All Forum Posts by: Paul Caputo

Aren't you answering your own question by looking at other long term societal factors that are not dependent on real estate investing? I'd say it's more of a symptom than a cause. Many things play into the national economy and global economy, real estate being one slice of a very big pie. 

The key is to put yourself in a position that when (not if) corrections and recessions occur you can ride it out and not sell until the market rebounds. Or just wait for recession and buy everything at a nice discount. But I don't think that's anything you don't already know @Rich Weese 

Real estate markets going crazy is usually a good indicator of something about to happen, but I wouldn't say real estate causes the recession; rather the pre-recession creates artificial upward pressure on real estate. 

A lot depends on how you tackle this. If you sell it to her for FMV of $330K you're looking at over $200K in capital gains which are taxed at 15%, so that's $30K in capital gains tax. You also have depreciation recapture which goes up to 25% based on your tax rate. So on a property bought in 1995 you've already had 22 years of depreciation or 80% of the initial cost basis depreciated since the rental is depreciated over 27.5 years. Assuming 20% land value your initial cost basis should be right around $102K. Meaning you've taken around $81K in depreciation so far. When you sell the depreciation tax benefit is "recaptured" meaning you have to pay it back. So your depreciation recapture on this would be about $20K in recapture taxes.

So if you do that you're looking at about $50K in taxes on the sale, so you'll get about $280K out of it which still more than doubled your money on the property so that's good. 

If you do a 1031 exchange you can defer taxes until you sell the replacement property. This is a great option if you want to buy another rental property with these proceeds. If you want to put the cash in your pocket you can't do this. They only allow you to defer taxes by replacing the original property with something of "like-kind" and transferring the depreciation schedule to the new property as if no exchange took place. So real property must be exchanged for real property and depreciation does not reset for the replacement property. Like-kind is actually pretty broad as long as you stay on the business side. For example you cannot use a 1031 exchange on a rental property to fund a personal residence, but you can exchange a rental property for nonresidential commercial property. In the same vein you can't exchange real property with other financial instruments such as stocks or bonds. You'll need the help of a Qualified Intermediary to handle the 1031 exchange for you. 

If you go that route be careful! The preferred strategy with 1031 exchanges is continue to exchange properties and defer taxes until you die. At that point the property goes to your heirs with a stepped up cost basis to FMV at the time. They can either sell it then and pay no taxes on the sale, keep the property and continue its business use or start the whole process over again with another 1031 exchange down the road. If you have done multiple 1031 exchanges and then have to sell the property you'll get hit with all the depreciation recapture on every property all at once which would significantly lower any gains made on that final sale.

When using an IRA you don't get depreciation. Your Tax basis in the IRA is $0, so your tax basis in the property would also be $0. The IRS generally doesn't let you have your cake and eat it too. You only get depreciation because you paid for the property (cash or financed doesn't matter) and can't expense it all at once since it has a useful life over one year. Using tax deferred or tax free funds means you already have tax benefits on these funds so you don't get further tax benefits on them.

As @Daniel Dietz points out you can still make it work quite well without depreciation if you set it up correctly. 

Keep learning! Don't worry about the money. All you need to do is put in the work to find a good deal and you'll be able to find a partner with the money. Trying to save up takes a long time, and putting all your eggs (cash!) in one basket isn't a good idea.  You're gonna have to do all the work, but there are plenty of people who want to invest in real estate without doing all the legwork. Find a few people like that and you won't have to plan to save up for 2 years just to still not have enough for a down payment. 

Given your current situation it'd be tough to get approved for any financing, even if you do well over the next 2 years it could still be tough. So realizing now that it'd be best to partner with others on your first few deals will put you a step ahead of worrying about financing.

You should think big, but realistically as well. There's nothing wrong with reaching for the stars. Thinking bigger will help you figure out how to make it happen. If you think small you'll stay small, If you think bigger you'll force yourself to grow.

Isn't that what these forums are about? Politely offering differing opinions? :) @Craig Kleffman You have striking and well thought out arguments here, just trying to add my perspective. The truth is it's out there so someone will buy it sooner or later. It just seems more likely it'd be someone who would be able to structure the investment in tandem with other things perhaps in an effort to turn those negative numbers into positive ones. 

Of course it makes sense for a larger investor to go into a larger 5+ property, but there are plenty that stay in the 4 and under market because that's where they're at with their personal strategy. Saying why doesn't everyone do that misses the complexity in pairing the individual investor with the overall market. If everyone did the same thing we'd all be living in apartment complexes (instead of just me!) but that's not the case there's a wide variety of options. Different living conditions are acceptable to different tenants just like different investments are acceptable to different investors. 

Just trying to help prove your point that maybe this isn't the best investment for you. Is it the epitome of CA excess? Perhaps. Are there better alternatives to this? Probably. But that's really up to you and what you want. Ten years from now would you make the same decision? 

You're much farther along than I am and I applaud you for it, and I'm sure you owe that to hard work and recognizing what to do with constructive advice. Matt has a point here, 5th Avenue is a lot more expensive than Queens. You might be confusing your best place to live with your best place to hold a rental. If you want to combine the two you may need to compromise.

Thank you @Matt H. for chiming in, things always become clearer with a local perspective! 

Plus you're getting depreciation if it's a rental. That's your main deduction tied to the purchase. Depreciation is basically a deduction for the cost of the property over time. It wouldn't make sense to allow a double deduction for the cost with depreciation then again with mortgage principal payments. 

An LLC protects you from being held responsible for the company's debts, not the other way around. If you file bankruptcy and own an LLC they can liquidate it to repay your debts. So no that won't protect the house from your personal financial issues.

If the only use of the guest house is your personal use every once in awhile that's fine, but you're losing out on a whole year of rent for that space so you can use it once in awhile. Wouldn't it make more sense to rent both units and just stay somewhere else when you go to California once in awhile? Are a few weekend trips going to cost more than a year of rent there? 

Also if you only have the main house as a rental and the guest house is your vacation spot you are only allowed to claim depreciation on the cost basis of the main house and the guest house is non-depreciable since it isn't rental property it's personal property. That can have a big impact on your taxes if you're not paying attention.

This is just a guess, but it'd probably be a real estate professional with many other properties renting out all the units as opposed to owner occupied. If they can make it work to eventually go positive the short term losses are mitigated by future returns. Pair that with being able to put losses here against gains elsewhere and it starts to make more sense. 

Also be careful if you're not a real estate professional rental income is considered passive income and you can only deduct passive losses to the point of passive income, anything further is disallowed in the current year and carries forward to next year. If you continue showing passive losses and don't have other passive income it'll just keep adding up and you won't be able to take it until you go positive. So again it'd probably be a real estate professional doing these types of deals since the short term losses would lower their taxable income and they could make it work long term.

Depreciation can be very helpful! It's one of the biggest tax deductions available for property owners and few understand the full benefits of it. When applied properly, Modified Accelerated Cost Recovery System (MACRS) depreciation helps property owners keep thousands upon thousands of tax dollars in their own pockets. So it makes perfect sense that a lot of depreciation will put you in better position with lenders. More depreciation = less taxes paid = more cash in your pocket to pay a loan. 

Great info here @Andrew Postell! Thanks for the insight.

I believe @Scott Davidson is pointing to the passive income rules. Since you're not a real estate professional your rental income is passive income. Losses from passive income activity can only be deducted against passive income. Any excess would be carried forward to the next year. So if you're already showing a loss on your properties that loss will be disallowed this year and go to next year. 

Check out https://www.irs.gov/pub/irs-pdf/p925.pdf Publication 925: Passive Activity and At-Risk Rules for more info on that.

The carpet IS tangible personal property (unless it's in the bathroom or something weird that changes it) with accelerated depreciation treatment, but because of the low cost it could be eligible for safe harbor: that depends if you've done anything else that qualifies for safe harbor and have high enough unadjusted cost basis since there are limits. Also safe harbor isn't automatic you have to elect to use it with a statement when filing taxes. Again if you're already showing losses this would be disallowed until next year: if you're still showing losses then it keeps going until you're allowed to take it.