How to reduce my active income tax liability? Bonus depreciation?

[Donald F.]

I have appx $250k worth of active income this far (commercial real estate broker), and I have another $300k in income coming (though I am rolling my fee as equity into the deal so it will not be reported as income on my tax return this year). 

What are the best ways to offset the huge majority of that $250k income I have? I was thinking bonus depreciation. However, I wanted a better idea of how much I would be able to offset. Hypothetically, if I invested $200k into an $800k duplex/triplex (financed $600k), what % of that do you think could typically be depreciated in year 1?

If you have any other creative tax incentives/ideas of how I can reduce my tax liability this year, I'd really appreciate it! Thank you.

[Bjorn Ahlblad]

@Donald F. welcome to BP! Why would you not have a crackerjack accountant working with you through the year and more at tax time? You have income to protect and you need professional advice.

[Donald F.]

[Donald F.]

Originally posted by @Bjorn Ahlblad:

@Donald F. welcome to BP! Why would you not have a crackerjack accountant working with you through the year and more at tax time? You have income to protect and you need professional advice.

thanks bjorn! unfortunately though, easier said than done. i've spoken with many and it is really tough to find an accountant, tax professional, etc. everyone i talk to says something different and has different advice. additionally, they all want $ upfront before really proving their worth. it's tough to know how to make the best decision in finding the right one. 

[Tim Delaney]

@Donald Flynn I’m not an accountant so take my two cents with a grain of salt. I also know there is a lot of different advice out there. I found reading Tax Free Wealth by Tom Wheelright and BP’s books on taxes (the book on tax strategies and the advanced book on tax strategies) by Amanda Hahn and Matthew Macfarland to be very helpful. Any one of those three people may be worth reaching out to about being your CPA.

As for your question - I think it’s tough to say what % of the cost would be eligible for bonus depreciation. It depends on what type of equipment and land improvements it has, so it could vary quite a bit.

As for not having to declare that equity as taxable - you may want to investigate that further. I have specifically been told by a CPA and lawyer that taking equity in a business as payment is taxable income. You can avoid this by taking options instead of actual equity, but when you execute those options you will need to declare the income.

[Joe Splitrock]

Originally posted by @Donald F.:

I have appx $250k worth of active income this far (commercial real estate broker), and I have another $300k in income coming (though I am rolling my fee as equity into the deal so it will not be reported as income on my tax return this year). 

What are the best ways to offset the huge majority of that $250k income I have? I was thinking bonus depreciation. However, I wanted a better idea of how much I would be able to offset. Hypothetically, if I invested $200k into an $800k duplex/triplex (financed $600k), what % of that do you think could typically be depreciated in year 1?

If you have any other creative tax incentives/ideas of how I can reduce my tax liability this year, I'd really appreciate it! Thank you.

 You can shelter a fair amount year 1. Just don't forget about year 2, 3, 4 and beyond. Your property will net more profit in future years as a result of accelerating depreciation in the early years.  Also remember that you are accelerating depreciation, but you are still subject to depreciation recapture when sold. You can exchange a property to avoid taxes on sale, but depreciation is also exchanged into the new property. 

The 100% bonus depreciation is phased out starting with a step down in tax year 2023. I only mention that because you will not be able to just acquire a new property every year to keep avoiding the taxes.

You are essentially kicking the can (taxes) down the road. Every time you kick it, the can gets bigger and harder to kick. Also factor in that marginal tax rates are almost certainly going to increase on higher wage earners in future tax years. If you push that tax burden to future years, you could just end up paying more in the long run. Of course if you expect your tax burden to be large this year, but lower in future years, that may not be a concern.

[Donald F.]

Originally posted by @Joe Splitrock:

Originally posted by @Donald F.:

I have appx $250k worth of active income this far (commercial real estate broker), and I have another $300k in income coming (though I am rolling my fee as equity into the deal so it will not be reported as income on my tax return this year). 

What are the best ways to offset the huge majority of that $250k income I have? I was thinking bonus depreciation. However, I wanted a better idea of how much I would be able to offset. Hypothetically, if I invested $200k into an $800k duplex/triplex (financed $600k), what % of that do you think could typically be depreciated in year 1?

If you have any other creative tax incentives/ideas of how I can reduce my tax liability this year, I'd really appreciate it! Thank you.

 You can shelter a fair amount year 1. Just don't forget about year 2, 3, 4 and beyond. Your property will net more profit in future years as a result of accelerating depreciation in the early years.  Also remember that you are accelerating depreciation, but you are still subject to depreciation recapture when sold. You can exchange a property to avoid taxes on sale, but depreciation is also exchanged into the new property. 

The 100% bonus depreciation is phased out starting with a step down in tax year 2023. I only mention that because you will not be able to just acquire a new property every year to keep avoiding the taxes.

You are essentially kicking the can (taxes) down the road. Every time you kick it, the can gets bigger and harder to kick. Also factor in that marginal tax rates are almost certainly going to increase on higher wage earners in future tax years. If you push that tax burden to future years, you could just end up paying more in the long run. Of course if you expect your tax burden to be large this year, but lower in future years, that may not be a concern.

thanks for the message, joe. yes, i understand RE phase out and recapture. for this property i would intend on just refinancing and 1031'ing until I die/pass it on.

I think it's especially important for me to take advantage of bonus depreciation this year though because i am looking to buy a house in a year or two for myself. my understanding is that with the way traditional mortgage underwriting is done, they can add the bonus depreciation back to my income for this year. 

[Jeffrey Donis]

I am not a tax expert, but as a passive investor in a real estate syndication deal, you can write off the depreciation of the asset. Tax deductions are a MAJOR benefit of being a passive investor in an apartment complex. PM me if you have any specific questions about what this looks like! I'd love to hop on a call with you. 

[Joe Splitrock]

Originally posted by @Donald F.:

Originally posted by @Joe Splitrock:

Originally posted by @Donald F.:

I have appx $250k worth of active income this far (commercial real estate broker), and I have another $300k in income coming (though I am rolling my fee as equity into the deal so it will not be reported as income on my tax return this year). 

What are the best ways to offset the huge majority of that $250k income I have? I was thinking bonus depreciation. However, I wanted a better idea of how much I would be able to offset. Hypothetically, if I invested $200k into an $800k duplex/triplex (financed $600k), what % of that do you think could typically be depreciated in year 1?

If you have any other creative tax incentives/ideas of how I can reduce my tax liability this year, I'd really appreciate it! Thank you.

 You can shelter a fair amount year 1. Just don't forget about year 2, 3, 4 and beyond. Your property will net more profit in future years as a result of accelerating depreciation in the early years.  Also remember that you are accelerating depreciation, but you are still subject to depreciation recapture when sold. You can exchange a property to avoid taxes on sale, but depreciation is also exchanged into the new property. 

The 100% bonus depreciation is phased out starting with a step down in tax year 2023. I only mention that because you will not be able to just acquire a new property every year to keep avoiding the taxes.

You are essentially kicking the can (taxes) down the road. Every time you kick it, the can gets bigger and harder to kick. Also factor in that marginal tax rates are almost certainly going to increase on higher wage earners in future tax years. If you push that tax burden to future years, you could just end up paying more in the long run. Of course if you expect your tax burden to be large this year, but lower in future years, that may not be a concern.

thanks for the message, joe. yes, i understand RE phase out and recapture. for this property i would intend on just refinancing and 1031'ing until I die/pass it on.

I think it's especially important for me to take advantage of bonus depreciation this year though because i am looking to buy a house in a year or two for myself. my understanding is that with the way traditional mortgage underwriting is done, they can add the bonus depreciation back to my income for this year. 

 What I was trying to say is doing a 1031 will delay your taxes, but it also reduces your depreciable basis on the new property. Without much depreciation to offset income on a rental property, your taxable income in the future will be much higher. I didn't realize this when I did my first 1031 exchange, but realized it quickly when that property was showing heavy tax income. All I am saying is the bonus deprecation will be great in year one, but you need to thoroughly think through how it affects taxes in future years. It could push you into a higher tax bracket or you may even find yourself in a higher tax bracket due to tax law changes.

As far as mortgage underwriting, whether bonus or straight line depreciation it doesn't matter for calculating your income. 

[Dan Schwartz]

@Donald F. there are many high-quality CPAs here on BP and - guess what - they don't always all agree on strategies!  They have, however, shown a firm foundation in what is and isn't part of the tax code.

I'm not a CPA, but I wonder from your post if you can really defer the $300K by converting it to equity in the deal.  Was the income earned?  Do you have constructive use of it in order to roll it into the deal?  Or have you (or more likely, your brokerage) organized a structure or mechanism by which the compensation can be deferred for tax purposes?

As for bonus depreciation: you can't take bonus depreciation on the property structure itself, which is usually the largest element of the purchase cost.  You probably know that you can't take any depreciation on the land.  If you did a cost-segregation study, you could bonus depreciate the various components of the property like the fixtures and some improvements, etc.  I've never done, nor felt it was economical to do, such a study on my properties, so I don't know how much bonus depreciation this could generate.

[Bonnie Griffin Kaake]

@Donald F. This is a specialty area of taxation. There are many tax and cash-flow benefits available all during the ownership of a commercial or residential rental property. It appears that you are in the 24% tax bracket. If you do a cost segregation study on the hypothetical $800k duplex/triplex, you can expect about 30-40% of the purchase price will consist of tangible property that can be depreciated in year one. You can usually count on about 6-10% of your purchase price in after tax cash-flow the first year. That is about $48k to $80k in taxes you don't have to pay and can reinvest. The American Institute of CPAs (AICPA) recommends to their member CPAs that a cost segregation study is done on EVERY property over the purchase price of $750k. It is usually beneficial for any commercial or residential rental over the purchase price of $200k. Our range nationally is $200k to $2 billion in purchase price. CSSI and I teach CPAs/tax professionals how to leverage tax benefits for their clients. 

There are many other benefits available to commercial property owners and I would be happy to talk to you about additional benefits of getting a cost seg done and beyond. Under the current administration, leveraging the available tax benefits is going to be even more important for commercial property owners. And, doing it with an engineering-based study (IRS' preferred methodology) with audit defense included, is going to be even more important. The IRS is currently hiring thousands of young aggressive and technically savvy tax professionals. Audits of depreciation schedules will be on the rise. Why pay more in taxes than you need to pay? Reinvest that bonus at a more lucrative rate of return than letting that money sit with the IRS.  

[Michelle Lutz]

@Bonnie Griffin Kaake Great answer! Thanks for sharing.

[Alex Keathley]

@Donald Flynn

Check out oil and gas leases. May or may not help you. Find a financial advisor who specializes in this with a long track record. Definitely not something I would try doing alone. You could really get burnt if you’re not careful.

[Erickson Sainval]

Can look at many tax vehicles and shelters or change the structure of how you run your business. Instead of taking all the income can look at making a business structure and paying yourself a reasonable income while everything else is run through the business.

[Yonah Weiss]

@Bonnie Griffin Kaake you are really seeing 30-40% of the purchase price reallocated to tangible assets on a duplex/triplex?

Do you mean 30-40% of the tax basis, after land allocation? Even still, that is extremely high for a duplex in my experience.

[Bonnie Griffin Kaake]

@Yonah Weiss Yes. Nevertheless, there are some exceptions in cities or resort towns where the land values are off-the-charts as you probably know. I just pulled up my last duplex project and although I don't have the land value easily accessible, the ratio is a little over 37% of the basis after land allocation. Our studies should not be all that different from each other on the bottom line. 

[Jay Hinrichs]

Originally posted by @Tim Delaney:

@Donald Flynn I’m not an accountant so take my two cents with a grain of salt. I also know there is a lot of different advice out there. I found reading Tax Free Wealth by Tom Wheelright and BP’s books on taxes (the book on tax strategies and the advanced book on tax strategies) by Amanda Hahn and Matthew Macfarland to be very helpful. Any one of those three people may be worth reaching out to about being your CPA.

As for your question - I think it’s tough to say what % of the cost would be eligible for bonus depreciation. It depends on what type of equipment and land improvements it has, so it could vary quite a bit.

As for not having to declare that equity as taxable - you may want to investigate that further. I have specifically been told by a CPA and lawyer that taking equity in a business as payment is taxable income. You can avoid this by taking options instead of actual equity, but when you execute those options you will need to declare the income.

I was going to mention the equity is taxable from what I understand.. just like winning a car on a game show.

[Aaron Zimmerman]

@Donald F. Are you a real estate professional? If yes, cost segregation might be advised. The biggest thing is understanding if you're willing to take the depreciation all now or later. This is the exact type of conversation you should be having on a regular basis with your accountant (amongst other things too). I'd recommend setting up a time to talk at a minimum twice a year for your situation. Your tax situation must be looked at holistically and in alignment with your goals. 

[Bobby Larsen]

@Jay Hinrichs

Deferred equity can absolutely be tax deferred if structured as an earn out.

[Jay Hinrichs]

Originally posted by @Bobby Larsen:

@Jay Hinrichs

Deferred equity can absolutely be tax deferred if structured as an earn out.

right staying in the deal  but if you dont stay in the deal and earn it its income I think  but i could be wrong for sure.

[Paul Moore]

@Donald F. you got some great feedback.  Good thread here.  I wrote a BP article about four years ago about why real estate investors need a tax strategist. I have been inundated with hundreds of requests to share CPA information. You may want to connect with some of the CPAs and professionals who replied above. Otherwise, feel free to message me and I’ll send you some possibilities. Good luck!

[Bill Hampton]

Donald, 

I recommend finding an accountant that specializes in real estate taxation. You may want to consider working with your accountant remotely to expand your options.

I would also recommend looking for a tax strategist who is willing to work with you throughout the year, not just when preparing your tax return. You want an accountant that can help you strategize and who is responsive when you want to know the tax consequences of the decisions you are making throughout the year.

Good luck and let me know if I can be of assistance.