What tax benefits does one have using BRRRR Strategy

Question

Are there any big tax benefits to using the BRRRR Strategy? Are any of the expenses accumulated while fixing up the house tax-deductible?

Zach Westerfield · Answer

@Cole Shope First i am not an accountant, but there are big tax benefits to BRRR.

First, you avoid or defer capital gains tax - BRRR involves improving a property to increase the equity. This equity becomes a capital gain, and when you realize that capital gain (ie sell) you owe taxes on it. In the case of a fix and flip that occurs in less than a 12 month timeframe, this is considered short term capital gains. With BRRR, you are holding the property, and once you hold it more than 12 months, you now swap to the long term capital gains bracket, which is typically a lower tax burden.

Second, you dont pay taxes until you sell, and after you hold for 12 months you are eligible for a 1031 exchange. I wont go into those details here, but with the 1031 you have the potential to defer taxes indefinitely.

Third, as you asked, yes the renovation you complete can mostly be depreciated as well. Talk to your CPA on this, but you can also cost segregate the renovations and accelerate depreciation up front. This is not possible with flips. Capital improvements such as roofs, kitchens, etc can be depreciated on different schedules.

There is another tax advantage of BRRR which I have not seen mentioned before - Property Taxes. This would definitely vary state by state, but I have done BRRR's in Florida which by law can only increase property taxes a maximum of 10% per year. When you buy a run down property, many times what you pay for that property is less than the taxable value determined by the local tax assessor. If this is the case, you can contact the tax assessor and show them you closing documents, and they may lower the assessed value which in turn lowers your property taxes. After renovation, your value goes up but many times the assessors don't bother re-evaluating. In the Florida case, this becomes the new baseline and taxes can only increase 10% per year. I have properties that have appreciated 100% over what i paid for them, but my taxable value is still slowly increasing from the purchase price. I pay a lower property tax rate compared to other properties in the same area.

Sean Ross · Answer

@Cole Shope, let me elaborate a little on @Zach Westerfield's point about 1031 exchanging and tax benefits there.

1. 1031 exchanges allow for tax deferral, which effectively acts like an interest-free loan from the government equal to the taxes you would normally owe upon sale. To do this, you reinvest your sale proceeds into a property of equal or greater value (and you must use a 1031 intermediary to perform this action). As Zach mentioned, you may do this indefinitely!

2. You don't necessarily need to wait 12 months to be eligible for a 1031 exchange.  "Time held" is only one of many factors that the IRS considers.  What matters most is your intent for the property -- and it's possible to have the intent to hold for long-term business or investment use even if the property sells before 12 months.

3. When you do a 1031 exchange, you don't reset to a brand new cost basis in the new property.  Your old basis carries forward with some adjustments.  So you will likely lose out on a little bit of depreciation.  This is not always a huge factor, but important to know.