Maximizing Real Estate Professional Status

[Ben Polansky]

Hi BP - first time poster here! 

I own a few properties in the Los Angeles area with a partner. This year is the first year I will qualify as a real estate professional and be able to take some aggressive deductions through things like cost segregation studies.

The issue I have and would like to hopefully get some advice on is the below:

In real estate specific tax strategies - it is my understanding that I would be able to generate significant “losses” through the use of bonus depreciation and other strategies. It is also my understanding that this would result in large tax returns (from depreciation offsetting my other active income) that I could use to continue to expand my portfolio. 

My partner however is NOT a real estate professional and won’t be able to capitalize on the deductions as much as I will be able to due to their share of the “loss” being a passive loss. This fact makes accelerated depreciation seem unattractive as it feels like we are not getting any IMMEDIATE benefit out of his half of the depreciation expense. If our main goal together is to acquire as many properties as possible as fast as possible - it feels like this leaves us with a smaller tax return, thus less capital to use to reinvest into new properties. 

My question is - is it more advantageous to have me own the business entirely so that I can capitalize on the tax deductions & tax refunds so that I can in turn contribute more capital to purchase future properties together?  

It is important to note that my business partner is a family member and we are aligned on pursuing whatever strategy is most optimal for our main goal of acquiring as many properties as possible collectively, regardless of ownership percentages on paper. 

Thanks for your time! Looking forward to some creative responses and hopefully a tax attorney referral! 

[Sean O'Keefe]

Quote from @Ben Polansky:

Hi BP - first time poster here! 

I own a few properties in the Los Angeles area with a partner. This year is the first year I will qualify as a real estate professional and be able to take some aggressive deductions through things like cost segregation studies.

The issue I have and would like to hopefully get some advice on is the below:

In real estate specific tax strategies - it is my understanding that I would be able to generate significant “losses” through the use of bonus depreciation and other strategies. It is also my understanding that this would result in large tax returns (from depreciation offsetting my other active income) that I could use to continue to expand my portfolio. 

My partner however is NOT a real estate professional and won’t be able to capitalize on the deductions as much as I will be able to due to their share of the “loss” being a passive loss. This fact makes accelerated depreciation seem unattractive as it feels like we are not getting any IMMEDIATE benefit out of his half of the depreciation expense. If our main goal together is to acquire as many properties as possible as fast as possible - it feels like this leaves us with a smaller tax return, thus less capital to use to reinvest into new properties. 

My question is - is it more advantageous to have me own the business entirely so that I can capitalize on the tax deductions & tax refunds so that I can in turn contribute more capital to purchase future properties together?  

It is important to note that my business partner is a family member and we are aligned on pursuing whatever strategy is most optimal for our main goal of acquiring as many properties as possible collectively, regardless of ownership percentages on paper. 

Thanks for your time! Looking forward to some creative responses and hopefully a tax attorney referral! 

Based on what you say, your business partner will have Suspended Passive Activity Losses if you decide to pursue cost seg + REPS tax strategy. Although they can't leverage the losses to offset non-passive income, like someone with REPs, there's still the opportunity to use the Suspended Passive Activity Losses to offset cap gains on sale or offset other passive income.

If this isn't an attractive alternative to your business partner then you might consider changing the ownership structure or operating agreement as one of your options. Since we don't have all of the details about your business partner's situation and the types of properties you own I've assumed LTR. I'd need more details to provide more helpful feedback. 
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*This post does not create a CPA-client relationship. The information contained in this post is not to be relied upon. Readers are advised to seek professional advice.