Cost Segregation to offset Cap Gains?

Question

Hi BP!

I'm evaluating a property that has had a lot of capital improvements and because of its location, are not reflected in the value of the property.

I'm selling another commercial property and wondering if buying this new property and performing cost segregation for accelerated depreciation will help me offset the capital gains on the property I'm selling.

Questions are:

#1) Is this a viable strategy to offset liabilities? (Knowing depreciation clawback will happen upon its eventual sale.)

#2) Does the purchase of the new property have to happen in the same calendar year to take advantage of the depreciation?

Thanks!

Adam

Michael Plaks · Answer

@Adam Byrne

#1 - maybe. It does not "offset" capital gains directly. You have a tax hit from one and a tax reduction from another, so their combined effect could be anything.

#2 - you can claim depreciation in a different year, but it won't offset this year's capital gain, and it may result in those additional depreciation deductions locked up. So yes, for your plan to work, it needs to be the same year.

What you're overlooking could solve these problems. It is called a 1031 exchange, where money from the sale is applied to the next purchase, and your capital gain is rolled forward. KEY: you must hire a "qualified intermediary" BEFORE you sell your current property.

For more details, talk to one of the intermediaries, @Dave Foster. Warning: Dave cannot stand these 1031 exchanges and always posts about how lame they are. (JK)

Dave Foster · Answer

@Adam Byrne, I like the strategy.  Given the short timeline you may want to hedge your bets and start the 1031.  Even if you decide to blow it up later it will die in 2021 so you can report an installment sale with all gain received in 2021 after so you can comfortably get your cost seg and tax trigger in the same year - unless... is there a 2020 sunset on this Michael and Ashish?

And if you can't make the cost seg work you can always complete your 1031 and at least you won't recognize the gain that way.

Today schmoday.  Our record is 22 minutes. I don't have a lot of non-gray hair left.  But for you .... :)

Adam Byrne · Answer

I love you, BP!

Ashish and Michael, your responses are very helpful and corroborating, so thanks for that.

And @Dave Foster is my guy for 1031s.

My immediate problem is that I'm closing today on my sale and that only gives me ~3 weeks to close on this depreciation-strategy property. Yikes!

Dave Foster · Answer

LOL.  You can't fool @Adam Byrne that easily @Michael Plaks.  He needed to talk to smarter guys than me on this one :).   You're accountants - you work for a living !

Lane Kawaoka · Answer

If you are able to implement a real estate professional status tax strategy (REP) you can use passive losses from syndication deals to lower your ordinary W2 income. If not (ie two full-time working spouses) your only other option is going into land conservation deals, solar deals, or oil and gas deals - all of which have some risks.

Explained in a different way...

1) There are ordinary/W2/active income on one side. Lets call that the :( side.

2) And there is the happy side... passive income (syndications, passive partnerships ie medical/dentist offices) and passive losses (depreciation, bonus depreciation via cost segregations common in syndications). You can you passive losses to neutralize/eliminate passive income. Thats what this is the good side and why passive losses are called PALs too for passive activity losses.

So there is a barrier between 1 and 2 above. You cannot offset passive losses (PALs) for active income. UNLESS you are are real estate professional status for tax designation purposes.

PS - I am not an attorney but I became financially free doing this for myself after 10 years working as a w2 engineer :( world

Dave Foster · Answer

@Yonah Weiss, You are da man!!

Yonah Weiss · Answer

You don't have to have the cost seg completed before 12/31, as long as it's done before you file your taxes. So you have a little more time to think about it and perhaps get a free feasibility analysis done to see if it even will get you enough depreciation to benefit you.

Ashish Acharya · Answer

Your losses (becuase of the cost seg) might not be deductible because of the Passive activity loss (PAL) limitation. If you don't have that limitation, yes you can offset your gain with the losses. Read more on the PAL, Real estate professional status, and ctive rental exception to PAL.

Yes, the purchase and the cost seg of the new property need to happen in the same year of the sale.

Adam Byrne · Answer

Thanks, Lane!

Unfortunately for employers, I'm not a great employee. Craving creativity and autonomy, I've had to make my way as a self-employed investor the last many years so I don't have any W2 income to cancel out. Mostly passive income from real estate activity.

I love Hawaii. How are things going for you on the investment side?

Yonah Weiss · Answer

Yes.

Cost Segregation to offset Cap Gains?

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