All Forum Posts by: Paul Caputo

Hi @Glenn Cosburn Congrats on your first post and welcome to BP! 

The recovery period for residential rental property is indeed 27.5 years. I believe it's a mid month convention and straight line method. 

The $40K in improvements will be depreciated, but also the existing portion of the house that is now the airbnb unit would also be depreciated. 

For something like this that's about as complex as you need to get. The truth is there would be assets that would qualify for accelerated depreciation over 5 years (possibly though unlikely 7 year or 15 year too) in there as well, but figuring out what qualifies is complicated. 

@Dan Handford In this situation depreciation will generally only offset passive income from this or other passive investments. It'll usually be split proportionally between the investors depending on ownership unless they're something strange going on in the operating agreement. The exception is if the investor makes less than $100k then they can offset up to $25k on active income, which phases out from $100k to $150k income. Also if the investor qualifies as a real estate professional for tax purposes they can offset active income and passive income with the depreciation. 

If the passive losses are more than passive income they're suspended and they'll carry forward and offset passive income next year. 

Are you utilizing cost segregation? $1mm in depreciation per year on straight-line would be a pretty big rental property . If the investors can use the additional losses accelerating the depreciation with cost segregation would be a great idea. 

@Lawrence L.You'll likely get part or all of the exclusion depending on what you do and when you sell. Did you initial occupy 100% of the property and now occupy 50%? If so how long have you rented vs fully occupying the house? Or have you been renting the top and living in the basement since the purchase? 

Section 121 eligibility is living in the property as primary residence for 2 of the last 5 years. So you can live somewhere for 2 years or longer, rent it out for 3 years or less and then sell and get the full exclusion of $250k single/$500k married on the gain. When you rent part of it that basically turns the property into a duplex for tax purposes. So when you sell you'll be eligible for the exclusion for the basement (as long as you've lived there for 2 of the last 5 years) and possibly some of the exclusion for the top (again as long as you've lived there for 2 of the last 5 years). So if at some point you decide to stop renting the top and occupy the entire house and then 2 years go by before selling you'll be eligible for the basement and part of the top. 

But I'm not a CPA, let's see if some CPAs have any thoughts @Natalie Kolodij @Linda Weygant @Michael Plaks @Alan Rohrer

@Ouman You if she rents it and then does a 1031 exchange the replacement property will also have to be an investment property. A 1031 is for "like-kind" property so investment for investment. I suppose theoretically she could hold the replacement as an investment property for a period of time and then make it her residence, but thats a question for the QIs and CPAs. 

Doesn't really sound like she wants to rent out her place for 2 years, rent or buy another place for 4 years, exchange into the new place and rent/hold it for 2 years then move into that new place. But maybe she does?

She could keep the old place, cash out refinance it and use all that equity to buy a new place and another rental while keeping it as a rental. 

I'd look at as many options as possible before taking a $900k tax hit. 

@Chuck Schmidt on a single SFR of this size it largely depends on your marginal tax rate if it makes sense or not. At a cost of $140K with land value of $20K you've got $120K to play with on depreciation. On average a SFR will have at least 8% tangible personal property - 5 year assets and 8% land improvements - 15 year assets. That's just average, some might be less, some may be more it depends on the facts and circumstances of the property. Just to make things easy let's say there's 10% of each, $12,000 tangible personal property and $12,000 land improvements and $96,000 residential rental property.

Using straight-line depreciation for a $120K rental you'd get $4,363 depreciation deduction each year for 27.5 years. The actual tax benefit of that depends on your marginal tax rate. At 37% that $4,363 deduction is worth $1,615 in tax savings each year. At 24% the same deduction is worth $1,047 in tax savings per year.

With cost segregation and 100% bonus depreciation you'd get $27,491 depreciation deduction the first year and $3,491 depreciation every year for the next 26.5 years. At 37% that's $10,172 in tax savings the first year and $1,292 in tax savings each remaining year. At 24% the same deductions are worth $6,598 in tax savings the first year and $838 in tax savings each remaining year. 

As you can see you're trading a much bigger benefit in the first year for a little less in the remaining years. At this size property it's debatable if spending $2,500 on a cost segregation study is worth it. At 37% you're getting $8,557 more in tax savings the first year and $323 less in remaining years than straight-line. At 24% you're getting $5,551 more in tax savings the first year and $209 less in remaining years. 

As you can see there is an advantage to using cost segregation, but it isn't huge. Now if you're looking at doing this on multiple SFR's it would absolutely make sense.

Yes, bonus applies on assets with a life of 20 years or less, so all the 5 year and 15 year assets qualify for 100% bonus. You can also opt to only do 50% bonus and do the other 50% over the normal 5 or 15 year schedules, or no bonus and do 100% on the normal 5 or 15 year schedules. 

On a new construction there would be more opportunities to maximize the benefits of cost segregation. We consult with builders and advise them on how to make small changes that will allow more assets to qualify for accelerated depreciation. Flooring is a great example. If it's considered permanent flooring like solid nailed in hardwood or grouted in ceramic tile that's a 27.5 year floor. If it's not considered permanent like carpet of floating laminate/engineered hardwood that's a 5 year floor. There are many little and big things that can be done to make cost segregation more effective at the pre-construction phase. 

I think taking full advantage of depreciation and leverage is going to be your best bet on this. Depreciation deductions are not affected by leverage, you'd have the same deductions whether you paid cash or used 100% financing. So by using leverage you can get more property and in turn more depreciation. 

If you want to supercharge the depreciation you can have a cost segregation study done on the property. Generally you'd see 10%-30% of the property eligible for accelerated depreciation. Out of the qualifying assets you'd be able to pick if you want to do 100% bonus depreciation, 50% bonus depreciation or just use the regular 5 year or 15 year schedules. We're regularly able to help clients show a loss with accelerated depreciation. 

Obviously it's a good idea to talk to a CPA who knows real estate, but this shouldn't be too difficult to get done. As you said most of your rentals show a loss, but you get good cash flow. Do the same thing. 

I'm not a CPA, this is not tax or legal advice.

@Yonah Weiss is correct about this. There are lots of assets that qualify on a rental. The 100% bonus depreciation is generally only used on a property that has had cost segregation, since without it the entire property cost is allocated to the long life 27.5 or 39 year schedule. On an average property there can be anywhere between 10% to 30% of the depreciable cost basis that would qualify for bonus depreciation as either 5 year tangible personal property or 15 year land improvements. It all depends on the specifics of the property and the level of build out. You could have two properties that are similar and one could have 15% qualifying assets and the other could have 25%.

A/C and furnace would generally not qualify for bonus depreciation, but on a nonresidential commercial property they now qualify for section 179. An exception would be if the A/C or furnace had a specialized purpose such as in a climate controlled self storage facility or a restaurant walk-in freezer. Then it'd be a 5 year asset and eligible for bonus. So in a rental the A/C, furnace, roof, and windows are all long life assets.

I'm sure the Guide to Tax Deductions is helpful, but without a qualified construction engineer or architect you'll find it difficult to take advantage of bonus depreciation on a property. 

Generally not a good idea. You'd be paying rent with taxable dollars and then your company would have more income which would get taxed as well. As always talk to a good real estate CPA, but I don't see any way this makes sense.

The unit you're in is considered your personal residence and the other units are rentals. You get depreciation on the rentals, but when you sell you'll get the gain on your unit tax free (up to $250K/$500K) as long as you meet the section 121 requirements. 

I dunno how it works in CA, but in CO I believe you have to tell your employing broker about any real estate activities. I'd also think you have to disclose to the seller that you're a licensed agent and still follow any rules and regulations. 

In CO doing that requires disclosure so the seller knows you're an agent and are more sophisticated and have more knowledge than they do. But in CO we have standard contracts that must be used. 

If anything I'd think CA is more rigorous than CO. Doing this may be a one way ticket to getting your license revoked if anything goes wrong and the seller reports you to the Department of Real Estate.

It's all a negotiable business so I don't see any reason why you couldn't inform your employing broker about the deal and still move forward with no commissions paid on a direct deal. 

I don't think that's a good idea. I'm not an agent yet, but my license should be issued in the next week.

If you weren't licensed then there would be no issue, but you are. Do it the right way.

The only way you're "locked in" with an agent is if you sign an agency agreement with them. If you want to keep working with agents it's best to do good by them as far as deals go. If an agent was the procuring cause of your deal you should work with them on that deal. 

Some agents won't talk to you more than a couple times without a signed agreement. Just like anyone else, they don't want to work for free and they only get paid at closing. 

Most agents only work with primary residence home buyers. The investing side is a different animal and requires agents who "get it". You'll be lucky if 1 in 10 gets it on the investing side. 

Just be honest and lay out what you want. You should be able to figure out if they can help you in about 5 minutes. Focus on the ones that get it and you'll be well represented.