Buying real estate to offset other businesses

[Matthew Ficorilli]

I have a general question about business and real estate. I keep hearing places that people often buy real estate to offset other businesses. Is this just for tax purposes? I need some more detail on this subject. Thanks in advance BP world!

[Steven Hamilton II]

Originally posted by @David C.:

I suspect that they are talking about the benefit of depreciation expense.
disclaimer: not an accountant, not tax advice, not legal advice.
A % of the value of the property you are invested in can be taken as an expense on your taxes each year - this is somewhere around 1/30th of the value(I think you can't count the land, just the building) - and the years are probably tricker than 30 like 27.5 or different based on the property.

But say you are a successful doctor - you make 400k/year and are in a very high tax bracket. All you short term gains are taxed at a very high rate - because they 'sit on top' of your income.

If you buy a million dollar property - each you can take roughly 30,000 in 'depreciation expense' - even though the cash is not leaving your pocket. You use that to offset your net income from the property and if the income is lower than that - it can offset other investment income, and eventually even 3,000 of your doctor income.

You get nailed on this when you sell - because deprecation reduces you 'cost basis' - so your 'gain' gets bigger - even if you sell it for the same 1 million after 30 years, instead of having no gain, you have depreciated it down to zero, so you have a million dollar gain. This can be avoided by dying and letting someone inherit it (the cost basis goes back up) - or by doing a 1031 exchange where you sell one property and re-invest. Often these investors keep 1031'ing into bigger and bigger properties as they use up the depreciation on each one.

Numbers are very rough - explanation probably has a few flaws - but this is the basics.

David,

That is not exactly correct.

Depreciation on a residential building is taken over 27.5 years. That means. 1,000,000 - 10% land value = 900k / 27.5 years = 32,727.28 of depreciation per year to offset the income on the building.

If you paid cash:
If the building is grossing 60k per year in rent. Half of that to expenses (50% rule) you will have 30k in net income. Minus 32,727.28 of depreciation. You will have a "loss" of 2,727.28 That will NOT be deductible if your income is over 150k.

If you income is between 100k and 150k. You lose .50 of a special 25k allowance for every dollar of income over 100k.

Depreciation will be recaptured upon selling This is capped at a maximum tax rate of 25%. Your long term capital gain over that will be taxed at 15 or 20%.

The part about 1031 exchanges and "step up" in basis upon death is correct.

@Matthew Ficorilli here is the correct information.