Newbie with questions before 1st buy! Entities / Depreciation?

Question

Greetings! I'm a newbie here to Bigger Pockets and excited to start in real estate investing. I've been reading suggested books here like crazy and going through podcasts galore to learn, learn, learn! Some questions here and I'd greatly appreciate the expertise feedback from those on this forum!

1) Entities: I have not created a real estate business entity yet to hold my first property but I'd read that since I'm doing traditional borrowing (i.e. 20% down and financing 80% through bank) I'd have to purchase it in my personal name and then after 2-3 months I can transfer to the entity. Thus, when purchasing my 1st property do I even need the entity yet? I anticipate purchasing a starter single family home (i.e. $100,000-$130,000) in the next few months but if I cannot even transfer it into the entity by the end of the year then should I wait to open the entity/LLC until after the new years so that I don't have to file a tax return for the entity in 2020 and wait to create/transfer property/file tax return in 2021?

2) I live in Virginia but first property will be in Indiana. Do I need to just make one LLC in Indiana and is that enough to hold 1-5 properties there eventually? Or I've read of people doing an LLC in the state for several properties and then a master holding LLC in Wyoming or such for more protection. Is that overkill to make an additional holding entity like Wyoming as a newbie?

3) Taxes and Bonus Depreciation: I have my primary business that gives me significant distributions/K-1 wages on my schedule E as passive income in the ballpark of $50-60k. I'm trying to figure out how to generate passive losses/depreciation from real estate investing. If I were to purchase my first rental property before the end of 2020, I realize that the traditional depreciation "loss" would not be that much but I've read about Bonus Depreciation taking more up front. When I read about Bonus Depreciation thought it seems like this is for large commercial or apartment properties but I haven't seen people doing this for single family homes. My question is how can I maximize the losses/depreciation on the property to offset the passive income from my business? Can I do bonus depreciation on a single family home? Does anyone do a cost segregation study on a single family home? Is the cost to a cost segregation study so high that it makes it not worth it? If doing bonus depreciation in this first year about how much could one expect to depreciate on the front end?

4) I'm trying to figure out the maximum way to generate losses / depreciation to offset other K-1/distributions ... any suggestions for a newbie?

Thanks in advance!!!

Jeff

Jerry W. · Answer

@Jeffrey Sicat, wow. I am actually uncomfortable answering any of your questions. You don't actually seem interested in buying an income property, but just buying a loss for depreciation. I don't think you are going to get what you are looking for with a single family home purchase. The cost of a cost segregation study for a sfr is going to be much higher than it is worth. You need to look at multifamily for huge tax breaks. I would not invest with that as my criteria, I want to invest to make money.

Dave Spooner · Answer

@Jeffrey Sicat Caleb did a great job answering but I wanted to take these on directly:

1) An LLC is about limiting liability. If you just own one SFH as an investment, unless you have substantial other assets, it's probably overkill at this time. Regardless, you do not need to setup that entity this year (based on your circumstances). Next year will be perfectly fine if you choose to pursue it. Speaking with an attorney is a great idea.

2) While speaking to the attorney, you can ask them about this too! It's good to have a relationship with one anyway, so it never hurts to reach out. Creating a series LLC for one property is definitely overkill. I also think creating an LLC specifically in the state sounds like overkill. It could simplify some filing requirements to have the LLC there and depending on state laws, there could be other advantages too, but that's about it as far as I know.

3) If you really want to maximize depreciation, consider a reno job or a BRRRR. Bonus Depreciation and the De Minimis Clause are incredibly powerful. After reaching out to that attorney, I'd contact a good CPA. Sounds like a lot of your interest is in tax advantages and they will be able to help a lot. Regarding cost segregation, it really depends on the property and your investment strategy. Keep in mind that depreciation is recaptured at the time of sale, so if this is a short term flip, it is definitely not a good idea.

4) Too difficult to say without knowing more about the project! But again, a CPA will have all sorts of suggestions.

Good luck!

Caleb Genry · Answer

@Jeffrey Sicat I hope I can help shed some light on quotations you had.

If you are creating a single member LLC, this is called a disregarded entity with the IRS. This means that it is embedded in your tax return and does not require a separate tax return. So it would not matter if you created the entity this year or next. If it was a partnership or S-Corp though, it will have a separate tax return.

In terms of needing a holding entity in Wyoming, I would speak to an attorney, but I think it is overkill, especially as you are starting out. In terms of the number of entities, I have clients that hold each property in a separate entity and some that have them all under 1. Again, speak with an attorney and a lot will depend on your risk tolerance. In my opinion, the cost for a separate LLC is very small compared with the peace it can provide.

If you acquire a property, you can't use bonus depreciation on anything included in the sale unless you do a cost segregation study. If you do any renovation though, there could possibly be bonus depreciation involved. I have had clients who did bonus depreciation on their single family properties and they loved it as they were in a high tax bracket and used it to offset their W-2 income. I think knowing your tax bracket will help make the decision as well as the benefit you would get from it would help make the decision. If you want to be safe, take 20% of the purchase price and that could be around the amount you will get to depreciate in year 1. Obviously it could be more or less, but they is usually a good bet.

Jeffrey Sicat · Answer

@Kevin C. Thanks Kevin, that's very helpful ... so as a new non-RE professionally looks like I have to stick with the regular depreciation schedule ... Thanks for the link ... I'll read in depth!

Kevin C. · Answer

@Jeffrey Sicat For the entity question, it's all about the lenders. If you know which lender you will use, ask them about an LLC. Some will not allow them, some will charge more, etc. Most people use one LLC for each property to separate the assets. Owning multiple properties in a single LLC may only be advisable if the lender would provide better terms for more security (more houses to foreclose on). Buying a property with a loan, then transferring it to an LLC, is not recommended since it is a violation of the loan terms and can trigger a repayment of the loan (even if you didn't sell the house).

For depreciation, look into the Real Estate Professional tax rules. Tony Nitti wrote a good article (link below). You must (1) qualify as a RE Professional (under the Code) and (2) materially participate in the activity to use net real estate losses to offset any active W-2 or active K-1 income.

https://www.thetaxadviser.com/issues/2017/mar/navigating-real-estate-professional-rules.html#:~:text=A%20taxpayer%20qualifies%20as%20a,providing%20personal%20services%20in%20real

Jeffrey Sicat · Answer

Thanks David and thanks Jerry for the insight and replies. For me I'm trying to slowly build a passive income stream and not be an active real estate investor (so no BRRRR for me) so I like both your feedback of keeping it simple in terms of entities until I figure out how this all works... I'm excited to get started! Thanks again!

Jerry W. · Answer

@Jeffrey Sicat, there are so many variables when it comes to entity formation. First if you try to use an LLC the bank will charge you more interest as it is a commercial loan. Normally you cannot get a 30 year loan. You can start with a personal loan, but there is always some risk the lender will get upset if you transfer it to a corporation after you get your loan. Keep in mind that every layer of LLC protection brings with it a small cost and more book work. Each LLC needs it's own bank account, and its own set of books. For me time is very important, so fewer entities, at least in layers is important. I was running only 2 entities for over 40 units, but recently added another entity as there really is too much in one entity. It is really important to keep the books and finances separate. Comingling is one the most common ways to pierce the corporate veil. Undercapitalization is another. Of course keep good insurance. I really like the LLC for most things except flipping or wholesaling. If your bank rates are nearly the same for using an LLC as for personal use the LLC, if not buy in your name and try transferring it later, if the balk then put it back in your name. I wouldn't worry about a second level entity until you get a few up and running. It does occur to me that buying fix up property may help you the most for taxes, but unfortunately you have to put more money into them. Talk to your accountant, they are the best for tax planning. Either way good luck. The big advantage for me in having a real estate company was I lived off of my day job so it really accelerated my company growth. If you keep reinvesting all your income you grow rapidly. In the beginning we usually lost some money every year and had to [pitch in a few thousand at the end of the year to pay land taxes. Now it makes more money and is costing us more in taxes. Again ghood luck.

Jeffrey Sicat · Answer

Hi Caleb, thanks so much for the information... very, very helpful! If I do pursue a cost segregation study for bonus depreciation, do you know how much a ballpark cost would run to do so on a single family residence? It would be helpful to know (i.e. if very expensive not worth it but if not too expensive could save me considerable tax dollars to be able to bonus depreciate)?

Jeffrey Sicat · Answer

@Jerry W.

Greetings Jerry. Thanks for the reply. No I’m quite interested in buying income producing real estate (for the income - not the losses) and am quite interested in getting started. I’m just trying to make sure I protect myself in terms of entities and there is so much written about depreciation benefits and I’m trying to make sure I truly understand these things instead of regretting that I missed something later in. Any feedback would be appreciated!

Newbie with questions before 1st buy! Entities / Depreciation?

Newbie with questions before 1st buy! Entities / Depreciation?

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