Ask me (a CPA) anything about taxes relating to real estate

495 Replies

@Nicholas Aiola "For rental real estate, the useful life is 27.5 years. So, if you bought a property for $275,000, you'd be able to depreciate $10,000 per year. Depreciation reduces your taxable income." 

I believe only the building portion of the total property cost basis is depreciated.  For example, if land is accessed at $100,000, only the building cost of $175,000 is to be depreciated over 27.5 years.

Originally posted by @Nicholas Aiola :

Hey, guys!

I've been on BP for about 7 months now and I have quickly learned two things:

  1. There is no better place than BP to talk real estate
  2. The wealth of information on BP is immeasurable

I've read and learned quite a lot while scrolling through this site, and figured I'd create an open forum to (hopefully) offer some help and advice back to the BP community.

I'm a CPA in New York with a passion for real estate and I'd be happy to answer any tax questions I can!

 If you rented and lived in a condo in 2016 and 2017, but owned a house 50 miles away that no on rented from you or stayed in, you just used it whenever you wanted, is the house you own considered your second home and can you itemize the mortgage interest, RE taxes?

@Stuart M. Yes, the property taxes and the mortgage on the house you own would only be deductible as itemized deductions on Schedule A in 2016 and 2017.

Starting in 2018 (thanks to the new tax law), however, the deduction for property taxes (and state and local taxes) is limited to $10k and the limit for figuring the mortgage interest deduction is reduced from $1mm to $750k (this only applies to new mortgages).

Nicholas Aiola, CPA in New York (#119518)

Why wont it let me @ you on an iphone?

Thank you for doing this btw. 

Another question I have, this is about casualty losses. Say you bought a house (first or second home) that had a bad roof. After the roof was removed but before the new one was put on, a tornado comes along and damages the inside of your house. Insurance refuses coverage because you removed roof so no reimbursement. How do you determine FMV of roofless house and FMV of roofless damaged house to calculate casualty loss (just prior and just after right?)

You also have to reduce loss by $100 and 10% of AGI, yes? This is for 2017 and prior. 

@Stuart M. Honestly, I wouldn't be able to give you a reliable answer on how to determine the FMV of a roofless house for casualty loss purposes. I'm sure an appraiser or insurance agent would be able to shed some more light on that.

But what I can tell you is, if that is indeterminable, that the adjusted basis could possibly be used instead. Casualty losses are based on the lesser of (1) the adjusted basis of your property and (2) the decrease in FMV of your property as a result of the casualty.

You are correct about the $100 and 10% of AGI reductions. You are also correct about this applying to 2017 and prior, seeing as the new tax law made it much harder to claim a casualty loss.

Nicholas Aiola, CPA in New York (#119518)

Under the new tax law, do you have to hold real property 3 years before you get long term capital gains treatment on the sale as opposed to the profit being taxed at ordinary income? 

@Todd Willhoite No, the long-term holding period still applies to assets held for more than one year.

I think you're referring to carried interests (interests in the long-term capital gains given to a general partner in connection with providing investment services), in which case the long-term holding period was modified from more than one year to more than three years.

Regular investors are not affected by this.

Nicholas Aiola, CPA in New York (#119518)

@Nicholas Aiola Are the tax rates different when you take a buy out (sell your interest in the partnership) or sell all the properties and dissolve the partnership? Assuming both will result in a gain. 

@Dan V. It depends. Selling partnership interests and selling properties within a partnership are two different things. Generally, the concept is the same in either case, however - short-term gains would be taxed at ordinary rates and long-term gains would be taxed at preferential rates. Depending on the circumstances, there could be differences, such as depreciation recapture on the sale of a property, which would not affect a sale of partnership interest. 

There are other factors to consider when discussing selling the interest vs. selling the assets, as well, and they would apply to each situation and taxpayer differently. It would be a good idea to consult with your attorney and CPA before selling either so you are in the best position to keep your tax bill low.

Nicholas Aiola, CPA in New York (#119518)

@Nicholas Aiola Thank you.  Yes I read it in an article where they were also talking about carried interests and was unclear if the new law related to both.

Thanks for offering this ask me anything!  I am unsure if I should be deferring taxes by maximizing my retirement plan contributions ($300k+) or pay tax on the income and use

the personal cash instead. Specifically:

  1. I hear that one of the best things about real estate investment is the tax benefits - namely, depreciation. Since the income of the retirement plan is tax-free, doesn't this make depreciation a moot point?
  2. Leverage seems to be a key ingredient of real estate; however, this creates a taxable income (unrelated taxable business income) in an investment vehicle that has an otherwise tax-free environment.

Thanks again!

Hey Nicholas, this is awesome! Taxes are the most confusing part of the whole thing haha. My brother and I just flipped our first house under our LLC. I read somewhere that you can avoid capital gains tax if you can prove that your intent was to keep the property as a long term investment. A week after we bought the place we had renters warehouse come give us a quote just for shits and giggs. Would something like that help us since our intent was to rent but ended up selling the place? Also would that allow us to roll the money on a 1031 exchange? Thanks for your help bud!

@Jeff Ju I assume you're talking about pre-tax retirement plan(s). If that's the case, the income isn't necessarily tax-free, it's tax-deferred. When you draw on that money in the future, you'll be paying taxes at your ordinary rates. Depreciation is technically tax-deferred, too, if you sell (due to depreciation recapture, but that tops out at a tax of 25%). 

Leverage could result in UBTI depending on the circumstances, but that is if the investments are held in a self-directed retirement account. But again, the retirement account isn't tax-free, it's tax-deferred (unless it's a Roth). 

Ultimately, it comes down to your specfic situation and preference. Saving the tax money now by putting it into a tax-deferred retirement account could benefit you more than paying the taxes on it currently and earning "tax-free" money through rental activities.

Alternatively, the opposite could benefit you more. It would depend on a variety of factors.

I hope this helps!

Nicholas Aiola, CPA in New York (#119518)

@Matt Tobler I'm glad you think that because otherwise I wouldn't have a job haha.

You're on the right track... It's not capital gains tax you can avoid, it's self-employment tax.

Intent does go a long way. If you did intend to hold it as a rental but wound up selling it, you could make a case for it to be a sale subject to capital gains tax and not a flip subject to ordinary rates + self-employment tax. 

As for a 1031 exchange - the IRS generally likes to see long-term investments being exchanged, but that doesn't mean doing a 1031 exchange on a short-term sale is not allowed; it's just not as common. 

@Dave Foster what are your thoughts on this?

Nicholas Aiola, CPA in New York (#119518)

@Nicholas Aiola , WOW!!  this is the thread that won't die.  Keep it going man!

@Matt Tobler , Nick is absolutely right.  The true test is your intent and not a specific holding period.  But holding longer is better than shorter.  Most people feel that anything more than a year is pretty good evidence.  But it's always conceivable that your intent could have been to hold but an unsolicited offer came along that you couldn't refuse.  Just remember - once is a fortunate accident.  4 or 5 times in a row looks like something else entirely.  What can you demonstrate?

But you may have an even bigger issue on this one.  If you've already sold it then it is no longer eligible for a 1031 anyway.  The process must be started before you close your sale.  Maybe food for thought on the next time.

@Nicholas Aiola Thanks so much! 

Yes, it's a defined benefit plan and I contribute anywhere from $150k - $325k a year. It has been sitting in a checking account other than one hard money loan I made to an RE investor which earns tax-deferred interest and a syndicated minority stake in an apartment building which has UBTI. I just don't want to use it in the stock market (regret that now!) but I realize sitting in a bank account isn't the wisest decision either. 

I could potentially buy something out-of-state for all cash but not utilizing leverage doesn't sound like a great strategy. While I understand depreciation is tax-deferred, it's my understanding that the tax liability for recapture when selling can be avoided via 1031 exchange. 

Would I be able to use depreciation to offset UBTI for investments made through the self-directed defined benefit retirement account? 

Thanks again for providing this wonderful thread. 

Hi Nick--thank you for offering your time to answer tax questions--this is much appreciated and perfect timing for many of us!

Apologies if this has already been asked as I have not read through all the replies, what I am interested in getting clarity on is with regard to what qualifies as "real estate services" in order to write off expenses as a real estate professional.  

More specifically, I started focusing on RE full time in July of 2017. I have spent a significant amount of time in the learning process and wonder if, a) time spent in RE education can be included in the 750 hours of required RE services and, b) can tuition and related expenses be written off? 

Since I'm just getting started, I had very little actual RE income in 2017 (just minor cash flow from a rental), but am filing jointly with my husband and have a good $20K in educational expenses I would like to be able to write off. I do not have a CPA at this time. Thanks again for your advice.

@Jeff Ju You are correct about using a 1031 exchange to defer depreciation recapture.

One important thing to note is that leverage generates UBTI in an IRA, not a 401(k). You can use leverage to acquire rentals in a self-directed 401(k) without the fear of generating UBIT.

Also, you need to have net income in order to have UBIT. If your rental produces a loss, you won't have a UBIT liability, so depreciation can certainly contribute to that. Filing would still be recommended though to carryover the NOL. 

@Dmitriy Fomichenko is the expert in this arena - Dmitriy, what are your thoughts on this?

Nicholas Aiola, CPA in New York (#119518)

@Elaine Hester you're very welcome!

To answer your questions:

a) Generally, hours spent learning and educating yourself do not count towards the 750 hours.

b) Tuition and related expenses can be written off, but the question is where. Educational expenses (seminars, training, etc.) related to your rental could (depending on the circumstances) be deducted on Schedule E against rental income. General tuition and related expenses could generate a credit (again, depending on the circumstances) on page 2 of Form 1040. 

If you have any other questions or would like to chat further, feel free to PM me!

Nicholas Aiola, CPA in New York (#119518)

Thank you again for doing this. 

I want to know if I have the basics right. 

Say you bought your first house to rent in 6/17 and you did all the work to it yourself, and you end up placing it in service in 1/18. My understanding is that in 2017 you expense any tools you bought, and any business expenses not related directly to your rental. For 2018, you determine your basis for your rental house to depreciate it over the next 27.5 years by taking the lesser of the completed current appraised value (adjusted by building:land ratio) OR the cost of purchase, plus mortgage interest, home insurance, PMI, RE taxes, utilities, new roof, electrical/plumbing, appliances, drywall and their labor cost, insulation, doors/paint/trim, lawn service, and tool rentals, basically EVERYTHING I've spent up to the in service point, adjusted by building:land ratio. 

I hope that is right. The one thing im unsure of, if you dont own a vehicle, and you rented a truck or car to solely drive from your personal residence to the rental house, go buy supplies etc, for the months you were working on it, can you immediately expense those costs (plus the tolls and gas) for 2017 or do you add them to the basis of the house you were working on? If it matters your spouse owns a vehicle but they need their car so you cant use it.

@Stuart M. Any expenses incurred before the property is placed in service that does not become part of the property's basis should be classified as start-up expenses. These expenses are deductible (up to $5,000) in the year the property is placed in service. Anything over $5,000 is amortized over 15 years.

As for the basis - the only time you can use the lesser of the FMV or cost of the property to determine basis is if you convert a personal residence to a rental. If you purchased a property strictly for a rental from the start, your basis is the cost (plus applicable expenses prior to being placed in service, improvements, etc.).

Mileage (and related expenses) between your home and your rental is only deductible if you have a home office and it's considered your principal place of business. Otherwise, the IRS treats your rental as your "office" and, therefore, transportation between your home and rental would fall under the commuting rules.

Nicholas Aiola, CPA in New York (#119518)

I understand the mileage on personal vehicles for business use. But if you rent a F150 pickup truck from Hertz for a month because you need to pick up lumber, roofing materials, appliances, etc during work days from Home Depot, and you drive the truck home to sleep at night, my understanding is you cant expense "mileage" on a rental, so how do you expense the rental truck?

On your second rental house you buy, do you again have "startup costs" where the limit is 5k or do normal business expensing rules come into play?

@Stuart M. Same rule applies regarding the commuting rules, but if you're renting a car, you may benefit more by using the actual cost method as opposed to the standard mileage rate method. You would have to separate business and personal use and apply that ratio to the cost of the rental truck.

Generally, each property would have its own start-up costs; operating expenses related to a property cannot be expensed as normal until the property is ready and available for rent.

However, if you have expenses that relate to your business as a whole and that are not specific to the 2nd property, you may be able to deduct them as normal operating expenses.

Nicholas Aiola, CPA in New York (#119518)

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