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

920 Replies

@Inga Fonder you are correct about expensing most costs incurred after the in-service date. It's important to distinguish between a repair and a capital improvement.

Pest control and snow removal costs (including supplies) are certainly deductible!

@Cory Kerr Sure thing! To answer your questions:

  1. You don't have to use one specific method. You can use either or, or an average of both. If you use one over the other, it may be a little more difficult to substantiate why you chose that method over the other one, aside from it giving you a more favorable improvement ratio. The appraisal should also list comps, which could be factored into the determination.
  2. No proof needs to be submitted with your tax returns. The proof is only necessary during an audit. If the expenses are ordinary and necessary in the course of your business (and you're able to explain why) and there are receipts to back up the expenses, an audit would be a breeze. As long as there is an explanation for why the expense is ordinary and necessary, and that the explanation makes sense, you are deducting expenses within the limits of the law. The store receipt just proves that it was actually purchased. If you want to be extra careful, you can write the purpose of the purchase on the receipt before you scan it or make a note next to the receipt, take a picture of both, and store it on Google Drive or something similar.
  3. I'd apply the same rationale here as I did to #1 - I wouldn't recommend just "picking" one method for the simple reason it benefits you more; there has to be some reasoning for why you are choosing that method. That said, either example you mentioned is viable. I've split house-hacked properties by both bedrooms and square footage for my clients. You could also do an average of the two. You should work with your CPA on this to make sure you're on the same page.
  4. Theoretically, you could if you have a repair business, for example, but, as you said, you would have to report income on the other side, which would transform passive income to active income subject to SE. Not smart (in most cases). Short of doing that, you can't deduct the equivalent of your labor costs. Consider it sweat equity :)

@Nicholas Aiola Thanks again for being such an incredible resource for so many people here on BP!!

I was hoping you could answer another question for me. I'm in the process of purchasing a 4 unit investment property here in Los Angeles and am trying to figure out the best type of title to take as both my name and my wife's name will be on the property. 

Option 1: If we take title of new property as Joint Tenants, I understand that if I die before she does, she will inherit the property with just a single or partial step up in basis.

Option 2: If we take title of new property as Community Property w/ Right of Survivorship, I understand that if I die before she does, she will inherit the property with a FULL step up in basis to the current market value at the time of transfer. 

My questions are as follows: 1) In California, does this stepped up basis lead to a reassessment calculation in property taxes? I realize you're in NY, so I understand if this is something I should probably look up on my own.

Question 2) Does it matter that this property is being purchased as part of a 1031 exchange? I.E., if the property is titled as Community Property WROS and I pass before she does, will it still transfer to my wife fully stepped up to current market value, thereby eliminating not only the gains from the current property but also the built-in reduction in basis that was transferred in during the 1031 exchange? It almost seems too good to be true.  Only ONE of us has to die in order to escape the capital gains tax liability...and not both of us, which is what I initially thought.

Hi Nicholas, I have shown a loss for several yrs on my non real estate business and don't want to show another. I plan on closing business at end of this yr. I know I have to take allowed or allowable depreciation when I sell depreciated property, but what is your advice on not claiming depreciating this yr in order to show a profit? I understand I will lose the depreciation if not taken.

@Tony Kim To avoid going back and forth on the thread please PM to continue the conversation :)

@Arn S. Depreciation is not a choice; if you don't claim it, you will be filing an incorrect tax return. 

Thanks Nicholas, follow-up question can I gift the LLC say $5k so it will show profit this yr. or would this throw up red flags?

Updated 3 months ago

Again this is in order to show profit for business..... Is it possible to convert say 1/2 of business property to personal (ex. 1/2 of cattle herd-which are a depreciable asset) and therefore only have to claim 50% depreciation on business assets such as equipment?

Updated 3 months ago

income for yr is only @ 2k

@Nicholas Aiola Thx in advance and really appreciate the help. I own 3 STRs in South Lake Tahoe CA. My CPA told me I don’t really need an LLC to realize all the tax benefits of owning real estate, but if I was concerned about liability, I could do it for $1000/yr (CA cost) or just throttle up my umbrella policy for added protection. And that I wouldn’t see greater tax dedications by creating an LLC. So I’d didn’t even though I had all the paperwork ready. As I’m listening to various real estate podcasts, I’m beginning to question whether this is the case. BP friends, can someone smarter than me chime in with their thoughts? Appreciate it. Jared

@Arn S. A gift would not be reported as income. If your business deductions are legitimate, why are you hesitant about showing a loss? Your CPA should be able to advise you further on this. 

@Jared MontBlanc Your CPA is correct. An LLC is not a tax entity; they are for liability/asset protection purposes. Owning an LLC does not unlock any additional tax benefits that would otherwise be available to you outside of an LLC.

If the LLC has multiple members, a partnership tax return will be filed but all activity will ultimately be passed through to the partners via Schedule K-1 and reported on their respective tax returns. If you are the single owner of an LLC, the IRS views the LLC as a disregarded entity, meaning as if it doesn't exist - all activity is reported directly on your individual tax return.

Your CPA is also correct about LLCs costing an arm and a leg to maintain in CA. Another option for CA investors is a Delaware Statutory Trust (DST) structure. Speak to an attorney about that further if you're interested - @Scott Smith and @Brian Bradley  are the best of the best; they're certainly the ones to talk to about DSTs. 

@Nicholas Aiola is there any changes to the $2500 de minimis safe harbor for expenses that I need to be aware of for my taxes this year? 

Or just in general is there any major changes in the new tax code relative to how you expense versus capitalize? 

@Joe Splitrock No changes to the de minimis safe harbor limits but bonus depreciation is 100% in 2018 as a result of the TCJA - that should certainly help on certain items that must be capitalized.

Originally posted by @Nicholas Aiola :

@Joe Splitrock No changes to the de minimis safe harbor limits but bonus depreciation is 100% in 2018 as a result of the TCJA - that should certainly help on certain items that must be capitalized.

Thanks! Does the bonus depreciation include residential rental property? For some reason I thought it was commercial and furnishings of short term rentals only. I have single family rental houses. I put a $6000 roof on one of the properties this year. I think every other expense is either repair or under $2500.

@Joe Splitrock Bonus depreciation includes personal property with respect to residential rentals, not the property itself (useful life must be less than 20 years). A roof would not fall under this category.

@Nicholas Aiola , I got lucky and had a house flip over very quickly this year for about a $30K profit in only a few months.  I realize I will take a short term capital gains hit.  The entity is a sub S corporation.  I am considering buying a truck for about $40K.  Will that in anyway defray the hit of Short term capital gains?  Or only regular gains?  Next would it be better to take some wages to try to reduce taxes?  I don't really want to pull money out of the Corp but would like to avoid the big tax hit if possible.

@Jerry W. Flip profits are actually taxed as ordinary income subject to SE tax. It could, however, be treated as a CG depending on intent and circumstances. Auto expenses cannot directly offset CG but can be deducted against ordinary business income. The purchase of a truck could yield a sizeable depreciation deduction (among other deductions) in Year 1, depending on details of the vehicle (specifically weight). But, obviously, it will need to be a business-use vehicle to receive any benefits as a business tax deduction.

Regarding wages, S Corp shareholders are required to draw a reasonable salary from the business. "Reasonable" should be determined between you and your CPA but a guideline to use is: "how much would I pay someone else to do my job in this business?" Other factors must be considered, as well, like income from the business for the year, geographic location, and other demographic data.

Thanks Nick.  The truck I am looking at is a one ton, it doesn't ride great, but I need a big truck to haul my dump trailer I use for tearing off roofs and cleaning up properties.  I know I need to draw a salary, but I try to keep my profit or loss pretty close to zero if I can.  This year I won't be able to do that unless I do a big purchase and all of it won't be deductible in one year.  I have been pretty aggressive this year on fixing up some properties that needed small repairs or appliances to help offset the large profit from the quick profit I made.

@Jerry W. One thing to keep in mind - if the properties you were fixing up (small repairs and appliances) are long-term rentals, the activity (income or loss) is considered passive and passive losses cannot be used to offset other types of income (active, portfolio, etc.) if your AGI exceeds $150k.

In other words, if your AGI > $150k, your passive rental losses cannot offset your active income from the flip.

Thanks I had forgotten about that.  Is that gross income or net income for the $150K?  I know I am grossing over $10K a month, but if you take out interest and repairs I am well under that, if you can take out depreciation, well i am just above break even most of the time hehe.

Looks like I need to read up on that part.

@Jerry W. It's your AGI, which is your total income (including net rental income after depreciation) less adjustments to income.

Hi @Nicholas Aiola ! Thanks again for this great thread and making yourself available to answer all these questions.

My mom will be gifting me a property that she has been renting since 2006 (12 years). I don't believe she claimed depreciation on it until the last 3 years. Regardless I know the depreciation recapture taxes will have to be paid for all 12 years she's rented it. I will continue to rent the house when she gifts it to me but might sell it some time in the future once I've depreciated the remaining 15.5 years of it.

When she gifts the property to me will she have to pay the recapture tax on the tax year she gifts me the house for the 12 years? Or does that pass on to me and will I have to pay all the recapture taxes whenever I sell it?

@Francisco Rosas The donee assumes the donor's basis, so you will obtain your mom's basis in the property. No depreciation recapture will be due at the time of the gift.

You should speak to your CPA about filing Form 3115 to catch up on missed depreciation. 

@Nicholas Aiola . I have a 1031 question. If I create an S Corp entity for flipping houses that’s 50/50 w a business partner. My aim would be to do a few flips each year under that entity but then hold one as a rental property (BRRRR) strictly for myself and buy out my flipping partners interest/equity in the property so he still makes a profit on it. My other rentals are held in LLC’s belonging to my wife and I. So how should I take title on the intended BRRRR (in the flip S Corp then do I quit claim it into LLC. Is it possible to 1031 it to my LLC business? Does money need to be transferred? Am I making this too complicated?

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