All Forum Posts by: Daniel Murphy

I'm happy to have a discussion with you.  Feel free to reach out & we can schedule a time at your convenience. 

I actually just posted a topic with deeper thoughts on the supplemental benefits of doing a cost seg study.  My property was much less than yours & I saw significant benefits, both now and in the future.  "cost seg from a financial planners perspective" in the same forum.  

Hey all, I did a cost seg study on my short term rental for the 2022 tax year. I'm a financial planner by profession & really wanted to understand the nuances behind this topic more. I love comparing the hype vs real world.  I apologize if this is a bit long, but here's a random list of thoughts after digging into this and actually doing a study... 

Before Cost Seg

- $400k property purchased in Jan of 2022.  I reached out to get a cost seg estimate & came back with these estimates:

$352k building cost ($400k minus estimated land costs)

~$77k in estimated bonus depreciation

= $28k in estimated tax benefits ($77k in estimated bonus deprecation * 37% tax rate)

Note - the above is my main point of contention with these cost seg estimates.  These estimates always tend to show the max amount of bonus deprecation multiplied by the HIGHEST tax rate = your estimated tax benefit.  
1) Most of us are not in the highest tax rates and:

2) Tax rates step both up and down, so you can't simply take the bonus depreciation multiplied by a tax rate.  It doesn't work like that... IE - don't expect the estimated tax savings on your inital report to be your actual tax benefit. 

During

- the report actually took me much longer than anticipated to receive.  I had to follow up with the company multiple times and seemingly provide the same info to them multiple times.  

I would definitely recommend starting this early rather than later as the report takes months to complete.  

Actual numbers post report:

5 year property = $42k

15 year property = $120k

total building cost = $204k

Actual Tax Return 

~Married Filing Jointly

~$82k in W2 income

~$150k in self employed income netting $52k in K1 income

~$11k in capital gains from stock market investments

~$60k in rental income from Schedule E and $215k in depreciation expenses ($162k from cost seg bonus deprecation & the rest from first year costs / capital expenses)

We ended up with an AGI of -$80k

Nuances & Thoughts 
- Most frequently, Cost segs are focused on high income investors.  I don't believe I'm considered "high income".  

- Some will say doing a cost seg on a $400k property is not worth it but in this case, we absolutely found it worth it. 

- I ended up with a fed & state tax refund total of around $18k 

plus, I still have a significant loss carry forward that I should be able to use in future years. 

We also had ~$30k in charitable deductions that we could NOT use in 2022 due to AGI limits.  These will be carried forward to future years to offset future taxes. 

For the first time in years, we qualified for a property tax refund.  This was a little over $3,000

One thing to note, when your AGI & tax liability gets near zero, child tax credits are only refundable up to $1,500.  Meaning, you do not get the full value of the $2,000 child tax credit if you have a low AGI, you may only get a max credit of $1,500 per child. 

In my case, I ended up with around $20k in tax benefits in year one and should get nearly that much in a  year two carry forward. (complete guesstimate)

Financial Planning Opportunities

This is the area that really interests me.  As I've talked with my clients & other investors, here are some areas I can think of to maximize the benefits of a cost seg. (all as a result of an abnormally low AGI for the year)

- If you have any inherited / beneficial IRA assets, you could potentially do large withdrawals with little to no tax effect.

- If you're applying for financial aid for college or other institutions, you may potentially qualify for additional aid based on a low AGI. 

- If you have large capital gains, you may be able to realize them & qualify for the 0% tax rate. 

- You could potentially convert a portion of your 401k/IRA into a Roth 401k/IRA virtually tax free. After a 5 year holding period, you may be able to withdraw your basis from the Roth tax free to purchase more real estate (note, I need to verify this as I don't know this to be 100% accurate)

- You could potentially offset taxes from a year where you anticipate large gambling income, cancellation of debt or more likely, stock option awards or other employee stock incentives. 

This was not meant to be an exhaustive list. Moreso, I've been thinking of this a lot recently & just wanted to share some deeper thoughts.  When most people talk about the benefits of doing a cost segmentation study, they talk about tax savings.  I find the real beauty of this strategy in the other supplamental benefits that are not often considered.  

I hope this helps give another perspective on the cost seg / STR Loophole topic...

First, I would look at your most recent tax return to see if you itemized, or used the standard deduction.   If you used the standard deduction, you are not getting a tax benefit from your mortgage.  So it could make sense to pay off your mortgage.  

More importantly though, before you do this I would think long & hard about what you actually want to do long term. Do you want to be a RE investor? Do you want to be financially independent? Do you want less stress? Do you want to weather a recession easier?  Determining your why is the most important decision in this. 

Like many others have said, you'd probably do much better in the long run if you used that money to buy real estate or invest in the stock market than if you paid your mortgage off.  I see a lot of "Should I pay off my mortgage" questions on this forum which I think is kind of funny as this is a forum for real estate investors. Real estate investors LOVE mortgages & love keeping cash available for the next deal. 

If you're 23 & in a position to pay off your mortgage, you have an incredible opportunity to catapult your financial freedom forward.  I would think long &  hard about this decision.  I would have conversations with multiple people (as opposed to forum posts) to talk through the nuances of all options.  I'm happy to talk you through this further if you'd like.  

@James Hamling & @Zak Carchedi, I more or less just wanted to know what the market is like.  The Twin Cities are not a high tourism or travel area. When I look at Airbnb there don't really seem to be many "dedicated Short Term Rentals", it moreso seems like homes that people just have up for rent occasionally. 

Are there areas or properties with more demand & regular demand?  What type & how booked are they? 

@Mark Sacandy, Thanks for sharing the deeper story of why you want to retire. I would want to retire asap also if I had your work situation.  I think it's great to get answers to these questions you're asking. I see them all as data points. When entering retirement, it's important to have enough data points to make an educated decision. 

For what it's worth, I'm happy to do a quick call, enter some of your info into some financial planning software (you would retain access) and talk you through your questions as a whole.  Your 401k advisor most likely will have a limited amount of time to talk to you and 2) plan advisors tend to be focused on the company retirement plan and may not have the deepest understanding of actual retirement processes.  Think of it as a single family home investor vs. a commercial investor. They are both knowledgable in real estate, but with different expertise.  

The reality is that by the time you retire, you will likely have a handful of different investments.  This is good. Everyone inherently knows that diversification is good, but people don't often think of "product" or "tax" diversification.  

You can look at a handful of options that are available with your 401k. Withdraw to buy RE, take a loan to buy RE, move to a self direct IRA to buy RE. You'll find that many of these options are not the most advantageous.

Your 401k was set up with IRS incentives to do what it's doing, sitting there growing until you're older. My best suggestion would be to find ways to continue to build up assets outside of your IRA to invest in RE, then just let your 401k sit. At most, I would consider taking a small loan from your 401k for a down payment, but even that makes the numbers hard to work.

Fast forward 10-20 years & hopefully you'll have a bunch of RE investments which can have a big impact on your taxes. This is when it could make more sense to start withdrawing from the IRA/401k, when your taxes are lower & more controlled.

I'm staring at a tax return from a RE investor who has ~$150k in taxable income for being a realtor. Plus income from 12 rental properties.  Add everything up, and his taxable income is $633.  

He has a total income of over $200k & his taxable income is only $633. Next to nothing! This is the true power of real estate investments. When you get to this point, you can withdraw from your IRA/401k virtually tax free. Patience is key...

Sorry to hear about your loss... 

Paying off your house will have no tax consequence, other than the loss of the interest deduction. Which, you'd want to look at your 2022 taxes to see if you itemized, or claimed the standard deduction. If you claimed the standard deduction, there would be no tax consequence whatsoever. 

The 401k loan is a bit more open-ended & complicated.  Depending on the interest rate of your loan, I generally lean away from paying off your mortgage as the potential return you could see in another investment would likely be greater than the rate of paying your mortgage off.  However, mortgages are one of the financial topics that illicit more emotional responses than nearly any other. 

The fact that you're looking to pay off your home and potentially retire shows me, this is emotionally important to you.  If that's the case, go ahead... Give yourself the "win", especially when it comes from a personal loss.  This can make paying off your mortgage feel so much better... 

We've had a 3/2 with a pool in CC for a little over a year now.  The area is definitely struggling since Ian.  Last year, every day in Feb, March & April was booked.  

This year we had 5 open nights in March & we had to discount a few because they were open so last minute.  We know a bunch of others with properties in the area & they are all in the same boat.  Much slower than last year.