Wholesaler · Green Bay, WI · Member since 2016 · 136 posts · 41 votes
We are in negotiations on a 16 unit. Purchase price will be somewhere around $600K. We primarily wholesale and should end up somewhere around $400K this year of income from our wholesaling business. We met with our accountant and its looking like we will have about $40k-60K tax bill next year. Our wholesaling business is an S Corp and they recommended paying ourselves our salary and putting 17,500 each (husband wife) in to a 401K to help reduce some tax.
I have recently heard about cost segregation studies and bonus depreciation. Can anyone shed some light on how this would affect our tax situation if we were able to buy it this year and would you put money in to a 401K to reduce taxes or are there other avenues we should look at to reduce tax?
Cost Segregation Expert and Investor · Lakewood, NJ · Member since 2017 · 1k+ posts · 1k+ votes
7y
First of all congrats on your success @Corey Reyment. Having a high tax bill means you're making good money, nonetheless it's best to continue searching for strategies to further reduce that.
Bonus Depreciation is a great way to reduce your tax liability. Let's take your example and see how that would affect your situation.
Purchase price $600,000, let's say you allocate 15% to land (that's pretty standard in many places)
That leaves you with $510,000 depreciable basis.
Normal depreciation would give you $18,545 each year over the next 27.5 years, but the first year would be considerably less because you're buying the property in Q4 and depreciation is allocated according to when in the year you bought it. So let's say you would get approx. $4,636 of depreciation to write off. Not very much.
With Bonus Depreciation, you allocate (through a proper engineering based study) a good percentage to 5-year and 15-year property and take all of that in year 1.
Let's say the engineer was able to identify 25% of the value to 5 and 15 year property. That's $127,000 of depreciation! But it sounds like that's a bit too much for you. It would put you in a loss, and now there are limitations to how much passive loss you can carry forward.
With regular accelerated depreciation you could probably, get between $20-30K of extra depreciation (on top of that $4,636 in year 1, and $18,545 in years 2-6).
In terms of putting more into 401K you should speak to an expert like @Bernard Reisz on how to maximize those allocations.
Cost Segregation Expert and Investor · Lakewood, NJ · Member since 2017 · 1k+ posts · 1k+ votes
7y
First of all congrats on your success @Corey Reyment. Having a high tax bill means you're making good money, nonetheless it's best to continue searching for strategies to further reduce that.
Bonus Depreciation is a great way to reduce your tax liability. Let's take your example and see how that would affect your situation.
Purchase price $600,000, let's say you allocate 15% to land (that's pretty standard in many places)
That leaves you with $510,000 depreciable basis.
Normal depreciation would give you $18,545 each year over the next 27.5 years, but the first year would be considerably less because you're buying the property in Q4 and depreciation is allocated according to when in the year you bought it. So let's say you would get approx. $4,636 of depreciation to write off. Not very much.
With Bonus Depreciation, you allocate (through a proper engineering based study) a good percentage to 5-year and 15-year property and take all of that in year 1.
Let's say the engineer was able to identify 25% of the value to 5 and 15 year property. That's $127,000 of depreciation! But it sounds like that's a bit too much for you. It would put you in a loss, and now there are limitations to how much passive loss you can carry forward.
With regular accelerated depreciation you could probably, get between $20-30K of extra depreciation (on top of that $4,636 in year 1, and $18,545 in years 2-6).
In terms of putting more into 401K you should speak to an expert like @Bernard Reisz on how to maximize those allocations.
Rental Property Investor · Round Rock, TX · Member since 2016 · 1k+ posts · 971 votes
7y
@Corey Reyment If you own a big multifamily, you should have it in an asset holding (only!) entity (e.g. LLC) for asset protection purposes. If you do your own property management, you should do it through a public facing operations entity (another LLC, that holds nothing), with a property management contract with the asset holding entity. Then you can use that PM LLC to get property management fees (and/or your wholesaling S-corp) and since you'll have self employment income, you should be able to establish a Solo 401K plan - the best of all investing retirement accounts -and contribute up to 54K per year per person, money that you can use further in your investments. Talk with @Dmitriy Fomichenko for more details.
Regarding the cost seg, it's important to note the details of @Yonah Weiss's post, which addresses buy-and-hold real estate investment. If your deal is a "wholesale" or "flip" - as you indicate most of your deals are - things would work very differently.
Buy-and-hold real estate taxation is nearly the diametric opposite of wholesale/flip taxation; the former is an investment and the latter are businesses. They are subject to completely different tax regimes - and require distinct approaches towards tax mitigation.
For example, cost seg would benefit buy-and-hold, while 401k isn't even available to a pure buy-and-hold investor. In contrast, a 401k tax mitigation strategy can be very valuable to a wholesaler/flipper, while a cost seg would provide no value to a pure wholesale/flip strategy.
There's so much that I'd like to say - but I'll have to suffice with the following for now:
With regard to 401k, husband and wife could potentially contribute a combined ~$110k for tax deductions - far higher than the amount mentioned in your post. Of course, a 401k tax-deduction is limited by the amount of S-corp salary you pay yourself. Depending on your circumstances, there may be a trade-off here - between payroll tax strategy (S-corp) and income tax strategy (401k) - which warrants close analysis.
In general, I find that too many accountants view a 401k as only method to improve the appearance of a current year tax return. While it certainly does enhance your tax return, that's too narrow a view.
Many accountants fail to emphasize the investment benefits of tax-free compounding - it is truly awesome! Over time, the tax drag on your investments has an incredible impact on your wealth accumulation - and long-term tax-free compounding can provide you with several multiples of what comparable taxable investments can provide.
Accountants also tend to focus strictly on the contribution to a 401k - and not the investment options within the 401k. Reason being that the 401k contribution is reported on as a tax deduction on your tax return; however, once contributed to the 401k and the tax deduction is obtained, those funds are beyond the accountants purview because they won't ever again be a tax deduction on your return. The tax preparer may not even be aware of the fact that a 401k can be invested in all forms of real estate (including private lending, tax liens, hard money loans, etc). However, upon learning that a 401k can be used for real estate investmentsthe appeal of 401k contributions is greatly enhanced, to many.
Another factor to consider, which is not emphasized by tax preparers, is the potential to make Roth 401k contributions. Roth contributions do not provide a current tax deduction, but thereafter are tax-free forever. Therefore, while Roth 401k contributions may be the way to go in many instances - being that it does nothing to enhance your current year tax return, tax preparers tend not to point out the Roth option.
There are too many factors to address in a forum post. The overall theme that I'd like to convey is that (a) tax and financial strategy vary from individual to individual, (b) tax and financial strategy are integrated and must be approached holistically, and (c) while you should retain qualified professionals to assist you with the various components of your tax and financial strategy, you must remain an educated investor to ensure that optimal results are achieved.
@Yonah Weiss appreciate the tag. Would love to get your thoughts on the above!
Wholesaler · Green Bay, WI · Member since 2016 · 136 posts · 41 votes
7y
@Yonah Weiss, that was a fantastic reply! Exactly what I was looking for. Its hard to know what the bonus depreciation will actually equate to in reduction in taxes. @Bernard Reisz, yes, we wholesale/flip for our "job" but our long term strategy is to use the discretionary income above our living expenses to invest in larger multi-family.
I am now wondering what vehicle they were looking at for us that would only allow us each a $17,500 contribution max? What the pro's and con's are to that versus the solo 401k. Also, if we hire on someone, are we disqualified from using a solo 401K moving forward?
@costin
@Costin I., we currently hire out property management but it is something we are looking at possibly adding on in house for the future once we reach a level that will allow us to bring someone on for that role full time.
Regarding the limits, perhaps they're referring strictly to the employee-deferral portion of 401k contributions without utilizing the employer-profit share contributions. The employee-deferral portion was $18k in 2017 and is $18.5k for 2018.
If you bring on a full-time W-2 employee, you're not disqualified from using the 401k; it just loses it's status as a "Solo" plan and would be subject to a greater compliance and reporting burden. As a "Solo" plan you get all the upside available to 401(k)s without the compliance burden. Once there are full-time non-owner employees involved, it's often not worth incurring the additional compliance costs to maintain - but this does vary by investor.
We have to go all the way back to 2014 for the 401k employee deferral limits to be just $17,500. For 2018, the deferral limit is $18,500. Solo 401k plans can allow for profit-sharing and after-tax (non-Roth) contributions in excess of the deferral limit.
Investor · Cincinnati, OH · Member since 2012 · 506 posts · 331 votes
7y
I'm not the expert here, just use a Solo 401k... As an S-Corp, I can contribute the $18,500 and then up to a total of $55k at a rate of 20% of the profit of the business. Only employees can be self and immediate family.
Cincinnati, OH · Member since 2013 · 1k+ posts · 1k+ votes
7y
@Corey Reyment You received some great feedback from @Yonah Weiss and @Bernard Reisz. Lots of nuance depending on if you have a business (wholesale/flipping) vs. invest in buy and hold, but together these strategies should help you lower your tax bill.
Thanks for the vote! I'm glad that you find the post helpful.
Regarding your question ("Do you work with PA investors?"), I don't want to run afoul of BP's strictly enforced spam rules for public forums and private messaging...but myself, as well as many of us that are active on BP, have a national focus.
@Yonah Weiss Is it common to do a cost segregation study on less than $1 million property?
It's not as common as it is on properties purchased for over $1M, simply because there is not as much tax benefit. The depreciation deductions are proportionate to the cost basis of the property. While there are firms that commonly do it, we do not push it, unless the client desperately needs and wants that extra deduction.
@Yonah Weiss Is it common to do a cost segregation study on less than $1 million property?
It's not as common as it is on properties purchased for over $1M, simply because there is not as much tax benefit. The depreciation deductions are proportionate to the cost basis of the property. While there are firms that commonly do it, we do not push it, unless the client desperately needs and wants that extra deduction.
Wholesaler · Green Bay, WI · Member since 2016 · 136 posts · 41 votes
7y
@Bernard Reisz, the seller of this complex is looking to sell in 2019 for his capital gain tax purposes. If we did close december 31st, lets just say, would I be able to get a deduction for my 2018 taxes if I did a cost segregation study? He owns it outright so is it possible to close it december 31st and give him a note fully payable for sometime in 2019? This way, in my mind, i get the depreciation for 2018 and he gets his proceeds and gets taxed in 2019. I spoke to one accountant and it seemed that this option would be viable but he also was not fully focused on real estate as an accountant. Your thoughts?
CPA delivering RE Tax Tools: 1031 Exchange, SDIRA, 401(k), Cost Seg · New York City, NY · Member since 2017 · 581 posts · 563 votes
7y
@Corey Reyment There are 2 perspectives that you're looking to address: (1) buyer's (yours) and (2) seller's. There's (almost) always more than one way to address things. The way you're outlining sounds good, but there may be better alternatives.
From buyer's perspective, the key is bonus depreciation. Bonus depreciation is available for property with a recovery period of 20 years or less, which could be identified by a cost segregation study.
Let's say the engineer was able to identify 25% of the value to 5 and 15 year property. That's $127,000 of depreciation! But it sounds like that's a bit too much for you. It would put you in a loss, and now there are limitations to how much passive loss you can carry forward.
See if you can use a Roth conversion for some or all of the rest of the loss...tax CPAs may be able to answer. Tax deduction going in...tax free coming out...would be beautiful.
Retirement Accounts Attorney · Southfield, MI · Member since 2017 · 3k+ posts · 1k+ votes
7y
@Carrie Reyment
Making annual contributions to a self-employed solo 401k plan is certainly a good way to reduce your taxable earned income. In the case of an S-corp., the solo 401k contributions will be based on your respective W-2 wages.