Rentals Depreciated Out...now what?

[Joshua Schmidt]

I have a friend that has about 12 properties they have had for over 27 1/2 years. The properties are completely depreciated out, they are all SFR, and I'd like to be able to give them solid advice. We have already spoke about doing a 1031 exchange with them, but I want to make sure that is something that is good for them. I believe they would be open to that option, but if there are other options, I'd like to hear them.

[Dave Foster]

@Joshua Schmidt, Kudo's for paying it forward with your friend!  You mentioned you're "a lot younger".  As mentioned previously this is really what the 1031 is built for - to take highly depreciated properties and add depreciable basis through the acquisition of more and more expensive properties to keep the tax at bay and provide additional depreciation.

But when the investor gets to a certain place in life that option of expansion isn't nearly as appealing as it might be if they were younger.  So the strategy of continuing to defer the tax with 1031s but not adding depreciable basis in the form of purchasing more becomes attractive as well as simplifying and moving from active to passive investing.

I'd also take a close look at those properties they are selling.  One thing most people forget or don't know is that the basis of those properties is not "0".  Depreciation only applies to actual construction and not land value.  It is possible that the depreciation on those properties actually is a small fraction of the actual value.  This would shift the actual depreciation recapture amount.  

We had a Key West client with a rental trailer on the water (it's always that stuff that survives the hurricanes).  He was concerned because he had depreciated it out.  But the reality is that he had been depreciating $20K worth of trailer on a $200K lot.  That's still a tax hit.  But not nearly as much as he feared.