100% Bonus Depreciation + REP status = TAX FREE Roth Conversion?
Clarksville, TN · Member since 2017 · 40 posts · 37 votes
100% Bonus Depreciation + REP status = TAX FREE Roth Conversion?
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Michael PlaksPro Member
Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votesQuote from @Russell Roberts:
Here's a tax optimization idea I'm considering.
"Since the REP status allows the K-1 losses to be treated as non-passive..."
No, it does not, in most cases.
Read this please: https://www.biggerpockets.com/forums/51-tax-legal-issues-con...
Generally speaking, if you believe that you just discovered some tax magic not already being used by every other investor, then you're likely overlooking something. :)
23 Replies
- 1yJulius VincentBusiness MemberTax Strategist | CPA, MBA + Wharton FP&A | CFO-Level Planning · Houston, TX · Member since 2025 · 157 posts · 172 votes
Cool idea, @Russell Roberts! Just a heads up...Roth conversion income is always taxed as ordinary income, and unfortunately, real estate losses (even with REPS) can’t offset it. Where REPS + bonus depreciation do shine is in offsetting W-2 or 1099 income, which can be super powerful. Worth running the numbers with a tax pro before diving in.
Horizon Wealth & Tax Advisors510 Reviews- 1yRicky A.Pro MemberRental Property Investor · Chapel Hill, NC · Member since 2014 · 135 posts · 112 votes
@Michael Plaks @Julius Vincent @Jason Malabute
If the OP (@Russell Roberts) were to change #1 be a direct investment, say an expensive LTR capable of creating large tax losses via bonus depreciation (and assuming he otherwise does everything to legitimately qualify for REPS), would that be able to offset the ordinary income recognized from the Roth conversion?
I've been considering this tactic, and a quick convo with my CPA had suggested that it was feasible. Of course, I would speak more thoroughly with him prior to embarking on such a journey, but this quote from Julius has me second guessing: "Roth conversion income is always taxed as ordinary income, and unfortunately, real estate losses (even with REPS) can’t offset it."
- Clarksville, TN · Member since 2017 · 40 posts · 37 votes1y
Wow, THANKS for pointing out that Roth conversion is always taxed as ordinary income. I obviously did not realize that.
- Member since 2023 · 2 posts · 1 vote1y
@Julius Vincent. I was literally jumping on the forums to ask a very similar question. I'm thinking about cashing out my IRA to purchase a short-term rental. I'm 44 so I know I'll have the 10% penalty but wasn't sure about the tax implications. I do qualify as a real estate professional, so I also thought about the cost seg and bonus deprecation. Just so I understand if I cashed out $100K, I would be penalized $10k plus pay ordinary income tax (say 30%). Basically, be left with $60k and no tax benefit from buying a short-term rental?? Greatly appreciate your time to get involved on here!!
- 1yJulius VincentBusiness MemberTax Strategist | CPA, MBA + Wharton FP&A | CFO-Level Planning · Houston, TX · Member since 2025 · 157 posts · 172 votes
Quote from @Patrick Busch:
@Julius Vincent. I was literally jumping on the forums to ask a very similar question. I'm thinking about cashing out my IRA to purchase a short-term rental. I'm 44 so I know I'll have the 10% penalty but wasn't sure about the tax implications. I do qualify as a real estate professional, so I also thought about the cost seg and bonus deprecation. Just so I understand if I cashed out $100K, I would be penalized $10k plus pay ordinary income tax (say 30%). Basically, be left with $60k and no tax benefit from buying a short-term rental?? Greatly appreciate your time to get involved on here!!
Hey @Patrick Busch - You're exactly right that if you cash out $100K from an IRA at age 44, you'd face both the 10% early withdrawal penalty and ordinary income tax (say ~30%). That leaves you with about $60K net, and you wouldn't get to pair that withdrawal with cost seg/bonus depreciation. The IRS doesn't allow retirement plan withdrawals to be offset by real estate losses, even with REPS. Where cost seg + bonus depreciation does shine is when you're offsetting W-2 or business income outside of retirement accounts.Horizon Wealth & Tax Advisors510 Reviews
- Clarksville, TN · Member since 2017 · 40 posts · 37 votes1y
I expect @Julius Vincent is correct, but I have notes from a few years back from a podcast with a publicly notable tax advising expert. I'm not mentioning his name in the event that I may have misunderstood some of the detail (or tax rules changed). Below are my notes which seems to conclude differently, but this scenario was a 401k distribution instead of a pretax IRA to Roth IRA conversion.
my old notes: take large $ from traditional 401k, in same year, using adequate leverage and cost seq/accelerated depreciation in real estate, can get a deduction that more than offsets the recognized 401k taxable withdrawl income.. (Need to verify whether or not the real estate investment can be passive or needs to be active in order to offset the 401k withdrawl) his example takes 200K from 401k and invests as 20% down payment to control 1M asset that cost seq gives yr 1 300K deduction. Be older than 59.5 to avoid 10% penalty.
I wonder if these old notes are accurate? (cause that could be a doable tax optimization strategy in my circumstances too.)
- Member since 2017 · 3 posts · 2 votes1y
@Julius Vincent If you cash out the $100k and have losses on your real estate and you or your spouse qualifies for REPS and your ordinary tax liability is $0 why would you have to pay any tax on the withdrawal? Just the 10% penalty if you are under 59.5. You only pay the ordinary income tax at your effective rate, but if you have losses and don't owe taxes in that same year you are just liable for the penalty.
Please correct me if I'm wrong. I understand the cost segregation doesn't wipe out ordinary income, but losses on a property would.
- 1yJulius VincentBusiness MemberTax Strategist | CPA, MBA + Wharton FP&A | CFO-Level Planning · Houston, TX · Member since 2025 · 157 posts · 172 votes
Quote from @Robert Renaud:
@Julius Vincent If you cash out the $100k and have losses on your real estate and you or your spouse qualifies for REPS and your ordinary tax liability is $0 why would you have to pay any tax on the withdrawal? Just the 10% penalty if you are under 59.5. You only pay the ordinary income tax at your effective rate, but if you have losses and don't owe taxes in that same year you are just liable for the penalty.
Please correct me if I'm wrong. I understand the cost segregation doesn't wipe out ordinary income, but losses on a property would.
Hey @Robert Renaud - You're correct (see my other post clarifying). A 401k/IRA distribution is ordinary income, and if you (or your spouse) qualify as a REP and materially participate, your rental losses become non-passive. Non-passive losses can offset ordinary income. So in that case, yes, they could offset a distribution. The 10% penalty (if under 59.5) is always separate and can't be reduced by deductions.
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- 1yJulius VincentBusiness MemberTax Strategist | CPA, MBA + Wharton FP&A | CFO-Level Planning · Houston, TX · Member since 2025 · 157 posts · 172 votes
@Russell Roberts and @Patrick Busch - Sorry, let me clarify. Deductions can never offset the 10% early withdrawal penalty on distributions before age 59 and a half. That penalty stands on its own.
What can be offset, however, are the taxes associated with the distribution or conversion, since those amounts flow into your ordinary income. If your rental losses are passive, they won't help. But if you qualify as a REP and materially participate (or if you meet the STR rules), those losses are considered non-passive and can offset that ordinary income...including 401(k) distributions, IRA distributions, or even Roth conversions.
This is a nuanced area and the IRS has tightened interpretations over the years. A lot of older guidance, CPE, and podcasts oversimplify it, which is why you’ll see conflicting advice. The safest way to think about it is:
- Penalty = never offset
- Passive losses = can’t offset retirement income
- Non-passive losses = can offset ordinary income, including retirement incomeHorizon Wealth & Tax Advisors510 Reviews - Accountant , CPA, MBA in Finance, MS in Taxation · Redmond, WA · Member since 2025 · 172 posts · 135 votes1y
Quote from @Russell Roberts:
Here's a tax optimization idea I'm considering.
1) Make some new passive real estate syndication investments with 100% Bonus depreciation to create large K-1 losses in a given tax year.
2) Perform significant (750+ hrs) hands-ons renovation/remodel work on some currently owned single family rentals in order to qualify for REP status in the same tax year.
3) Convert pre-tax IRA to Roth IRA equal to the amount of K-1 investment losses. Since the REP status allows the K-1 losses to be treated as non-passive, it could be deducted against the ROTH conversion related income, I think?
Comments appreciated.
REPS only means real property rental activities are automatically or "per se" passive. You also need to materially participate in the real estate activity generating the losses. And those syndicated partnership losses on K-1 will be passive even if you're REPS because you don't materially participate.
BTW if you had a direct rental investment or investments--like short-term-rental property that generated nonpassive losses or a bunch of rentals that you'd grouped to get to REPS and which generated losses--sure, you could shelter the Roth conversion. (You would maybe get limited by Section 461(l)... but that's a pretty large limit.)
- Member since 2024 · 68 posts · 25 votes1yHow about a variation of what the OP asked?
Situation:
-NOT a REP (don't qualify and a STR doesn't make sense because I'm in a VHCOL area -- numbers just don't work)
-purchase a property (eg, $1,000,000)
-conduct a cost segregation study on it (eg, $500k accelerated, the rest is land and/or on a standard schedule)
-rent out property for 1-2 years
-sell property after 2 years, but you have not utilized all the bonus deprecation, say you have $400k left you've been carrying
Now my understanding is that I can utilize that $400k carryover to offset "active income" (eg, w2, interests, dividends, capital gains and ROTH conversions).
Essentially, I can convert $400k into a roth tax free? I'd have to pay recapture tax on what I've used thus far, but I can convert $400k tax free?
Can anyone confirm this?- 1yJulius VincentBusiness MemberTax Strategist | CPA, MBA + Wharton FP&A | CFO-Level Planning · Houston, TX · Member since 2025 · 157 posts · 172 votes
Quote from @Bob Dole:
How about a variation of what the OP asked?
Situation:
-NOT a REP (don't qualify and a STR doesn't make sense because I'm in a VHCOL area -- numbers just don't work)
-purchase a property (eg, $1,000,000)
-conduct a cost segregation study on it (eg, $500k accelerated, the rest is land and/or on a standard schedule)
-rent out property for 1-2 years
-sell property after 2 years, but you have not utilized all the bonus deprecation, say you have $400k left you've been carrying
Now my understanding is that I can utilize that $400k carryover to offset "active income" (eg, w2, interests, dividends, capital gains and ROTH conversions).
Essentially, I can convert $400k into a roth tax free? I'd have to pay recapture tax on what I've used thus far, but I can convert $400k tax free?
Can anyone confirm this?Hey @Bob Dole - Here’s how it works: the “$400K left” isn’t unused depreciation, it’s suspended passive losses. While you own the property, those losses are locked in the passive bucket and can’t offset W-2, dividends, cap gains, or Roth conversions.
When you sell the property in a fully taxable transaction, all suspended losses tied to it are released. At that point, they can offset any type of income in that year, including a Roth conversion. The catch is you’ll also have depreciation recapture (taxed up to 25%) and capital gains to deal with on the sale. So yes, you could pair the timing of a Roth conversion with the release of those losses, but it won’t be “tax-free,” just netted out depending on the numbers.
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- USA · Member since 2023 · 145 posts · 84 votes1y
@Russell Roberts Good question, and I like the creative thinking. Based on what you’ve laid out at the moment you essentially have three separate buckets and as structured they can’t offset one another (for example, #2 won’t unlock the losses from #1 to offset #3). It’d be smart to get a plan in place before 2025’s facts are “closed" and you can examine the details more closely as very nuanced.
- 1yMichael PlaksPro MemberTax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
Quote from @Russell Roberts:
Here's a tax optimization idea I'm considering.
"Since the REP status allows the K-1 losses to be treated as non-passive..."
No, it does not, in most cases.
Read this please: https://www.biggerpockets.com/forums/51-tax-legal-issues-con...
Generally speaking, if you believe that you just discovered some tax magic not already being used by every other investor, then you're likely overlooking something. :)
- 1yJason MalabuteBusiness MemberAccountant · Los Angeles, CA · Member since 2016 · 2k+ posts · 901 votes
Just a heads-up—if you do a Roth conversion, that income will always be taxed as ordinary income, and real estate losses (even if you qualify as a Real Estate Professional) can’t offset it. Where real estate really shines is in offsetting W-2 or 1099 income through REPS and bonus depreciation, which can be extremely powerful. It’s definitely worth running the numbers with a tax professional before making a move.
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My heads SPINNING!
- Clarksville, TN · Member since 2017 · 40 posts · 37 votes1y
Based on continued learning and all of the generous input (I may do a paid engagement with one of you),
here's the REVISED tax optimization idea.
1) Direct buy multifamily property and hands-on renovate/manage for minimum 500 hrs. Perform cost seg and apply 100% bonus depreciation to create significant 1st year loss.
2) Perform (250+ hrs) hands-ons renovation/remodel work on other currently owned single family rentals in order to "finish" qualifying for REP status in same tax year. "Group" with #1 above for REP.
3) Convert pre-tax IRA to Roth IRA (or take 401K distributions) that generates ordinary income, but that can be reduced by "non-passive" real estate loss created by #1 above.
Yes?
P.S. realizing that at some point down the road, I've got more depreciation recapture (potentially higher tax rate) to deal with, but there are options to 1031 or even gifting the property to a worthy cause at some point. Wouldn't that be great to be able to do!
- Accountant , CPA, MBA in Finance, MS in Taxation · Redmond, WA · Member since 2025 · 172 posts · 135 votes1y
Quote from @Russell Roberts:
Based on continued learning and all of the generous input (I may do a paid engagement with one of you),
here's the REVISED tax optimization idea.
1) Direct buy multifamily property and hands-on renovate/manage for minimum 500 hrs. Perform cost seg and apply 100% bonus depreciation to create significant 1st year loss.
2) Perform (250+ hrs) hands-ons renovation/remodel work on other currently owned single family rentals in order to "finish" qualifying for REP status in same tax year. "Group" with #1 above for REP.
3) Convert pre-tax IRA to Roth IRA (or take 401K distributions) that generates ordinary income, but that can be reduced by "non-passive" real estate loss created by #1 above.
Yes?
P.S. realizing that at some point down the road, I've got more depreciation recapture (potentially higher tax rate) to deal with, but there are options to 1031 or even gifting the property to a worthy cause at some point. Wouldn't that be great to be able to do!
I'm not sure this works. Remember Section 469(c)(7) (that's the chunk of the law that creates what we're calling REPS) says more than 750 hours and more than 50% of your work. Thus, you'd need to have whatever else you do clearly fall short of the hours spent on real property trades or businesses. (This is the famous situation of Dr. Zarrinnegar.)
BTW you also don't necessarily need to group those two activities for Section 469(c)(7). Section 469(c)(7) says you just need to have more than 750 hours and more than 50% of your work time in real property trades or businesses in which you materially participate. E.g., if you had two 500+ hour real property trades or businesses, a construction company say and a property management company, you'd be a real estate professional but wouldn't need to group. (You group to achieve material participation.)
Tangential comment: You can't group something like a construction business with real estate rentals. Not sure if that's implicit in your example above. But you'd want to make sure you're not relying implicitly on an invalid grouping. Rentals can't be grouped with nonrentals. Real property rentals can't be grouped with personal property rentals.
- Clarksville, TN · Member since 2017 · 40 posts · 37 votes1yThanks for reassuring the points about >50% of work. (My situation will fit that)
Quote from @Stephen Nelson:
Quote from @Russell Roberts:
Based on continued learning and all of the generous input (I may do a paid engagement with one of you),
here's the REVISED tax optimization idea.
1) Direct buy multifamily property and hands-on renovate/manage for minimum 500 hrs. Perform cost seg and apply 100% bonus depreciation to create significant 1st year loss.
2) Perform (250+ hrs) hands-ons renovation/remodel work on other currently owned single family rentals in order to "finish" qualifying for REP status in same tax year. "Group" with #1 above for REP.
3) Convert pre-tax IRA to Roth IRA (or take 401K distributions) that generates ordinary income, but that can be reduced by "non-passive" real estate loss created by #1 above.
Yes?
P.S. realizing that at some point down the road, I've got more depreciation recapture (potentially higher tax rate) to deal with, but there are options to 1031 or even gifting the property to a worthy cause at some point. Wouldn't that be great to be able to do!
I'm not sure this works. Remember Section 469(c)(7) (that's the chunk of the law that creates what we're calling REPS) says more than 750 hours and more than 50% of your work. Thus, you'd need to have whatever else you do clearly fall short of the hours spent on real property trades or businesses. (This is the famous situation of Dr. Zarrinnegar.)
BTW you also don't necessarily need to group those two activities for Section 469(c)(7). Section 469(c)(7) says you just need to have more than 750 hours and more than 50% of your work time in real property trades or businesses in which you materially participate. E.g., if you had two 500+ hour real property trades or businesses, a construction company say and a property management company, you'd be a real estate professional but wouldn't need to group. (You group to achieve material participation.)
Thanks for clarifying the reason to consider grouping or not. - 1yMichael PlaksPro MemberTax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
Quote from @Russell Roberts:
Based on continued learning and all of the generous input (I may do a paid engagement with one of you),
here's the REVISED tax optimization idea.
1) Direct buy multifamily property and hands-on renovate/manage for minimum 500 hrs. Perform cost seg and apply 100% bonus depreciation to create significant 1st year loss.
2) Perform (250+ hrs) hands-ons renovation/remodel work on other currently owned single family rentals in order to "finish" qualifying for REP status in same tax year. "Group" with #1 above for REP.
3) Convert pre-tax IRA to Roth IRA (or take 401K distributions) that generates ordinary income, but that can be reduced by "non-passive" real estate loss created by #1 above.
Yes?
P.S. realizing that at some point down the road, I've got more depreciation recapture (potentially higher tax rate) to deal with, but there are options to 1031 or even gifting the property to a worthy cause at some point. Wouldn't that be great to be able to do!
This plan involves monumental business decisions, and you mention them so casually, as if it's a matter of running to your grocery store for milk and cookies.
Also, taxes occupy a huge space in your thinking, and business - a tiny space in comparison. It really should be the other way around.
- Clarksville, TN · Member since 2017 · 40 posts · 37 votes1y
Quote from @Michael Plaks:
Quote from @Russell Roberts:
Based on continued learning and all of the generous input (I may do a paid engagement with one of you),
here's the REVISED tax optimization idea.
1) Direct buy multifamily property and hands-on renovate/manage for minimum 500 hrs. Perform cost seg and apply 100% bonus depreciation to create significant 1st year loss.
2) Perform (250+ hrs) hands-ons renovation/remodel work on other currently owned single family rentals in order to "finish" qualifying for REP status in same tax year. "Group" with #1 above for REP.
3) Convert pre-tax IRA to Roth IRA (or take 401K distributions) that generates ordinary income, but that can be reduced by "non-passive" real estate loss created by #1 above.
Yes?
P.S. realizing that at some point down the road, I've got more depreciation recapture (potentially higher tax rate) to deal with, but there are options to 1031 or even gifting the property to a worthy cause at some point. Wouldn't that be great to be able to do!
This plan involves monumental business decisions, and you mention them so casually, as if it's a matter of running to your grocery store for milk and cookies.
Also, taxes occupy a huge space in your thinking, and business - a tiny space in comparison. It really should be the other way around.
@Michael Plaks Thanks for the extra concern from your experienced viewpoint! and I agree with you. I was trying to keep the topic in this forum limited to the tax portion of my planning, but I'll share a bit more in case you or others are interested.
I'm approaching a season of life with more time discretion, making REP a more reasonable possibility. I have some LTRs that would benefit (market value and/or rental rate) from some improvement work. I also live in a town that has a lot of small multifamily real estate. Finding one that would adequately cash flow well seems only likely when buying one that needs some improvement work. I have some non-retirement funds for the equity portion of this potential investment. All of the above creates lots of hours of work needed for REP and builds on my progressing real estate investment experience. I have pre-tax 401K that I'll be ready to begin a tax withdrawal or conversion strategy on (post W2 earning season). I'd like to move to pre-tax IRA then Roth convert a measured amount with no immediate tax burden on the converted amount. The return of 100% bonus depreciation and my personal circumstances seems like the stars might be aligned to make it happen, Lord willing.
Thanks again for everyone's dialog and thoughtful input. There are some fantastic, smart and generous people in this thread!
- 1yJulius VincentBusiness MemberTax Strategist | CPA, MBA + Wharton FP&A | CFO-Level Planning · Houston, TX · Member since 2025 · 157 posts · 172 votes
Hey @Don Konipol - Fair point, this thread's gotten dense. Part of the reason is that even among tax pros/accountants, there’s been a lot of half-truths out there. Here’s a summary that should help clear it up:
- Early withdrawal penalty (10% if under 59.5): Always applies, no offset.
- Ordinary income from 401k/IRA distributions or Roth conversions: Taxed like wages.
- Passive rental losses: Can’t offset that income, they’re suspended.
- Nonpassive losses (REP + material participation, or STR loophole): Can offset ordinary income, including retirement income, but only if you materially participate.
- REP nuance: REP status alone doesn't magically make all K-1 losses nonpassive. You still have to materially participate. That's why syndication K-1s almost never help here. There are too many other investors and you're typically not involved in day-to-day operations, so the IRS won't view those losses as nonpassive.
Horizon Wealth & Tax Advisors510 Reviews - 1yJulius VincentBusiness MemberTax Strategist | CPA, MBA + Wharton FP&A | CFO-Level Planning · Houston, TX · Member since 2025 · 157 posts · 172 votes
Hey @Ricky A. - See my clarifications above. The taxable piece of a Roth conversion (or IRA/401k distribution) is ordinary income and can be offset by nonpassive losses. So if #1 is a direct LTR that you materially participate in (and you make the REP elections/meet the tests), cost seg/bonus depreciation that creates nonpassive losses can reduce the tax on the conversion.
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