Optimizing investment strategy to increase paper losses?

Question

Current Situation: My wife and I have been slowly getting into REI over the last 4 years. We currently have 5 SFH long-term rentals and a short term rental.Up until 2022 we both had W2 jobs, but we just had our first baby and my wife is now full time mom and full time managing our properties. I'm learning about how she can now qualify as a Real Estate Professional and she will meet the qualifications in 2022 (750+ hours). In my W2, I make about 200k a year and Id like to figure out how to pay less in taxes through passive losses in Real Estate but currently all of our properties cash flow well and even with write offs and depreciation we don't show losses. My CPA has advised that any cost- segregation studies would likely not be worth the cost on these SFH as they are around 150k homes. Goals:  Legally minimize taxes, build long-term wealthQuestion: Is there an asset class or investment strategy we should be targeting for future deals that can optimize paper losses (maybe through cost-segregated depreciation?) while still being cash flow positive. Any other recommendations for our situation? Thanks in advance!

Jim Pfeifer · Answer

There are plenty of syndicators who accept non-accredited investors.  As Paul mentioned, the paper tax losses can be great.  I would recommend joining a Community that specialized in syndication investing - there you will likely meet other investors who can share some of their favorite operators with you.  BP is a great place to start on every thing real estate, but sometimes you can get the specific information you are looking for from a more specific group.

Paul Moore · Answer

Hi @Jesse Dahms. I don’t know if you are interested in investing passively, however, with your family and job it might be a wise move. We have found that investing passively in mobile home parks can provide awesome paper losses. You’re going to want to be sure the syndicator does a cost segregation study.  We were shocked to get a paper loss of well over 200% of our investment in a mobile home park last year. Of course, using leverage and a great cost segregation study are necessary to achieve this.  Feel free to reach out to me if you want to see the math on this.  Good luck!

Justin Beasley · Answer

I get wanting to pay less taxes, but it sounds to me like you are on the right track. Tax strategy is certainly part of the process to become better RE investors but I am more concerned with finding great value, increasing cash flow, and mitigating risk. Also, on the tax side....with the increase in cost to purchase a STR in a vacation market I have met a number of people who are doing cost seg studies to accelerate their depreciation and plan to 1031 exchange their properties in 5 years or so.

Basit Siddiqi · Answer

DIY Cost Segregation studies are very affordable for $150K homes.Working with an accountant also means expecting them to connect you with competent connections.

Bill F. · Answer

@Greg O'Brien

Thanks for keeping me honest. I was under the impression that no matter what the deprecation recapture is 25%. I take it that is incorrect?

How does it work? Keeping it simple, I'm in the 22% tax bracket forever; if I have a SFR that I take deprecation on every year for five years and end up with $100k in accumulated deprecation. When I sell it what rate do I pay on that $100k? My marginal rate?

@Tony Kim

Sorry for not making that clear in my original post.  I'm of the camp that deprecation mainly does two things for you, an interest free loan from Uncle Sam and an opportunity to get some tax rate arbitrage. The former is nothing more than a time value of money play so you need to account for it when doing any analysis.

You hit the nail on the head about the counter argument from sponsors, but I think that's a lot like asking your barber if you need a hair cut. Deprecation recapture is a feature not a bug to their business model. Most of us hate paying taxes and the longer you cycle your investments the larger the recapture becomes and we will roll our money into less and less profitable deals to avoid paying the tax man. I think if investors aren't careful this will lead them to step over a dollar to pick up a dime, but that's just me.

I agree 100% about the red flag. If I had a high paying W2 and a spouse as a RE Pro, I'd keep my account on speed dial lol.

Greg O'Brien · Answer

@Bill F. Recapture doesn’t work exactly that way. You recapture at a MAX of 25%. However, there are great strategies to minimize the impact. The lower your tax bracket the lower the marginal benefit from the TVM created by accelerating depreciation

Tony Kim · Answer

I reread your post and it appears that you are basing your numbers on the actual tax benefit that one would receive after accounting for the the recapture that would inevitably come after you've kicked the can down the road as far as you could go. In that case, I agree with your numbers. I agree that when accounting for recapture when a syndicated deal matures, the tax benefit is limited only to deferment and the actual amount of hard dollars you would save is quite minimal.

Of course, a syndicator would say, "that why you cycle your investments". I.E., keep investing in new deals every year so that your accelerated losses can offset any recapture. I believe this might work, but at the same time, I can see things crashing pretty hard into a perfect storm if one relies too much on this strategy. I'm happy to take my accelerated losses, but I also feel more comfortable rolling them forward as large PALS on an annual basis instead of cashing them in against my ordinary income.

And this is of course, assuming one would qualify as a RE professional, which IMO is one of the reddest of the red when it comes to IRS flags. And even if you do qualify, rest assured the IRS will do  thorough job of reviewing the rest of your return. 😊

Tony Kim · Answer

You'd need to invest around 200k to get paper losses of around 100k your first year. At least that's what's been happening with the deals I've been investing in. The accelerated depreciation is applied to the entire property. Equity investors would represent what? Around 25 to 35% of the financing? Some even less.

Yonah Weiss · Answer

@Jesse Dahms if you're not accredited, you'll have to at least be a 'sophisticated investor' and have a pre-existing relationship with the syndicators who are doing a 506(b) exempt offering, before investing. I know quite a few that are in the MHP space, and happy to make some intros if you want, feel free to send me a DM

Jesse Dahms · Answer

@Paul Moore This is exactly what I'm looking for, however I am not an accredited investor. I haven't been able to find any syndications that will allow me to invest. Any recommendations?

Optimizing investment strategy to increase paper losses?

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