Utilizing property to reduce taxable income

4 Replies

Hello and Good evening BP Brothers & Sisters.


Tonight I wanted to post a question I have been thinking a lot about lately. "How could an investor best utilize property to lower taxable income"?

We currently own two properties we had the good fortune of purchasing with VA loans that started as primary residences and became rentals for one reason or another. I am semi active in acquisition side of wholesale aside from having a traditional real estate team. We are working on buying additional properties for buy and hold to become FI.

-Could I accelerate depreciation on multiple properties to reduce my taxable income if the plan is buy and hold? If we did this and needed/decided to sell a property and utilized a 1041 exchange could we roll the accelerated tax implications forward while still utilizing accelerated depreciation on next property without having the tax implications of accelerated depreciation realized? Copy paste repeat?  Maybe another way of doing this? 

Just trying to brain storm some ideas, any suggestions would be warmly welcomed. : )

Cheers 

Lucas

Disclaimer - not a CPA and have not done this myself. Information shared based on reading up on this subject.

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I believe you are referring to "Double Declining Balance" type of depreciation method.

https://corporatefinanceinstitute.com/resources/knowledge/accounting/types-depreciation-methods/

If you utilize it on Property A and then sell Property A to do a 1031 Exchange to Property B, you get to choose how you wish to depreciate Property B. I do not believe there is any concept of "depreciation roll over" as part of 1031 Exchange. The main purpose of 1031 Exchange is to defer capital gains if you sell to buy another "like property".

@Lucas Rowell

Say you have a $100k property, depreciated $30k of it via accelerated depreciation and then used a 1031 exchange to exchange it into a $120k property. (Land allocation ignored for simplicity.)

At the exchange time, the $30k does not bite you back (again, the reality is more complicated), however you cannot depreciate $120k from the new property. You can only depreciate $70k left from the old one plus $20k of the additional investment.

You can still apply accelerated depreciation to this new $90k asset, however the rules get complicated, and it's not a DIY project. And it's very important to keep in mind that the 1031 exchange rules got much more complicated after the tax reform when it comes to accelerated depreciation and cost segregation. Get good help.

Originally posted by @Michael Plaks :

@Lucas Rowell

Say you have a $100k property, depreciated $30k of it via accelerated depreciation and then used a 1031 exchange to exchange it into a $120k property. (Land allocation ignored for simplicity.)

At the exchange time, the $30k does not bite you back (again, the reality is more complicated), however you cannot depreciate $120k from the new property. You can only depreciate $70k left from the old one plus $20k of the additional investment.

You can still apply accelerated depreciation to this new $90k asset, however the rules get complicated, and it's not a DIY project. And it's very important to keep in mind that the 1031 exchange rules got much more complicated after the tax reform when it comes to accelerated depreciation and cost segregation. Get good help.

Michael,

That is an awesome reply and exactly what I was trying to figure out. Now the second part of this question: Is there any limit to the amount of properties that I take accelerated depreciation on at one time if not rolling over?

Also
If there are mortgages on these you can only write off interest on loans for the personal residence?

Thank you again for the insight :) 

Cheers 

Lucas

 

@Lucas Rowell The questions you are asking are both the right questions and far more complicated than people can answer for you in a forum. I’ll give you an example. The property that you allocate from 27.5 yr to 5 yr 200DB would not be available for 1031 exchange... most of the time. 27.5 has to go to 27.5, like to like. You can not exchange 5yr to 27.5. So to fix this you can either value the 5yr property very low but not zero. Not zero because you would have to define the date that the property hit zero and you should have taken a disposal deduction. Or you can create 5yr property in the new building and like to like transfer it then.

This is one example of the issues that can come up, but there are lots more.

Talk to someone that knows these things, find out what applies to your strategy, and make sure you document everything.

Good Luck!