Long Term Strategy for Real Estate Professional

[Joey Harris]

Hi. My wife and I are in escrow on a duplex in our city. We are both 30 and currently we both work full-time W2 jobs. I am considered a high earner and in the top tax bracket currently. Our plan is to move her to part-time next year and have her qualify for REPS. We have good friends who are taking this approach  and we understand all the requirements we need to meet, which we are confident she will be able to do. 

My first question is that can I do a cost seg next year, when she qualifies for REPS (as she doesn’t qualify now), and use that depreciation for my W2 income in the second year of us renting the property? My second question is if I take most of the deprecation on the property in the first 5 years, is it in my best interest to purchase another rental property within those 5 years? Do I need to continue repeating this process to offset my W2 and at what point do you stop? Does it make sense to take this approach if we don’t plan on owning and managing a ton of properties?

 We plan to consult a tax professional but I wanted some general thoughts and considerations prior to that meeting. Thanks!

[Dave Foster]

@Joey Harris,The 1031 is designed to allow you to indefinitely defer paying tax on profit and depreciation recapture (a big big deal over time).  Think of the IRS code as a behavior incentivizer.  If you do what they want you are rewarded with lower taxes.   That's the 1031 exchange.  Our economy depends on a robust and active real estate market.  The 1031 exchange incentivizes you to keep buying and owning real estate.  And if you do it right you'll never pay the tax.  Here's how you can make it work with that 20 year plan.

1.  Any time you sell a piece of investment real estate you do a 1031 exchange which lets you use the gain for your benefit.  And doesn't diminish the depreciation benefit by making you pay it back.  Sell one and buy several.  Sell one and buy bigger.  Sell and buy a different type.  Sell and buy in a different location. The whole time you're using the tax for your benefit. This is your growth phase.

2. Sell several and buy fewer.  Sell several smaller properties and buy larger properties that can be managed.  sell LTRs and buy Vacation rentals where you and your family can enjoy as well as make income.  This is your lifestyle phase.

3. Sell and move into NNN commercial properties where the tenant pays the taxes insurance and maintenance. Buy larger MF properties that can be managed cost effectively. Buy passive Delaware statutory trusts and TIC syndications that can all be totally passive. Convert rentals into your next retirement home and convert some of the gain from tax deferred to tax free. Still using all of the deferred tax to make money for yourself. This is your passive phase.

4. Finally die - Your heirs get the property without any tax associated with it.  You don't pay it.  Your estate doesn't pay it.  They don't pay it.  It goes away.  This is your death phase (which lasts a long time.  But you won't care any way.  And your heirs will always be grateful for the tax free legacy of wealth you left Them.

Post being - Deferring tax on real estate is even more powerful than investing in a tax deferred IRA or 401K because there are several off ramps to eliminate the tax throughout your entire life - and beyond.