Depreciation Schedule Expiring

9 Replies

My father in law owns a 176 unit building in Los Angeles.  It was built in 1991 meaning the depreciation schedule is beginning to expire.  He is worried about losing the tax benefits.  How big of a concern is this?  Would updating the units be a good way of replacing it?  Any other suggestions are welcome.  Thank you!

Hi @Douglas Stewart

This might be a good opportunity because of the new law section 199A and bonus depreciation and Section 179 new limits to do a value-add renovation to the property and increase rents while reaping the tax benefits.

You get:

1. Higher Rents / Higher NOI

2. Depreciation

3. Possibly section 199A, Bonus Depreciation, and Sec 179

4. Higher Sales price due to #1

Thanks for the reply @Matt Popilek . I should've been a bit more clear in my original post, but a 1031 would be a little difficult to execute at the moment for various reasons. Cap rates in LA are still very low, so finding an asset with a higher ROI is nearly impossible. There is significant equity in the building, so when cap rates go down the plan is to refi and buy more multifamily. He's more looking for a way to push out the depreciation schedule until that happens.

I hear you @Douglas Stewart I was thinking you could buy outside of CA. It would be nearly impossible to do anything in CA. There are really good multifamily markets that would give him a lot higher cash flow and ROI if he bought outside of CA. Good luck on the other plan, I hope it works well!

@Douglas Stewart One option to create extra depreciation would be to do major renovations, as you mentioned above. All of the new assets that are replaced in the property, begin depreciation from new. For example, if he spends $1,000,000 on renovations that dollar amount can now be depreciated. Those assets hat fall into the 5-year and 15-year depreciation life, can have depreciation accelerated, and take those deductions early on. So he'll still have to spend money in order to get 'new' depreciation' not necessarily worth it.

1031 won't help a lot @Matt Popilek , because the basis of the old property which has been fully depreciated is not carried over to the new property. He will be able to depreciate any additional amount that is put into the new property.

@Douglas Stewart a bit of clarification, please. You said it was built in 1991. Did your father in law build it in 1991 or did he acquire it after that? The year a building was built is irrelevant for depreciation, the in service date for the current owner is when depreciation starts. If he built it and is the original owner then his in service date would be 1991, but if he acquired it later, say in 2000 that would be his in service date and when the depreciation started. A building could've been built in 1850, but if you buy it today a new depreciation schedule starts.

If he's the original owner since 1991 then yes his depreciation benefits will run out next year since it's 27.5 years for rental property. Although I'm sure he'd have done some improvements over the past 27 years so any improvements would have schedules starting from when they were put in. 

He could update the units and would get new depreciation schedules for the new assets, but I'd only do that if he was planning on updating them anyway. Spending a dollar to get fifty cents in tax benefits doesn't really make sense. I bet he could raise rents with updating the units so if it makes sense because of that it's a good move, but don't base it solely on the depreciation.

With something like this I'd be looking into some different complex trust options, which could allow him to sell the property while virtually eliminating capital gains and depreciation recapture, which would be a huge tax hit. 

Doing a 1031 wouldn't start the depreciation over again as that schedule simply shifts over to the new property. The only new schedule would be for assets in excess of the unadjusted cost basis, but with that why not just buy a new property and get the full depreciation benefit? 

If he did place it in service in 1991 that depreciation ship has sailed, if he wants more depreciation he either needs new assets or a new property. New to him, not newly constructed.

@Douglas Stewart

If there is considerable equity in the property - he can do a cash-out refinance where the equity pulled out can be used to make improvements to the property.

This does 2 things.
It makes the interest on the refinance deductible.
It also allows you to make improvements which would be depreciable.

Congrats to your father in law. I can only imagine the appreciation he received since owning it.

@Paul Caputo thank you for the reply.  Yes, he has owned it since construction in 1991.  I know he is working on the trust stuff.  I appreciate the feedback.  He was thought about most of that...I just wanted to make sure there wasn't anything big he was overlooking.  Thank you!