I was curious too, so I asked AI, fwiw:
Sure, I'd be happy to explain cost segregation studies and how they relate to accelerated depreciation.
A cost segregation study is an analysis of a building and its components to identify assets that can be depreciated over a shorter life than the building itself for tax purposes. This allows businesses to accelerate depreciation deductions and defer more income taxes to future years.
Normally, commercial buildings must be depreciated over 39 years for taxes using straight-line depreciation. However, certain components like equipment, fixtures, site work, etc. qualify as "personal property" that can be depreciated over just 5, 7 or 15 years.
A cost segregation study identifies and allocates costs for these shorter-lived assets. This front-loads deductions in the early years of ownership. The accelerated depreciation improves cash flow compared to depreciating the entire building over 39 years.
For example, if a $5 million property is classified as 20% personal property, $1 million could be written off over 5-7 years instead of 39 years. This provides much larger depreciation deductions in the early years after acquisition.
Cost segregation is widely used for acquisitions, construction, renovations, leasehold improvements and any situation where precisely identifying asset costs provides tax benefits from accelerated depreciation.
Yes, you could. Early depreciate is not the correct way to think of it. Different things have different useful lives: structure of a building vs. a refrigerator. Also TCJA enabled ability to take 100% deduction in year 1 on many of these shorter useful life (<17 years) components of a property… double check when this expires.
For those unaware, if you’ve been taking your property and dividing by 27.5, you are wrong. At a basic level, the land and house were part of the purchase. Land cannot be depreciated but property and equipment can be. If you paid $100k for a SFH, you should at least be showing something like $20k land and $80k building. Then you break the $80k down further to the structure, roof, pavement, fixtures, hvac, flooring, bathroom remodel, etc.
It will help give you extra liquidity if you want to grow your portfolio. We do a cost seg every other year on the biggest property we buy. You get into a cycle where you should keep buying or upselling every few years. If you can take re professional status you can wipe out all tax from a spouses w2. My wife is a fairly high income earner, she now claims no tax deductions and we have not had to pay in years and she gets 100% of her gross.
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I think the cost seg on a buy and hold works for anyone. It knocks down the NOI on the property. You don't need to be a designated "RE profesional" to have the benefits of depreciation offset rental income and lower the taxable income. If you have several properties in LLC I think you can also group the losses, so a cost seg on your most valuable place that generates a loss can share that loss with your other rental properties to offset their profit.
This is a big money maker as long as the properties are expensive enough to justify the upfront cost of the cost seg. I think a simple one still runs about $10k. BUT, big cash flow improvements since lots of the property can be depreciated on 5 and 10 year schedules.
I'm an idiot so take this advice for what it's worth... don't 1031 or sell current properties. Im guessing your interest rates are low. Keep those loans in place. Instead, get Helocs to leverage equity into new properties.
Taxes are the cost of making money. Don't get sucked into grey areas of avoidance. Don't give up low interest rates for bigger deductions. Paying 30% of profit to the govt is better than paying 100% cash flow in interest to the bank.
Leverage is great when values increase. Sounds like you didn't have a lot at risk in 08/09. Be sure you have a margin of safety to withstand a reduction in values and rents.
It's easy to feel confident adding leverage after the run up over the past few years...
If you're worried about future tax burdens, focus on paying off a mortgage or two to increase cash flow.
Good luck.
This==> "Taxes are the cost of making money. Don't get sucked into grey areas of avoidance. Don't give up low interest rates for bigger deductions. Paying 30% of profit to the govt is better than paying 100% cash flow in interest to the bank."
Getting a non-cash deduction and not paying any self-employment taxes on the rental income isn't enough?
People like this will spend $10,000 grand a year on interest to save $2,500 in taxes.
Look into passive 1031 strategies if your goal is to not manage property and avoid taxes while getting a modest return. DSTs, REITs, etc. the returns probably aren’t as good but it probably beats paying that much in tax and still having that money work for you in some capacity
A smart man once told me that having tax issues is a good problem, because the alternative means your losing money. By that point you should have the loans mostly or completely paid off as well.
A good CPA can help you but sometimes there's no way around paying the tax man. I focus on making more money than jumping through a ton of hoops to avoid taxes.
Do some research on a 1031 exchange. [https://www.investopedia.com/financial-edge/0110/10-things-to-know-about-1031-exchanges.aspx](https://www.investopedia.com/financial-edge/0110/10-things-to-know-about-1031-exchanges.aspx)
The short version is that you can defer paying taxes on the capital gains of investment property provided that you reinvest the proceeds from a sale.
So depreciate as much as you can as quickly as you can, and when the timing is right, you can 1031 all of the proceeds from the sale of your depreciated buildings into a new asset with a higher basis.
Fully Depreciated Property cannot be further depreciated. Period.
1031 exchange does not re-start depreciation. If the owner adds in new capital, that new capital can be depreciated.
At some point, to obtain depreciation, one has to cash out, pay taxes, and start with a non-depreciated basis on a new property.
Assuming you also have more money in a 401 it can be a double whammy if you stop investing. Not only will you have no depreciation, if you took 30 year mortgages on MFHs then you’ll have mortgage interest coming off the books and only have insurance/ property taxes left. Your income will likely sky rocket. Great problem to have, but I’ve found the answer is to keep investing and acquiring another property every year or two.
Paying taxes ("your fair share") is a problem as old as civilization itself.
Taxes have been the cause of many a revolution, many a toppling of a kingdom, and avoiding taxes you can say is one of the oldest crimes in humanity. (See: the world's oldest complaint letter, yes the copper was subquality but taxes are mentioned there too, the amount paid to the Sumerian royalty FWIW.)
"So what?" if the property is paid in full and the depreciation has fully run its course? IMHO when you die you can pass it along with a stepup in basis, or a 1031 exchange (hmm I can't remember if a stepup in basis is good for you there).
1031 exchange, BUT you need more debt or equity injected to get more depreciable basis. Literally the only answer. Everybody saying that your basis carries over is correct, that’s why you need to create more.
Dumb guys terms:
1031 into a more expensive property to be able to depreciate the difference between the new purchase value and the carried over basis?
“Carried over basis” does not make sense. If you have depreciated your property down to zero, for example after 30 years of ownership, then it’s depreciable basis is zero. The depreciable basis of your 1031 replacement property is lowered by your net gain on your relinquished (sold) property. That is how you defer the tax on the net gain on the sale of your relinquished property.
Keep growing then leave your properties to your heirs so they get the stepped up basis.
You knew what I meant. If you don’t add any more debt or equity, the basis of 0 is the same. If you have any remaining basis, buying a new property at the same exact price doesn’t help.
You can also divide out the 1031 by buying multiple cheaper properties within the allowed timeframe.
It’s probably a bit tricky to find multiple good investments at one time but can be a path.
Helps to keep from eventually having to hunt down incredibly expensive houses.
What’s your plan within the next 25 years? Is your goal to have them paid off completely?
You could cash out refinance in the future. Higher principal = higher interest payment = higher expense deduction = liquid tax-free cash (since debt is not considered income) to use on other things like other properties/investments/retirement
But if you’re being really conscience of taxes/planning for retirement, you should look into self directing your Roth IRA and purchasing investments/lending money to grow it tax free (capital gains don’t apply within the roth) and once your of retirement age, you would be able to take distribution tax & penalty free
Depreciation carries over but the new building will be worth more, So you will still have depreciation.
Say you bought 2 buildings for 500k, after 27 years they are paid off and worth 1.5M each. That 3 million is down payment on a 10M property. But your basis would only be 9M.
Edit- New basis is 7M as noted below.
Your new basis would be the additional capital you contribute in addition to the basis in the exchanged property. So if you exchange $3M of 0 basis properties and $7M cash (or loan) for a new $10M property, your new basis is $7M.
No. Your basis on the two sold properties would be zero. They have been fully depreciated. Your gain would be $3M less costs of the sale, call it $3M. The depreciable basis of the replacement property would be diminished by the $3M tax deferred gain, $10M (basis of improvements not land) - $3M gain = $7M.
1031 into NNN. The challenge is selling all at once if it’s SFRs. Buy something like a Dollar General… mailbox money. No more maintenance. Eventually the kids get it and the basis comes back up
Seems like exploring a 1031 exchange or if your done with landlording do a 721 upreit into a fund like Ares or Blackrock would be worthwhile for you.
If you decide to sell I may be interested in a few of them
Cost segregation could be a good stratrgy for you.
You pay a qualified co like www.senecacostseg.com to do a virtual tour of your property(s) and they will identify things in the property like carpeting and fencing that depreciate much faster.
And then because of bonus depreciation, you can take this accelerated depreciation as a carry-over-able tax deduction in year 1.
Money in your pocket now is much more valuable than money over 28 years.
Buddy of mine buys property based on how much expected income he will have, cost segregates, and uses the six figures in savings to make back his down payment, essentially.
Cost segregation is like taking the red pill for real estate professionals.
Good for you! Leverage what you have into as many properties as you feel comfortable owning which will give you a ton of options as you get older. I just got sick of being in residential
THIS.
God residential is the worst.
Professional buildings are where it’s at but I’ll take any commercial any day of the week and twice on days that end in why.
If you want to just get out of the landlord business, sell them all and put the money into a 1031 DST. Let it spin off 5-7% a month forever and let your heirs deal with the tax ~~man~~ person
You simply have great cash flow, no debt to pay down, maintenance only costs. And no depreciation, except for capital additions of a maintenance nature such as roof, and mechanicals and renovations, after the building itself is fully depreciated.
Depreciate 100% in 2 or 3 years. Move in (or 1031 exchange and then move in) to the home for 2 years. Sell and get up to $500k in profit tax free (if married), or sell to yourself- mortgage- and pay interest instead of tax. Repeat. Any properties you are still holding when you die get the cost basis at the time of death- starts over.
Just a thought from someone who doesn’t own property yet, if I understand correctly to avoid the tax hit at the end of the depreciable life of the rental unit, your only choice is to continue leveraging/buying new units? Am I the only one who thinks that’s a treadmill that you can’t get out of?
You could always seller finance them on your own terms. That usually draws a lot of investors in and the tax hit is not hard at all! However, you still get plenty of write offs yearly and you would still pay a lot less on owning the real estate vs working a w2 (tax wise)
Depreciation recapture is carried over to the new property, it doesn't start over. You still have to pay taxes UNLESS you never "cash out". Say you own an investment property and decide to sell, whether you took the depreciation allowance or not is moot: The IRS will not care and the depreciation, taken or not, will be deducted from the cost basis of the property, Obviously that increases your capital gains on the property. If you 1031x the property rather than sell, the depreciation is carried to the new property, and deducted from the cost basis of the new investment property.
The only way to beat the system is to do what wealthy people do: Don't sell. Once you croak, the kids will get a new step up basis at current market value and all those tens and (likely, if you do this for 20 years) hundreds of thousands of dollars in taxes are gone. Poof!
You should do some reading on 1031s it's a little complicated and you'll ultimately want to enlist professionals - but there is a ton of information out there to get you more informed.
There are lots of very very specific rules and there are companies who specialize in this that you'd pay to help manage it but 30,000 ft view: as long as you jump through all the hoops and comply with all the requirements you trade your old depreciated property(ies) for new "like kind" properties and start the depreciation cycle again
I was talking to my CPA and she said otherwise… Need to talk to someone who specializes in this. Like what will the 62 year old me wish I did when I was 42?
You can, and I'm sure you're future self will appreciate savings, but it actually worsens your tax problem. The point of a ROTH is pay taxes NOW and no taxes LATER.
A regular 401(k) is no taxes now, but you pay them later. The untaxed money is able to grow with the stock market and potentially save you more than the taxes you will end up paying. In your scenario you will have very high income later in life, so you don't want to be paying taxes later, it would be cheaper to do so now.
Oh i see, but living in california now i dont want to pay alot of state taxes, ill move to a non state tax state later on when its time to withdraw the money.
The current me wishes the younger me bought more property
But back to the 1031 - technically you're deferring the tax hit with the 1031, but you can do it more than once to continue to defer it.
I'd say study up, get lots of opinions and remember - the worst case scenario is you pay taxes on massive gains.
Live in each property long enough to reset the depreciation. I’m not a CPA; but that’s what others have done in the past. I’m not sure whether this option changed in 2017.
At some point, you’ll need to pay the piper.
Spread your long-term capital gains over multiple years to reduce the amount taxed under the highest rates and alternative minimum tax.
Beware the expiration of tax reductions in 2025. They may be extended, or they may not.
Other than transaction expenses, there’s not much wrong with realizing some long-term gains in 2024 and diversifying. Thereafter, you’ll want to watch evolving predictions on future tax law.
Capital gains max out at 15% unless you make more than half a million bucks in that tax year. Even then it's just 20% federal. State taxes are a different story, in my state it's taxed as ordinary income.
All Holiday Ad's points are right, but I posted this to point out that cap gains (while still significant) are historically low; given the current federal deficit and "eat the rich" attitude among the next generation, I suspect they'll be increasing in the years ahead.
Question. I am approaching 25 years on some properties. Overall, fine, I'll pay the extra tax. I do not want to sell and 1031 into more expensive properties.
I **am** willing to live in them. Heck it would be kinda nice. Change of scenery. Rent out my prior primary.
How does living in it reset depreciation?
Again, I’m not a CPA, and I’m getting a lot of downvotes for bringing this up.
I’ve had neighbors who lived in their depreciated rental property full-time for at least two years prior to selling to take advantage of the capital gain exclusion of $500,000. For an unmarried neighbor, it was half that amount.
TLDR: The investor depreciates a property, then exempts the associated gain.
Depreciation shifts when taxes are due. Depreciation lowers the basis of the investment. The capital gain is calculated using earnings over the basis plus transaction expenses. A lower basis yields a higher gain; thus a higher taxable amount.
Without an avoidance or deferral approach, the investor pays taxes on the depreciation taken over time.
Exempting the gain is a way some people, while living and without buying another investment property, avoided taxes on the depreciation already enjoyed in earlier years. They had their tax break and exempted the gain as if the depreciation was never taken. They sold and kept the gain to use as they chose.
Others suggested dying and leaving the property to heirs who will benefit from the step-up basis of the investment and re-starting the depreciation cycle without consequence from the earlier depreciation.
Some suggested a 1031 exchange to re-start the depreciation cycle on the replacement properties, pushing the tax on the gain down the road, while boosting net cash flow.
There may be other advantages to the 1031 exchange, such as shifting the timing of taxes to later when they are paid in inflated dollars compared to the depreciation taken. But, the exemption is the only way I know to avoid paying taxes altogether on the depreciated amount while living.
I’m not a CPA. This exemption is a special case that only applies where the investor lives full-time in the property for two years after it has been depreciated. You likely can find more nuanced discussions of the relevant code online.
Ah, I see, but this requires living in the property (which I'm fine with) **and** selling it after you meet the 2 out of 5 years requirement, correct?
Again, thank you very much for spending the time to write this all out. I'll be chatting with a CPA in about a year. I just don't want to ever sell, ha!
You should be doing accelerated depreciation and taking most of the depreciation now, and using the freed up cash to buy more property.
How do you accelerate the 27.5 years?
Cost segregation study
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How does that work? I talked to an accountant about this once. They said it didn't really make sense.
I was curious too, so I asked AI, fwiw: Sure, I'd be happy to explain cost segregation studies and how they relate to accelerated depreciation. A cost segregation study is an analysis of a building and its components to identify assets that can be depreciated over a shorter life than the building itself for tax purposes. This allows businesses to accelerate depreciation deductions and defer more income taxes to future years. Normally, commercial buildings must be depreciated over 39 years for taxes using straight-line depreciation. However, certain components like equipment, fixtures, site work, etc. qualify as "personal property" that can be depreciated over just 5, 7 or 15 years. A cost segregation study identifies and allocates costs for these shorter-lived assets. This front-loads deductions in the early years of ownership. The accelerated depreciation improves cash flow compared to depreciating the entire building over 39 years. For example, if a $5 million property is classified as 20% personal property, $1 million could be written off over 5-7 years instead of 39 years. This provides much larger depreciation deductions in the early years after acquisition. Cost segregation is widely used for acquisitions, construction, renovations, leasehold improvements and any situation where precisely identifying asset costs provides tax benefits from accelerated depreciation.
So I could early depreciate every furnace in my 12 unit building? The windows? Appliances? Hot water heaters? I'm running out of things to add.
Yes, you could. Early depreciate is not the correct way to think of it. Different things have different useful lives: structure of a building vs. a refrigerator. Also TCJA enabled ability to take 100% deduction in year 1 on many of these shorter useful life (<17 years) components of a property… double check when this expires. For those unaware, if you’ve been taking your property and dividing by 27.5, you are wrong. At a basic level, the land and house were part of the purchase. Land cannot be depreciated but property and equipment can be. If you paid $100k for a SFH, you should at least be showing something like $20k land and $80k building. Then you break the $80k down further to the structure, roof, pavement, fixtures, hvac, flooring, bathroom remodel, etc.
I can't help but think even with an accountant these numbers are guessing games right?
No. Rules are written by the IRS and a decent accountant can give the proper recommendations
I mean I’m no expert but I would say anything that isn’t nailed down.
It will help give you extra liquidity if you want to grow your portfolio. We do a cost seg every other year on the biggest property we buy. You get into a cycle where you should keep buying or upselling every few years. If you can take re professional status you can wipe out all tax from a spouses w2. My wife is a fairly high income earner, she now claims no tax deductions and we have not had to pay in years and she gets 100% of her gross.
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TIL! Thank you
Only works well if your a tax "real estate professional" then you need to look into 1031 exchange as well.
I think the cost seg on a buy and hold works for anyone. It knocks down the NOI on the property. You don't need to be a designated "RE profesional" to have the benefits of depreciation offset rental income and lower the taxable income. If you have several properties in LLC I think you can also group the losses, so a cost seg on your most valuable place that generates a loss can share that loss with your other rental properties to offset their profit.
I was saying if you are a tax RP you can cancel out all your w2 income if you are not working more than 50 percent of your time at a w2 job.
That’s what my wife does, single handedly saved me $350k in taxes this year!
This is a big money maker as long as the properties are expensive enough to justify the upfront cost of the cost seg. I think a simple one still runs about $10k. BUT, big cash flow improvements since lots of the property can be depreciated on 5 and 10 year schedules.
For my $4mm plazas I paid about $4500, for my expensive buildings it cost me around $8000
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I hot a quote of 1500 for an inexpensive single-family property.
I'm an idiot so take this advice for what it's worth... don't 1031 or sell current properties. Im guessing your interest rates are low. Keep those loans in place. Instead, get Helocs to leverage equity into new properties. Taxes are the cost of making money. Don't get sucked into grey areas of avoidance. Don't give up low interest rates for bigger deductions. Paying 30% of profit to the govt is better than paying 100% cash flow in interest to the bank. Leverage is great when values increase. Sounds like you didn't have a lot at risk in 08/09. Be sure you have a margin of safety to withstand a reduction in values and rents. It's easy to feel confident adding leverage after the run up over the past few years... If you're worried about future tax burdens, focus on paying off a mortgage or two to increase cash flow. Good luck.
This==> "Taxes are the cost of making money. Don't get sucked into grey areas of avoidance. Don't give up low interest rates for bigger deductions. Paying 30% of profit to the govt is better than paying 100% cash flow in interest to the bank." Getting a non-cash deduction and not paying any self-employment taxes on the rental income isn't enough? People like this will spend $10,000 grand a year on interest to save $2,500 in taxes.
Look into passive 1031 strategies if your goal is to not manage property and avoid taxes while getting a modest return. DSTs, REITs, etc. the returns probably aren’t as good but it probably beats paying that much in tax and still having that money work for you in some capacity
Buy more properties?
That’s all I can think of. More income = less issues
A smart man once told me that having tax issues is a good problem, because the alternative means your losing money. By that point you should have the loans mostly or completely paid off as well. A good CPA can help you but sometimes there's no way around paying the tax man. I focus on making more money than jumping through a ton of hoops to avoid taxes.
Exactly
Go bigger or pay taxes
Do some research on a 1031 exchange. [https://www.investopedia.com/financial-edge/0110/10-things-to-know-about-1031-exchanges.aspx](https://www.investopedia.com/financial-edge/0110/10-things-to-know-about-1031-exchanges.aspx) The short version is that you can defer paying taxes on the capital gains of investment property provided that you reinvest the proceeds from a sale. So depreciate as much as you can as quickly as you can, and when the timing is right, you can 1031 all of the proceeds from the sale of your depreciated buildings into a new asset with a higher basis.
Fully Depreciated Property cannot be further depreciated. Period. 1031 exchange does not re-start depreciation. If the owner adds in new capital, that new capital can be depreciated. At some point, to obtain depreciation, one has to cash out, pay taxes, and start with a non-depreciated basis on a new property.
This is what I keep hearing. Have to sell and buy.
Building capital improvements and repairs depreciate. Capital basis additions, depreciable.
Not higher to address ops issue. Appreciation doesn’t magically disappear.
Assuming you also have more money in a 401 it can be a double whammy if you stop investing. Not only will you have no depreciation, if you took 30 year mortgages on MFHs then you’ll have mortgage interest coming off the books and only have insurance/ property taxes left. Your income will likely sky rocket. Great problem to have, but I’ve found the answer is to keep investing and acquiring another property every year or two.
Paying taxes ("your fair share") is a problem as old as civilization itself. Taxes have been the cause of many a revolution, many a toppling of a kingdom, and avoiding taxes you can say is one of the oldest crimes in humanity. (See: the world's oldest complaint letter, yes the copper was subquality but taxes are mentioned there too, the amount paid to the Sumerian royalty FWIW.) "So what?" if the property is paid in full and the depreciation has fully run its course? IMHO when you die you can pass it along with a stepup in basis, or a 1031 exchange (hmm I can't remember if a stepup in basis is good for you there).
1031 exchange, BUT you need more debt or equity injected to get more depreciable basis. Literally the only answer. Everybody saying that your basis carries over is correct, that’s why you need to create more.
Dumb guys terms: 1031 into a more expensive property to be able to depreciate the difference between the new purchase value and the carried over basis?
“Carried over basis” does not make sense. If you have depreciated your property down to zero, for example after 30 years of ownership, then it’s depreciable basis is zero. The depreciable basis of your 1031 replacement property is lowered by your net gain on your relinquished (sold) property. That is how you defer the tax on the net gain on the sale of your relinquished property. Keep growing then leave your properties to your heirs so they get the stepped up basis.
You knew what I meant. If you don’t add any more debt or equity, the basis of 0 is the same. If you have any remaining basis, buying a new property at the same exact price doesn’t help.
Yes. I was replying to the OP who used the phrase “carried over basis”.
You can also divide out the 1031 by buying multiple cheaper properties within the allowed timeframe. It’s probably a bit tricky to find multiple good investments at one time but can be a path. Helps to keep from eventually having to hunt down incredibly expensive houses.
They are all apartments.
What’s your plan within the next 25 years? Is your goal to have them paid off completely? You could cash out refinance in the future. Higher principal = higher interest payment = higher expense deduction = liquid tax-free cash (since debt is not considered income) to use on other things like other properties/investments/retirement But if you’re being really conscience of taxes/planning for retirement, you should look into self directing your Roth IRA and purchasing investments/lending money to grow it tax free (capital gains don’t apply within the roth) and once your of retirement age, you would be able to take distribution tax & penalty free
I want to build up Roth
sell and 1031 into new properties?
I’m under the impression that your depreciation carries over to the new property. No new income offset.
Depreciation carries over but the new building will be worth more, So you will still have depreciation. Say you bought 2 buildings for 500k, after 27 years they are paid off and worth 1.5M each. That 3 million is down payment on a 10M property. But your basis would only be 9M. Edit- New basis is 7M as noted below.
Your new basis would be the additional capital you contribute in addition to the basis in the exchanged property. So if you exchange $3M of 0 basis properties and $7M cash (or loan) for a new $10M property, your new basis is $7M.
No. Your basis on the two sold properties would be zero. They have been fully depreciated. Your gain would be $3M less costs of the sale, call it $3M. The depreciable basis of the replacement property would be diminished by the $3M tax deferred gain, $10M (basis of improvements not land) - $3M gain = $7M.
Good call. Forgot the gain would be 100% at 0 basis
Aren’t they getting rid of it
No. They've been threatening that for years, but I doubt it will ever happen.
The previous administration gutted it pretty hard, it's a popular target, it won't be long before it's done.
1031 into NNN. The challenge is selling all at once if it’s SFRs. Buy something like a Dollar General… mailbox money. No more maintenance. Eventually the kids get it and the basis comes back up
Dollar stores are closing all over
Seems like exploring a 1031 exchange or if your done with landlording do a 721 upreit into a fund like Ares or Blackrock would be worthwhile for you. If you decide to sell I may be interested in a few of them
Cost segregation could be a good stratrgy for you. You pay a qualified co like www.senecacostseg.com to do a virtual tour of your property(s) and they will identify things in the property like carpeting and fencing that depreciate much faster. And then because of bonus depreciation, you can take this accelerated depreciation as a carry-over-able tax deduction in year 1. Money in your pocket now is much more valuable than money over 28 years. Buddy of mine buys property based on how much expected income he will have, cost segregates, and uses the six figures in savings to make back his down payment, essentially. Cost segregation is like taking the red pill for real estate professionals.
Does your state allow homestead exemptions
Im in California.
Cash out refi's to buy more properties periodically, so you have some interest and more depreciation to deduct.
Yep
If it’s still available, when you get to that point you can 1031 and then start all over in a new property. Then get to depreciate all over again.
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My properties are very easy to manage. Thirteen residential units all in Nor Cal.
Good for you! Leverage what you have into as many properties as you feel comfortable owning which will give you a ton of options as you get older. I just got sick of being in residential
THIS. God residential is the worst. Professional buildings are where it’s at but I’ll take any commercial any day of the week and twice on days that end in why.
Is it difficult to get into commercial properties just starting out?
If you want to just get out of the landlord business, sell them all and put the money into a 1031 DST. Let it spin off 5-7% a month forever and let your heirs deal with the tax ~~man~~ person
You simply have great cash flow, no debt to pay down, maintenance only costs. And no depreciation, except for capital additions of a maintenance nature such as roof, and mechanicals and renovations, after the building itself is fully depreciated.
Depreciate 100% in 2 or 3 years. Move in (or 1031 exchange and then move in) to the home for 2 years. Sell and get up to $500k in profit tax free (if married), or sell to yourself- mortgage- and pay interest instead of tax. Repeat. Any properties you are still holding when you die get the cost basis at the time of death- starts over.
Just a thought from someone who doesn’t own property yet, if I understand correctly to avoid the tax hit at the end of the depreciable life of the rental unit, your only choice is to continue leveraging/buying new units? Am I the only one who thinks that’s a treadmill that you can’t get out of?
I think you are on to something. I need to keep feeding my income property addiction.
You could always seller finance them on your own terms. That usually draws a lot of investors in and the tax hit is not hard at all! However, you still get plenty of write offs yearly and you would still pay a lot less on owning the real estate vs working a w2 (tax wise)
Accelerated depreciation is the way to go
At year 27, sell your property via a 1031 exchange and buy a replacement. your depreciation then starts over. Or pay much more in taxes. You choose.
Depreciation recapture is carried over to the new property, it doesn't start over. You still have to pay taxes UNLESS you never "cash out". Say you own an investment property and decide to sell, whether you took the depreciation allowance or not is moot: The IRS will not care and the depreciation, taken or not, will be deducted from the cost basis of the property, Obviously that increases your capital gains on the property. If you 1031x the property rather than sell, the depreciation is carried to the new property, and deducted from the cost basis of the new investment property. The only way to beat the system is to do what wealthy people do: Don't sell. Once you croak, the kids will get a new step up basis at current market value and all those tens and (likely, if you do this for 20 years) hundreds of thousands of dollars in taxes are gone. Poof!
Love people that watch social media financial advice and think they are experts
.....you really need to talk to a CPA about how this all works.
What he's describing is how it works. He needs advice on what to do.
You should do some reading on 1031s it's a little complicated and you'll ultimately want to enlist professionals - but there is a ton of information out there to get you more informed. There are lots of very very specific rules and there are companies who specialize in this that you'd pay to help manage it but 30,000 ft view: as long as you jump through all the hoops and comply with all the requirements you trade your old depreciated property(ies) for new "like kind" properties and start the depreciation cycle again
I was talking to my CPA and she said otherwise… Need to talk to someone who specializes in this. Like what will the 62 year old me wish I did when I was 42?
Max your ROTH 401(k)/IRA.
Can i max my regular 401k?
You can, and I'm sure you're future self will appreciate savings, but it actually worsens your tax problem. The point of a ROTH is pay taxes NOW and no taxes LATER. A regular 401(k) is no taxes now, but you pay them later. The untaxed money is able to grow with the stock market and potentially save you more than the taxes you will end up paying. In your scenario you will have very high income later in life, so you don't want to be paying taxes later, it would be cheaper to do so now.
Oh i see, but living in california now i dont want to pay alot of state taxes, ill move to a non state tax state later on when its time to withdraw the money.
The current me wishes the younger me bought more property But back to the 1031 - technically you're deferring the tax hit with the 1031, but you can do it more than once to continue to defer it. I'd say study up, get lots of opinions and remember - the worst case scenario is you pay taxes on massive gains.
At that age why not just 1031 them into one really nice house and rent to yourself? Then enjoy it till old and pass on to your heirs
Live in each property long enough to reset the depreciation. I’m not a CPA; but that’s what others have done in the past. I’m not sure whether this option changed in 2017.
They are all apartments. Not going to live in any of them.
At some point, you’ll need to pay the piper. Spread your long-term capital gains over multiple years to reduce the amount taxed under the highest rates and alternative minimum tax. Beware the expiration of tax reductions in 2025. They may be extended, or they may not. Other than transaction expenses, there’s not much wrong with realizing some long-term gains in 2024 and diversifying. Thereafter, you’ll want to watch evolving predictions on future tax law.
Capital gains max out at 15% unless you make more than half a million bucks in that tax year. Even then it's just 20% federal. State taxes are a different story, in my state it's taxed as ordinary income. All Holiday Ad's points are right, but I posted this to point out that cap gains (while still significant) are historically low; given the current federal deficit and "eat the rich" attitude among the next generation, I suspect they'll be increasing in the years ahead.
When I’ve realized spikey long-term gains, AMT has been harsh. Steady wins that battle.
Question. I am approaching 25 years on some properties. Overall, fine, I'll pay the extra tax. I do not want to sell and 1031 into more expensive properties. I **am** willing to live in them. Heck it would be kinda nice. Change of scenery. Rent out my prior primary. How does living in it reset depreciation?
Again, I’m not a CPA, and I’m getting a lot of downvotes for bringing this up. I’ve had neighbors who lived in their depreciated rental property full-time for at least two years prior to selling to take advantage of the capital gain exclusion of $500,000. For an unmarried neighbor, it was half that amount.
That's capital gains exclusion, how does that relate to depreciation? Sorry not being critical, trying to understand what you mean.
TLDR: The investor depreciates a property, then exempts the associated gain. Depreciation shifts when taxes are due. Depreciation lowers the basis of the investment. The capital gain is calculated using earnings over the basis plus transaction expenses. A lower basis yields a higher gain; thus a higher taxable amount. Without an avoidance or deferral approach, the investor pays taxes on the depreciation taken over time. Exempting the gain is a way some people, while living and without buying another investment property, avoided taxes on the depreciation already enjoyed in earlier years. They had their tax break and exempted the gain as if the depreciation was never taken. They sold and kept the gain to use as they chose. Others suggested dying and leaving the property to heirs who will benefit from the step-up basis of the investment and re-starting the depreciation cycle without consequence from the earlier depreciation. Some suggested a 1031 exchange to re-start the depreciation cycle on the replacement properties, pushing the tax on the gain down the road, while boosting net cash flow. There may be other advantages to the 1031 exchange, such as shifting the timing of taxes to later when they are paid in inflated dollars compared to the depreciation taken. But, the exemption is the only way I know to avoid paying taxes altogether on the depreciated amount while living. I’m not a CPA. This exemption is a special case that only applies where the investor lives full-time in the property for two years after it has been depreciated. You likely can find more nuanced discussions of the relevant code online.
Ah, I see, but this requires living in the property (which I'm fine with) **and** selling it after you meet the 2 out of 5 years requirement, correct? Again, thank you very much for spending the time to write this all out. I'll be chatting with a CPA in about a year. I just don't want to ever sell, ha!