What are the tax benefits of real estate?

Question

Can someone explain the tax benefits of real estate?  I know what the 1031 exchange is, but don’t know the concept of depreciation and how that is a benefit to real estate investors.  Any other tax benefits that you guys know of?

Michael Plaks · Answer

@Aaryan Patel

The thread mentioned in the earlier response is great, but it has accumulated hundreds of posts over the last 4 years and is impractical to read.

Here're two blog posts that are better as a starting point:

https://www.biggerpockets.com/...

BP published two books on real estate taxation, and there're dozens more on Amazon.

Jack Martin · Answer

There is an accelerated depreciation strategy sometimes referred to as "the lazy 1031" that combines cost segregation and bonus depreciation. Instead of completing a "like kind" exchange with time restrictions, you perform a cost segregation study and are able to take a significant passive loss, which is used to offset the gains you just incurred. And one of the best parts of the strategy is you have the entire calendar year to execute.

When a property is purchased, a formal cost segregation study is performed wherein the value of the property is segregated into land (which is not depreciated), buildings (which are depreciated on a 39 or 27.5 year schedule), land improvements (15 year schedule), and other smaller items like personal property. When the bonus election is chosen, then 100% of the allocation to the land improvements can be taken as a passive loss in the year the property was purchased.

This strategy can be executed with a direct investment yourself, or through a passive investment in a syndication with a sponsor who is choosing the bonus election. If you invest passively you should receive your pro rata allocation of bonus depreciation on your K1 along with the other investors. Either way, you should be able to garner passive losses equal to or greater than the amount of capital invested.

Those passive losses can be used to offset the gains you have incurred (or gains you expect to incur) as long as the gain AND the investment where bonus depreciation is being taken occur in the same calendar year. Any allocation of passive losses you cannot use in that calendar year will carry over, so they can be used in subsequent years.

Keep in mind, some property types will garner more bonus depreciation than others. Bonus depreciation is derived from the portion of the property's value with a shorter useful life than the buildings themselves. Therefore the property types that are the most favorable to generate bonus depreciation will be those with a high degree of what the tax code refers to as "land improvements". Examples are mobile home parks, RV parks, and golf courses where the value of the property is not primarily derived from building(s) but rather from the improvements to the land. In a mobile home park or RV park, most of the value is in the underground infrastructure, roads, landscaping, amenities, pools, fencing, pads, utility pedestals, etc, while only a small portion of the value comes from a building, like a clubhouse or laundry facility. In a similar fashion, if you can imagine how much landscaping and underground infrastructure is in a golf course as compared to the clubhouse, that will give an indication of why an extremely high percentage of the property's value is allocated to the land improvements. Properly executed, an investment in these types of property can garner passive losses equal to or greater than the amount of capital invested.

A few words of caution; be careful not to let the "tax tail" wag the dog. Each real estate type has different intrinsic performance characteristics, so make sure you understand the property type's risks and potential as an investment separate of the tax benefit. In other words, be careful not to invest in a poorly performing property simply for the depreciation. In that same vein, if you are investing passively in a syndication for bonus depreciation benefits make sure you vet the sponsor and understand the investment vehicle before you invest. Bonus depreciation is great, but when you combine that with great investment properties that produce cash flow and appreciation, that will be the best formula.

I am not a tax advisor or CPA. This perspective is solely from my own experience managing mobile home park funds and working with the tax experts around us. Here on BP, I would acknowledge @Yonah Weiss as he is an expert and contributes to bonus depreciation threads.

All the best,

Jack

Bruce D. Kowal · Answer

In broad terms the greatest benefit is the ability to depreciate borrowed money.  A building costs $100,000.  You put 10% cash down.  That is the amount at risk.  You borrow 90%.  You can write off the cost of the entire building, even though you only have $10,000 in the property.  That's the break.  Plus, as mentioned above, the ability to defer paying tax on gains from selling the property.   Together:  you can throw off "paper" losses which offset your W2 and other income, and when you sell the property you can put off paying taxes.  That's it in a nutshell.

Joe Martella · Answer

Such a broad topic.  I recommend that you read Taxfree Wealth by Tom Wheelright and Advanced Tax Strategies by Han

There is also a forum discussion that you should read.  https://www.biggerpockets.com/...

Paul Moore · Answer

Hi @Aaryan Patelgreat question! I did a BiggerPockets video on this exact topic and here is the link: How To Avoid Paying Taxes. Good luck!

Basit Siddiqi · Answer

There are many tax benefits for real estate investors1. Depreciation can help you be cash-flow from the investment but pay $0 in taxes2. potential exit opportunities that allow you to defer tax3. Many others

Aaryan Patel · Answer

Thanks! Will do!

What are the tax benefits of real estate?

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