All Forum Posts by: Paul Caputo

Well that is $1.75mm in equity just sitting there assuming it's all paid off with no additional liens. As long as all the bills are taken care of you can definitely do a cash out, just kinda depends how big do you want to go and do you want multiple properties or one big one.

Whatever you do when you get into a bigger property reach out to me on the cost seg :) Feel free to connect and PM me.

@Andrew C. Wow that's an amazing gain! But that's what 50 years will do! Yeah I wouldn't recommend just selling at this point that's a $444K tax hit, much better to get the step up basis as inheritance.

With using the $35K as the basis cost seg doesn't make sense. After it's passed down with the step up basis, cost seg absolutely makes sense. Even if the land value is 50% that's still over $800K in step up basis. The benefit of cost seg at that point would be tens of thousands in deferred taxes as long as it's kept as a rental. 

Here's the math i'm just gonna use easy numbers to illustrate: 

Say the depreciable basis now is $27,500. With straight line that's a $1,000 depreciation deduction every year for 27.5 years. At 37% tax rate that's a tax benefit of $370 per year. Or they do cost seg and get 20% short life assets or $5,500 that gets immediately expensed under the new tax law. The remaining 22,000 still does straight line, $800 depreciation per year or $296 tax benefit at 37%. So first year they get $6,300 depreciation, worth $2,331 tax benefit at 37%. If it cost $2,000 to do the cost seg they lose money since the difference between straight line and cost seg is less than $2,000, $2,331-$370=$1,961! 

On the other hand look at it with a stepped up basis of $825,000. That's $30,000 depreciation per year on straight line, worth $11,100 tax savings at 37%. With cost seg again do 20% short life that's immediately expensed at $165,000! $660,000 remaining still does straight line, $24,000 per year for $8,880 tax benefit at 37%. But that first year you get $189,000 depreciation for a $69,930 tax benefit at 37%! That's $58,830 more tax benefit the first year with doing cost seg vs straight line. Even if it cost $10,000 to do it it'd make sense at that point. 

But you can do a lot more with $1.75mm than buy a duplex. You could easily get into a 10-20+ unit in another market. Do some value add or just get something stabilized and have way more cash flow than a duplex. I'd look into keeping it as a rental for a year or so and then 1031 into something with better cash flow and leave the replacement as inheritance. 

I wouldn't think just turning it into a rental would be the best bet, but it's an option. The depreciation would be negligible on a $35K purchase price since the depreciable basis would be $35K less the land value ratio, so probably in the $20K-$30K range on the basis. With that low basis cost seg doesn't make sense since you'd probably see around $1K-$3K in tax benefits if they're in a higher tax bracket and the study would probably cost around $2K so it's basically a wash and probably would lose money. It'd make more sense to just take the straight line depreciation in this case.

With the value increase selling is probably the best way to go if they need the money. They'd be able to exclude $500K of gain under section 121 so they could sell for $535K and pay no taxes. 

If they want to keep it as a rental that'd probably be pretty good cash flow, but they'd need to be sure that they wouldn't want to sell down the road and would leave it as an inheritance since they'd lose the section 121 exclusion after 3 years of it being a rental and have huge capital gains selling. If they rent it and then leave it as an inheritance whoever gets it would be able to get the step up basis to the FMV and again there'd be no taxes paid on that. At that point it could be sold for FMV tax free or kept as a rental or whatever the heir wants to do including moving in there.

Another way to keep it as a rental but get more depreciation is a bit more complex and they'd have to be able to afford it. This would require a good real estate attorney to set it up properly so it doesn't raise any eyebrows. They could create a wholly owned S-Corp and deposit the necessary funds into it. They then sell the property to the S-Corp at FMV. They get the cash at FMV and the S-Corp now has a mortgage on the property. The cash flow would be lower than just turning it into a rental since they'd have mortgage payments on it again, but the much larger depreciation deduction would likely offset that quite a bit and they'd have a bunch of cash from the sale. Depending on the FMV it may make sense to do cost segregation at that point since the depreciable basis would be FMV less land value.

It all really depends on what their goals are with it, if they intend to leave it as an inheritance and just how much the value has skyrocketed. Alternatively they could also just convert it to a rental, keep it for a year and then 1031 exchange into a more desirable property. Again this would only be advantageous if they intend to leave it as inheritance since the replacement property would get the same step up basis treatment and they'd get hit with huge capital gains if they sell.

My firm does cost seg and it generally starts to make sense on property over $200K less land value. It is not a job for an accountant, it requires a specialist. 

@Edward Burke @Daniel Dietz I'd be happy to give you both a second opinion. My firm does forensic detailed studies and mostly works with small to mid size investors and business owners. 

Generally the cost isn't much different between a forensic detailed study and a modeling/sampling study, but the results can be different.

The difference between a modeling/sampling approach and a forensic detailed approach mostly comes down to accuracy. A forensic detailed study is 100% accurate, while a modeling/sampling study inherently has a risk of error. Even though individual units may appear to be identical or very similar, differences can exist. Any differences between the model and the actual assets can only result in one of two things: either underestimating the allocation which leaves money on the table, or overestimating the allocation which takes more than is allowable. The IRS guidance on the issue says modeling should use the least advantageous limit which would give the least benefit to the taxpayer. 

Simply put a forensic detailed study will get every dollar allowable, while a modeling study may not. Most cost seg firms use a modeling approach, very few use a forensic detailed approach. The IRS doesn't require any particular method, but they do look for accuracy. 

@John Jones Sure it'd be better if you were at the top tax bracket to take the depreciation, but it's better to take it regardless of where you sit. Paying $0 in taxes this year is better than paying $500 in taxes this year. Furthermore if it zeros out your tax bill it'll carry forward and reduce your taxes for next year. 

Say you sell the property in 10 years and you're at the top tax bracket then. You'd pay recapture at 25%, but along the way your bracket has gone up over 25% so it's a huge discount on the payback. If you're still under 25% you'd payback at that lower rate, so the article is incorrect. A big thing people don't seem to understand with this is that you're getting the deduction in today's dollars and paying it back in future dollars which are worth less due to inflation. 

This is an oversimplification, but if you take a $10,000 deduction today and pay it back in 10 years and average inflation is 2% per year that $10,000 in future dollars would only be worth $8,000 in today's dollars. Couple that with the fact that you're getting hit with recapture when you sell whether you take the depreciation or not and it should be clear that you should take it.

Alternatively you could not take it and file Form 3115 in the future to catch up on missed depreciation, but that'll cost you a pretty penny to have a professional fill it out for you and likely not be worth the difference from jumping a bracket unless it's a high value property and you'd pair that with accelerated depreciation which doesn't seem to be the case here. 

Just make sure you're using the correct numbers for depreciation. Only the improvement (building and land improvements) value is depreciable, the land value is not depreciable. On a rental the schedule is 27.5 years with a mid-month convention, so the month it became a rental is important that's when the depreciation starts, not the whole year. Also if you're only renting a portion of the property and still living in another portion the depreciation only applies to the rented portion.

Note: I'm not a CPA, but I have studied the depreciation rules.

After selling flooring for 3 years I'd highly recommend vinyl plank as many others have stated. All in all it'll hold up the best to whatever the tenants throw at it. it's basically waterproof, isn't going to fade from sunlight like hardwood, and the good ones look great almost like real wood. Some laminates look better, but the durability isn't comparable. It takes a lot of abuse to mess it up, and if you have a good installer they'll be able to replace individual planks if they get damaged (you'll need some extra planks for that so find one you like and use it everywhere.) It'll last longer than laminate and you don't have to worry about it expanding/contracting which could make gaps over time in laminate or wood. 

Carpet is for sure the cheapest, but it'll get destroyed by tenants pretty quickly. Replacing carpet after tenants moved out was something I dealt with in sales almost weekly. I'd rather pay a little more for something that'll last for many years than have to replace the carpet every time a tenant leaves. 

Vinyl tile (the hardy stuff that looks like real stone/ceramic tile and gets grouted in, not the multicolor squares you'd find at the gym) are great for areas where you don't want a wood look. Basically the same strength and durability as the planks and they won't crack like ceramic tile can under stress, be it the subfloor shifting or dropping something heavy. 

Some vinyl planks and other kinds of flooring have a "lifetime warranty" or a "20-50 year warranty" but that's just a marketing gimmick. Warranty only applies to an owner occupied personal residence, you need to have it professionally installed and professionally maintained, and just about anything that you do will void the warranty. 

Now that I work with accelerated depreciation on commercial and rental property I know another good thing about the vinyl planks is you can depreciate it over 5 years as long as it's a floating installation and not glued down. Flooring that's considered permanent and structural like solid hardwood and ceramic tile have to use the 27.5 year schedule, so if it's a big project thats a pretty significant tax benefit. Another thing on that is if you install it yourself you can only write off the material costs while if you pay someone to install it you can write off the material and labor costs. 

Shop around a bit and get a good deal, but remember you get what you pay for. Find a good independent installer with fair pricing, purchase the materials yourself unless the installer can get a better discount and will pass those savings onto you. You'll likely pay half the installation charge that way rather than getting a "package deal" from a bigger company or a "free installation" Note: I worked for a bigger company and the install charge and product markup were ridiculous. 

@Evan Barney the 100% bonus depreciation in the new tax law allows 100% of the allowable depreciation on assets under 20 year class life to be taken immediately instead of spreading the depreciation out over many years. This generally includes any 3,5,7,15 year assets placed in service 2018-2023.

The de minimis safe harbor allows full expensing rather than capitalizing and depreciating small amounts paid for tangible property up to $2,500 (or $5,000 with an applicable financial statement) 

Hope this helps and good luck with school!

@Craig Poskus cost of study depends on the property specifics. It also depends on the quality of the study. A detailed forensic study with a full 32 division building code tax asset detail will generally cost a bit more than a modeling or sampling study that isn't as accurate or detailed. As with everything you get what you pay for, and I wouldn't accept anything less than the best methodology. 

You can get a desktop study done using modeling for around $2,000 usually, but it likely won't hold up under audit and won't get as much benefit as a forensic study. 

Cost segregation fees are for professional service and are fully tax deductible, so the true cost of the study will be lowered depending on your marginal tax rate. 

The de minimis safe harbor rules (deducting tangible property costing $2,500 or less, $5,000 or less with an applicable financial statement) don't make a distinction between units being currently rented or under renovation as far as I know. But from what you've said it doesn't appear that what you're doing qualifies since you did a $75,000 renovation, it'd be tough to claim that was 30 independent $2,500 projects with de minimis. De minimis is more "I had to replace the toilet" than "I remodeled the bathroom" or in your case "I remodeled the entire building" But de minimis is not my expertise thats more of a CPA question, we do forensic cost segregation on entire buildings or tenant improvements.

@Ricky Stafford Wow that's a tricky one! Since they built it in the 80's bit by bit I'm guessing there's right around zero chance that their adjusted basis is higher than the FMV in 2013. So the FMV doesn't really matter but maybe you can use it to back up the reasonableness of what you figure out. You're going to have to estimate it in good faith and just go with that.

With the lack of records there's really no way for you, your parents or even the IRS to know what the actual cost basis is on the property. So there's really no way for you to get in trouble with the IRS on this unless your basis is deemed "unreasonable" so just be reasonable. 

I'd take @Michael Plaks advice and estimate based on historical averages. As long as you figure it out in a way that makes sense you should be fine.

One thing on the depreciation though, definitely do not amend your returns to take depreciation as thats a red flag and the improper way to adjust depreciation. File Form 3115 instead since it doesn't require amending, you can file it at any time and you'll get your catch-up depreciation credited to your taxpayer account within 30 days. Since you're only renting out 33% of the house this isn't going to be a big amount of depreciation anyway, but if you ever do sell it's much better to have taken it than not because there's recapture either way.

Yep @Dave Foster the depreciation schedule on the excess will still be 27.5 year for residential rental property and 39 year for non-residential commercial property.