff like cabinets, appliances, floor coverings, parking lots, fences, landscaping, etc. No rehab required. Is that totally wrong?
bingo...well said
- Developer · Houston, TX · Member since 2017 · 161 posts · 134 votes9y
ok guys. not going to get into a word smithing argument with you.
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