Significant Net "Losses" on Taxes despite Positive Cash Flow
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Investor · Wichita, KS · Member since 2017 · 584 posts · 813 votes
7yWhen you’re in front of the banker, you show all the money you are making. When you’re in front of the irs, you show all the money you are not making. That’s real estate. :)
72 Replies
- Investor · Wichita, KS · Member since 2017 · 584 posts · 813 votes7y
When you’re in front of the banker, you show all the money you are making. When you’re in front of the irs, you show all the money you are not making. That’s real estate. :)
- Rental Property Investor · Hummelstown, PA · Member since 2015 · 638 posts · 653 votes7y
@Andrey Y.
That’s how real estate taxes work! Welcome to one of the beauties of real estate.
- Rental Property Investor · Upstate, NY · Member since 2012 · 3k+ posts · 3k+ votes7y
I was audited for two adjacent tax years because of losses & after six 4-5 hour 'meetings', going through reams of logs & receipts, she asked me 'how do you make any money doing this'?
But I still have many friends working 9-5 into their late 60's to 'one day' afford retirement, then working a part-time menial job just to get by.
- Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes7y
Originally posted by @Jonathan R.:
When you’re in front of the banker, you show all the money you are making. When you’re in front of the irs, you show all the money you are not making. That’s real estate. :)
That's a great point! I have had a lender tell me that net losses are bad for getting a loan. He said I should set that up to make it "look better"..
- Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes7y
Originally posted by @Kyle McCorkel:
@Andrey Y.
That’s how real estate taxes work! Welcome to one of the beauties of real estate.
:) Yeah this totally blew me away. I always knew that real estate had good tax advantages but I think yesterday I just had a LIGHTBULB moment.
- Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes7y
Originally posted by @Pat L.:
I was audited for two adjacent tax years because of losses & after six 4-5 hour 'meetings', going through reams of logs & receipts, she asked me 'how do you make any money doing this'?
But I still have many friends working 9-5 into their late 60's to 'one day' afford retirement, then working a part-time menial job just to get by.
That's crazy! However after these years I can definitely say that real estate investing is not passive, no matter how you do it. Semi-passive, sure, however I would still say that its still work. We may happen to enjoy it but nonetheless, its still "working".
Whether it's managing tenants or investing "passively" in large apartment syndications, I still have to spend time on it. Definitely worth it though.
Curious, when you were audited, we're you a real estate professional? As I understand it, you can write off a lot more losses that way. I'm still not sure if the average working person can carry a loss of $3,000 or $25,000. This part always confused me.
- Rental Property Investor · Hummelstown, PA · Member since 2015 · 638 posts · 653 votes7y
Originally posted by @Andrey Y.:
Originally posted by @Kyle McCorkel:
@Andrey Y.
That’s how real estate taxes work! Welcome to one of the beauties of real estate.
:) Yeah this totally blew me away. I always knew that real estate had good tax advantages but I think yesterday I just had a LIGHTBULB moment.
I've had that exact same lightbulb moment. I had it when I read "Tax Free Wealth" by Tom Wheelwright.
That was the moment when I decided I wanted to go big time into real estate.
- Santa Rosa, CA · Member since 2016 · 43 posts · 36 votes7y
Many (most?) business keep two sets of accounting records. One for taxes, and one for investors/banks/executives/etc. The accounting standards for taxes are different than for US GAAP, which is the accounting standard for businesses.
One area that would make a very significant difference is in depreciation. For tax purposes, you refer to the MACRS schedule for how long to depreciate your assets. For property, I believe it's 27.5 years or 39 years (up to you). Under US GAAP, however, you determine the useful life of the asset based on how long you think it will last. The most common I've seen is 40 years, but if you owned a skyscraper in Manhattan I could understand the justification of something longer, maybe even 100 years.
The math looks like this:
Assume you purchased a $100,000 property. For taxes, your annual depreciation expense will be ($100,000/27.5) = $3,636.36. For US GAAP, it's ($100,000/40) = $2,500. So for the IRS, you just lost over $1,000 more in the year.
Also, depreciation is a concept; you don't actually pay for depreciation directly. That's why you can have positive cash flow and still sustain book losses.
Other similar concepts that reduce profits without impacting cash flow are accruals for maintenance and repair, capex accruals, vacancy accruals, etc.
- Edmond, OK · Member since 2012 · 456 posts · 270 votes7y
@Andrey Y. Dont let it blow your mind. By investing your capital, and taking on debt, you're taking on risk whereas the physician working full time W2 os not taking on any capital risk. As @Russell Brazil says, one should know rhat the higher the risk, the more the returns.
I think, all modern economies, 'reward' people who invest capital into the market and take risk, as they would be be keeping the economy humming along, something the government on its own cannot do.
- Edmond, OK · Member since 2012 · 456 posts · 270 votes7y
@Andrey Y. Also, you're probably not owing any taxes because any operational net profit is offset by your depreciation. When you sell, you'd own capital gains on it unless you do a 1035 exchange - which means you're being nudged by the government tax policy to keep your capital tied up in more risk (reinvest in the market).
- 7yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
Depreciation.. and good commercial bankers will add Depreciation back into our income to determine qualifying for their loans.. this can be an issue though with Owner occ type stuff.. were anything that is not positive takes a bunch of explanation.
Although keep in mind when you sell unless you stay in the rental game for the rest of your life.. your going to have recapture.. I am at the tail end of 35 years at this and selling off all my rentals the last 3 years so been dealing with the recapture..
Many start in this and say i will never sell.. but life forces change and thats when you deal with paying it back.. And if yoiu have good equity when You sell you just give some of your equity to IRS.. if you have no equity you have to literally cut a check to sell. This is why we talk about full cycle IRR to really determine what you made.. you will never determine how much U make on a property until you cash out.. or die and leave it to others.
Of course there is 1031.
and clients of mine to charitable remainder trusts and or have their own family foundation were they sell and donate to the foundation.. many ways once you get into the higher net worth were you need to worry about this type of thing
- Rental Property Investor · Brooke Park Drive · Member since 2018 · 1k+ posts · 2k+ votes7y
You can carry over the loss to future years, and if you have a gain in the future the loss can offset the gain. If at some point you pay off the mortgages and you are no longer deducting mortgage interest you might start showing gains at which time you can apply the losses to those gains.
- Member since 2019 · 5 posts · 3 votes7y
Don’t mean to hijack the topic, but I have two tax related questions:
1. What happens to those loss we reported every year. How do you apply it into your future tax report. I heard loss can be used to offset the gain, but I am not sure how.
2. What is the difference in tax reporting whether you are actively or passively having the rental?
PS I have been doing tax myself in the past, but with the rentals, I am getting more and more confused. Thanks in advance.
- Rental Property Investor · Erie, PA · Member since 2018 · 6k+ posts · 9k+ votes7y
Originally posted by @Tony Lee:
Don’t mean to hijack the topic, but I have two tax related questions:
1. What happens to those loss we reported every year. How do you apply it into your future tax report. I heard loss can be used to offset the gain, but I am not sure how.
2. What is the difference in tax reporting whether you are actively or passively having the rental?
PS I have been doing tax myself in the past, but with the rentals, I am getting more and more confused. Thanks in advance.
You need to sit down with a cpa
- Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes7y
@Andrey Y. don't get too excited. Depreciation isn't as great of a deal as it appears to be. Think about it logically. Imagine if you paid cash for a property and outlaid $100,000 expense in 2018. Tthe IRS says you can only claim a portion of it over the course of 27.5 years. So you spend $100,000 and are only allowed to claim $3636 each year. Depreciation is the government reducing your claimable expense and spreading it out over 27.5 years.
Depreciation isn't a free ride. When you go to sell the property, you have to recapture depreciation and pay taxes on it. I am sure savvy investors will quickly say, but I can 1031 exchange into another property and avoid taxes. This is true but there are two things to remember:
1. Depreciation is transferred during a 1031. That means LESS depreciation in the new property to claim. If you transfer $200K worth of depreciation into a $300K property, then you are only getting $100K of depreciation spread out over 27.5 years. Now the new property has taxable income!
2. The only way to permanently avoid taxes is to hold rental property until the day you die. That might sound fine now, but when you are 90 years old, do you want to be dealing with rental properties? Or acquiring new properties to 1031 your old ones? At some point most landlords want to cash out and then you pay the piper (IRS).
So sorry, no free ride. Enjoy it now and plan for later when the bill comes due.
- Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes7y
Originally posted by @Joe Splitrock:
@Andrey Y. don't get too excited. Depreciation isn't as great of a deal as it appears to be. Think about it logically. Imagine if you paid cash for a property and outlaid $100,000 expense in 2018. Tthe IRS says you can only claim a portion of it over the course of 27.5 years. So you spend $100,000 and are only allowed to claim $3636 each year. Depreciation is the government reducing your claimable expense and spreading it out over 27.5 years.
Depreciation isn't a free ride. When you go to sell the property, you have to recapture depreciation and pay taxes on it. I am sure savvy investors will quickly say, but I can 1031 exchange into another property and avoid taxes. This is true but there are two things to remember:
1. Depreciation is transferred during a 1031. That means LESS depreciation in the new property to claim. If you transfer $200K worth of depreciation into a $300K property, then you are only getting $100K of depreciation spread out over 27.5 years. Now the new property has taxable income!
2. The only way to permanently avoid taxes is to hold rental property until the day you die. That might sound fine now, but when you are 90 years old, do you want to be dealing with rental properties? Or acquiring new properties to 1031 your old ones? At some point most landlords want to cash out and then you pay the piper (IRS).
So sorry, no free ride. Enjoy it now and plan for later when the bill comes due.
I have stopped buying rentals a few years ago. Its mostly passive K-1 partnerships. Great tax incentives on the front end, but will pay the piper once its sold in one way or another. That said, 1031 exchanging into larger buildings/NNN is something I wouldn't mind in my 60s. If I can live where I want, travel, hang out with the kids, etc. I think I wouldn't mind to defer taxes until death.
Having a couple 100 unit buildings and a couple NNN should be pretty darn passive. Or at least 1-2 hours per month tops kind of passive. Certainly something you could handle from anywhere in the world.
- Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes7y
Originally posted by @Jay Hinrichs:
Depreciation.. and good commercial bankers will add Depreciation back into our income to determine qualifying for their loans.. this can be an issue though with Owner occ type stuff.. were anything that is not positive takes a bunch of explanation.
Although keep in mind when you sell unless you stay in the rental game for the rest of your life.. your going to have recapture.. I am at the tail end of 35 years at this and selling off all my rentals the last 3 years so been dealing with the recapture..
Many start in this and say i will never sell.. but life forces change and thats when you deal with paying it back.. And if yoiu have good equity when You sell you just give some of your equity to IRS.. if you have no equity you have to literally cut a check to sell. This is why we talk about full cycle IRR to really determine what you made.. you will never determine how much U make on a property until you cash out.. or die and leave it to others.
Of course there is 1031.
and clients of mine to charitable remainder trusts and or have their own family foundation were they sell and donate to the foundation.. many ways once you get into the higher net worth were you need to worry about this type of thing
I hear ya Jay. I was also thinking, the best strategy if probably to wait 27.5 years and then decide whether to sell or 1031. That seems to be the sweet spot. Being a landlord has becoming annoying and already not worth my time, and I'm in my 30s. I hesitate to get a PM for some of my rentals due to the location. I think they would take $4K per year without adding that value back to me. If you catch my drift.
Sounds to me like you're doing the right thing. I am hoping for some apartment apocalypse where we can pick them up at 50 cents on the dollar. Not sure we'll ever see that in my lifetime unless there is some big-time currency crisis or a civil/world war.
- 7yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
Originally posted by @Joe Splitrock:
@Andrey Y. don't get too excited. Depreciation isn't as great of a deal as it appears to be. Think about it logically. Imagine if you paid cash for a property and outlaid $100,000 expense in 2018. Tthe IRS says you can only claim a portion of it over the course of 27.5 years. So you spend $100,000 and are only allowed to claim $3636 each year. Depreciation is the government reducing your claimable expense and spreading it out over 27.5 years.
Depreciation isn't a free ride. When you go to sell the property, you have to recapture depreciation and pay taxes on it. I am sure savvy investors will quickly say, but I can 1031 exchange into another property and avoid taxes. This is true but there are two things to remember:
1. Depreciation is transferred during a 1031. That means LESS depreciation in the new property to claim. If you transfer $200K worth of depreciation into a $300K property, then you are only getting $100K of depreciation spread out over 27.5 years. Now the new property has taxable income!
2. The only way to permanently avoid taxes is to hold rental property until the day you die. That might sound fine now, but when you are 90 years old, do you want to be dealing with rental properties? Or acquiring new properties to 1031 your old ones? At some point most landlords want to cash out and then you pay the piper (IRS).
So sorry, no free ride. Enjoy it now and plan for later when the bill comes due.
Joe this is why for these reasons you delineated I have sold all my rentals at the top.. so I did not have to cut big checks to recapture..
can you imagine someone gets in a pinch has all this recapture and the market is way down.. UGH that would not be pretty :)
- Rental Property Investor · Ankeny, IA · Member since 2017 · 2k+ posts · 3k+ votes7y
@Joe Splitrock
Leave properties to heirs. Stepped up depreciation recapture. Free ride. Of course, I’m no CPA, and I do hire one to do my taxes.
- Edmond, OK · Member since 2012 · 456 posts · 270 votes7y
@Anthony Wick In order to leave it to heirs, I should pass away right? I wont be able to give it to my heirs with steppes up depreciation while I am alive, I think. Of course, I am no CPA, but I think the IRS policy thinktank is smarter than I am
- Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes7y
Originally posted by @Anthony Wick:
@Joe Splitrock
Leave properties to heirs. Stepped up depreciation recapture. Free ride. Of course, I’m no CPA, and I do hire one to do my taxes.
Like I said, the way to avoid paying the taxes to hold until death. You can do this, but will you really want to? Depreciation runs out. Let's say you are 40 years old. You buy a property and depreciate for 27.5 years. So when you are 68 years old, there is no longer depreciation. You are paying very high taxes on the property, without any depreciation to shelter. You can exchange into a larger property, but even then your new property has lower depreciation. The other factor is after doing this 30 years, does anyyone want to keep dealing with rental properties? When someone is approaching 70, do they want to be up-sizing to larger rental properties? When people are young, they say no problem, but when you get old you realize time is the only thing of value in life. Time is worth more than money.
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