All Forum Posts by: Paul Caputo

With an office condo you generally don't own the land, you only own the space within the condo. Usually whoever owns the entire building owns the land. If your land value is zero that's usually a good indicator that you don't own any land. 

My firm's sole focus is providing documentation for depreciation so here's how I see your situation: $600K purchase price for this medical office condo would put your initial depreciable cost basis at $600K assuming no land value. As a non residential commercial property it gets depreciated over 39 years: that translates to 2.564% of the initial cost basis per year. Depreciation for years one and 40 are adjusted based on when you purchase the property. Say you purchase in April then your first year depreciation would be 8.5/12 = 75% of full year depreciation or 1.819% of the initial cost basis. That's with mid month conventions. 

Now since this is a medical office condo there will be significant amounts of assets that qualify for accelerated depreciation over 5, 7 or 15 years. Anything that is not a structural component of the building could qualify for accelerated treatment. On the 5 year assets you can accelerate depreciation with double declining balance so instead of getting 20% depreciation per year on those assets the first year is 40% of their initial cost basis and then 40% of the adjusted basis in later years until fully depreciated. This is adjusted based on when the assets were placed in service in a similar fashion to the above adjustment, but these generally use half year or mid quarter conventions. 7 year assets usually also qualify for double declining balance, and 15 year assets can qualify for 150% declining balance. 

An average medical office condo has about 12% of the cost reclassified to 5 year assets on the low end, but it could be over 20% reclassified. So on that $600K medical office condo you're probably looking at between $72K-$120K in accelerated depreciation over the next 5 years. At the top marginal tax rate of 39.6% that's between $28.5K and $47.5K in tax credits over 5 years. 

If you put in any new tenant improvements most of that would qualify for 5, 7 or 15 year treatment as well as 50% bonus depreciation. 

Properly depreciating the property requires documentation of what is what: 5, 7, 15 or 39 year assets according to the rules of Modified Accelerated Cost Recovery System (MACRS). It takes expertise in construction, construction techniques, estimation procedures and the relevant tax code to properly apply MACRS. 

PM me for more info I'd like to help you out with this.

The thing about the IRS is all they care about is documentation and applying the tax code correctly. The problem is there are thousands of pages of tax code and they are constantly changing things. 

I did a little more digging for you on the subject and found this article. Check it out. 

http://www.nolo.com/legal-encyclopedia/taxes-when-you-convert-your-rental-property-your-personal-residence.html

Seems like there would be depreciation recapture when its converted to a residence, but that's probably gonna be around $10,000 or less and probably wouldn't be recaptured until the property is sold. ($79K initial cost, half depreciated = about $40K in depreciation taken that is recaptured at 25, probably about 20% less than this since there's some non depreciable land value in that initial $79K)

I was unaware of the non qualifying use rules mentioned in the above article. Any non qualifying use since 2009 applies pro rata to the exclusion. So she'd have to live there for 8 years to get 50% of the gain excluded since it had 8 years of non qualifying use before being converted into a residence. If she only lives there for the required 2 years and has 8 years of non qualifying use then she can only get 20% of the gain excluded.

So the more I delve into this the more it seems like it's not the best course of action. With the non qualifying use selling is probably the best bet unless she plans on living there long term. 

Even though it's really one building it's taxed like two separate buildings. It's figured proportionally based on square footage so if the two sides are equal size then each gets 50% of the cost if not it's proportional.

You'll have to get with a good Qualified Intermediary like @Dave Foster or @Bill Exeter and they'll help you get this all squared away. 

Cost segregation is my specialty. On a $1.8MM Class C property you're looking at the lower end of 5-15% tax savings on the depreciable cost basis. On the low end I'm guessing a $70,000 tax credit would be significant for your business. $180,000 would be better but that depends on your property and you. It all depends on the level of build out and the materials/techniques used in construction as well as your tax rate.

A forensic engineered cost segregation study has to be done by a construction engineer or architect with knowledge of the pertinent tax code, construction techniques and estimation procedures. The engineer does a site survey to document the property. Then the engineer deconstructs the property and groups it into the appropriate property classes. This process generally takes 4-6 weeks. The resulting cost segregation study will provide full documentation on every asset within the property and place each asset in its proper class. 

The nice thing is that the IRS accepts it with automatic approval and credits your taxpayer account within 30 days. 

The U.S. Treasury Department says that cost segregation is a lucrative strategy that should be used in almost every major purchase of real estate. So yes this is a good idea with a large multifamily property. Unless you want to pay more taxes.

PM me for more info on cost segregation. You can get a huge tax credit on that property. I'd like to help you get it.

The property has to be your primary residence for 2 of the last 5 years to get a section 121 exclusion on capital gains of $250K/$500K (single/married) But I bet he doesn't want to live there for the next 2 years. 

The tricky thing here is it's been a restaurant for the last 20+ years, not a residence. That makes it commercial property which gets depreciated over 39 years. So if he hasn't had it as a business for 39 years there should be some depreciation left. Congress changed the depreciation rules in 1987, so if he bought it before then different rules apply.

So to convert this from commercial property to a primary residence could take some work. You'd have to turn it back into a livable residence and probably remove everything that makes it a restaurant and not a house. You'll probably have to get approval from the city to convert it as well. They might want it to stay a restaurant. Was it originally his residence and he converted it into a restaurant?

Assuming he took depreciation the IRS is going to want that back when the property sells. Even if he didn't take depreciation they can still say it was allowable and want it back anyway unless he made a statement that he would not be taking depreciation which is very rare. 

You might be able to swing the conversion to a residence only because it is actually a house. So it makes sense that it would be a residence. Any other building and this would be ridiculous. 

If you actually convert it back to a residence and he lives there for over 2 years before selling he may be able to get the capital gains exclusion (thats a big may), but would likely have to pay depreciation recapture either way. 

Talk to a CPA that understands commercial real estate and everything should become much clearer. 

A condo is considered an air-lot. Meaning when you own it you own that physical space in the air containing the condo. This logically follows that the condo itself doesn't have land value since it's not on land it's in the air. Generally the common areas are appurtenances to all the condo owners in the building. 

Although later on in Publication 527 (chapter 4) it says condo owners do own a portion of the land. Here's the thing: someone owns the land. So it's either the condo owners or someone else. If the whole building is owned by the condo owners then they'd have pro rata land value. If another entity owns the building it also owns the land and the condo owners own their condos only. So it kinda depends. Check your Deed and Title, there should be info on there describing what you bought. If it's just the unit it's just the unit. If it's the unit and a portion of the land or rest of the building then it's that. 

If your assessed land value is zero, you probably just own that unit and everything else is an appurtenance. Generally when land value is assessed at zero it means you don't own the land. It's the same idea with a store in a shopping mall. The store owns everything in the store, but the mall owns the land, the common areas and anything else that isn't inside a store. 

So you could do what most everyone does and lump everything in the condo together as residential rental property and depreciate over 27.5 years. Some of the stuff in the condo would be considered tangible personal property depreciated over 5 years. The problem is knowing what's what and how much it cost. Unless you fully remodeled or built it yourself you wouldn't have the cost records so it can be difficult to figure it out without a depreciation expert doing a cost segregation study.

If the property cost over $200K (less land value) you could be looking at $10,000+ in tax savings by correcting the depreciation with cost segregation. PM me if you have any questions about how that works.

@Brett Dawson Yes the IRS allows you to catch up on any unclaimed depreciation with Form 3115. It's called a section 481(a) adjustment. You don't have to amend your returns to file this form. As far as the other deductions go talk to your CPA about that. 

If you want the most out of your depreciation deductions you can do a cost segregation study on the property. My firm includes Form 3115 ready to file with our engineered cost segregation studies. 

PM me for more info on cost segregation and correcting your depreciation. 

@Joseh Orobello I can help you out with cost segregation. PM me.

Your boss is just talking about the section 121 exclusion: If a property has been your primary residence for at least 2 of the last 5 years it qualifies for the exclusion up to $250K/$500K(single/married). This wouldn't apply to the half you rented since that's rental property. 

So your boss is half right. If you're buying with the strategy to 1031 until you die then you're not gonna pay any capital gains or depreciation recapture. You gotta be careful with that though because once you start you can't stop or you're gonna get hit with capital gains and recapture on all of it. 

I'd highly recommend consulting with real estate and tax professionals before doing anything like this. 

Technically you could rent to yourself by selling the property to a wholly owned entity and then renting it from that entity. You would have to pay fair market rent to the entity or it would be considered personal use and it wouldn't be a rental. This isn't that great of an idea since all the rent you paid to the entity would be taxable income, so you'd have to pay taxes on the rent you paid. Do you want to pay $12K per year in housing cost and add $12K to your taxable income at the same time? As opposed to paying $8,400 per year and not adding to taxable income? 

You would also lose any tax benefits you have from owning the home, so there's that too. If it's your residence you can get an exemption on capital gains up to $250K when you actually sell it down the road, that's not the case when you sell the rental: you have to pay depreciation recapture and capital gains. 

The other thing here is that is an unusual situation. The IRS doesn't like unusual situations, they give them a reason to take another look. They allow the rules for rental property because it is an income producing business. Living at your own house isn't exactly a business is it? 

So can you do this? Yeah. Should you? No.