BRRRR Investing Tax Questions

[Joe Roberts]

I have a few questions when it comes to calculating taxes on my BRRRR properties I am hoping someone can shed some light on.

1. I want to make sure from my research that I know how to properly arrive at the depreciable basis for a property. I have a property that I purchased for 101,000. Leaving closing costs aside (I have a question about them later), I then made 45,000 in renovations to the property and it later appraised at 199,000. The county assessor has placed a land value of $40,500 and an improvements value of $76,900, so the land % is 34.5% and improvements is 65.5%. Now for the refinance I had an appraisal done which placed the land value at $40,000. As I understand it, I now have the option of A) Multiplying 146,000 (purchase + capital improvements) by 65.5% for depreciable basis = 95,630 or B) Subtracting $40,000 (appraised land value) from 146,000 for depreciable basis = 106,000. Is this correct?

2. If I do a cost segregation study for the purposes of taking advantage of Bonus Depreciation (I am considering some of the algorithm-based DIY services) anything placed in the <20yr category and depreciated 100% is subtracted from my depreciable (27.5 year) basis. So if I can take $20,000 worth of 100% bonus depreciation, then the amount from the above example that I would depreciate over 27.5 years would be 86,000 (106,000-20,000). 

3. I know that I can add certain closing costs to the adjusted basis of my property, but in the case of a BRRRR, I am doing two closings in a year, so can I add all the costs which I incurred twice (e.g. recording fees) to the basis?

4. As long as I used that money from the refinance to further my business (i.e. purchase another property or renovate another property), which I did, I am allowed to deduct the interest payments correct?

5. Hard Money Loans and Private Loans. Can I deduct the interest and points I paid in Hard Money Loans or to Private Lenders for the purposes of BRRRR-ing a property?

6. HELOC. Can I deduct the interest I paid on a HELOC which I took out for the purpose of BRRRR-ing a property?

Anyone with any insight on any (or all) or these points is welcome! Thanks in advance!

[Stephen Rager]

While not helpful, good questions. Hope the bump gets you to the top of the thread for some answers. 

[Joe Roberts]

Thanks @Stephen Rager I am betting others have similar questions. As I have continued my research I think I have found the answer to questions 4, 5 and 6 and the answer is Yes. At least according to the RealEstateCPA in their youtube video on the subject of HELOCs and deducting interest

[Joe Roberts]

Ok, so I've got a few more questions for anyone reading this (CPAs???) regarding De Minimis Safe Harbor. 

1. Let's say I do a kitchen remodel and I get an itemized invoice from my contractor which breaks down the remodel into: $1500 for plumbing, $1000 for electrical, $2200 for cabinets, $1500 for granite and $1000 to remove a wall and drywall/paint. Can I take ALL those expenditure that would normally be capitalized and depreciated and apply DMSH to them against their applicable Unit of Property? Example: $1500 for plumbing gets deducted against the plumbing UOP, $1000 for electrical UOP, granite and wall removal against the UOP for the building proper. There is no doubt these are substantial improvements to a home's value, a kitchen remodel can add alot of value, but as I have read it, I can still apply DMSH in this manner, correct?

2. Second question (and from what I've read on these forums there appears to be two schools of thought amongst highly respected CPAs on BP) but can I take these DMSH deductions, in the way presented above, BEFORE I place the rental in service? I.e. BRRRR scenario where the house needs substantial renovations before its rented out?

[Dave Toelkes]

Not a CPA, but I will weigh in.  Hopefully, one of the CPAs in this forum improves on my response if I have misinformed you.

1. Your depreciation basis on the dwelling structure is calculated on what you paid for the property, then you add your renovation cost to the depreciation basis you had calculated.  In your scenario, you paid $101K for the property.  Use the tax assessor 65.5% ratio to arrive a an initial depreciation basis for the dwelling structure of $65,975. Now add your renovation costs to arrive at your final depreciation basis of $106,475.  Land is not depreciated.  Depreciation does not start until you place the property in service.  

2. Residential rental property only has three asset classes -- 27.5 year property, 15 year proprety, and 5 year property.  For a 1-4 unit property, a formal cost segregation study is generally not worth the cost for the tax benefit derived.  Since you did a major rehab, everything you did inside he property is in the 27.5 year asset class, so it would be depreciated with the building stucture anyway.  If you purchased new free standing appliances the cost of those appliances can be depreciated separately from the dwelling structure over 5 years, and their cost would not be included in the renovation cost you added to the dwelling structure depreciation basis as you outlined, 

3. For your BRRRR, only include the initial financing closing costs in your cost basis. When you refinance, the closing costs are amortized over the life of the loan, not depreciated.

4. This queston is a bit vague. You used financing to purchase the proprty, so your refinance will pay off the first loan. Interest on the portion of the loan that paid off your first loan is deductible interest for the BRRR property. If you are doing a cash out refinance, then interest on the portion of the refinance that exceeds your original loan amount can be deducted as an interest expense on the Schedule E for the investment property you purchased with that money -- not on the original BRRR proprety

5. I believe so, but will defer to someone with more expertise in this area.

6. HELOC. Yes, but the interest is expensed on the Schedule E for the BRRRR property, not the property used to collaterize your HELOC.

As to your follow on questions regarding DMSH.  I believe the DMSH rules only apply to an active business.  In my opinion, DMSH is only available to a property after you place it in service; you are not in business until then.  i maintain that make ready for rental use costs are always capitalized regardless of whether some portions of the rehab project might be considered repairs.  I understand that there is some disagreement among the professionals on this topic.

[Michael Plaks]

@Joe Roberts

Excellent questions, sir! I will provide my answers, with two disclaimers: 
A. I don't know enough about your situation, not being your accountant, so treat everything as general info as opposed to tax advice suitable for you.
B. Some of my positions are debatable, and my colleagues are likely to disagree here and there. It does not necessarily mean that one of us is wrong (which of course is possible) but rather that there's no black-and-white answers.

1. There're several ways to calculate it, all acceptable. The IRS allows "any reasonable method" for land allocation. You can use either the county assessment or the 1st appraisal for the initial allocation. You can subtract either the stated $ value of the land or you can apply the ratio of land to improvements to your actual $101k cost. You don't need to allocate any of the $45k rehab to land and can either add it to the depreciable basis left from $101k or set it up as a separate asset.

Alternatively, you can make the land allocation off of the $146k improved basis, using either the county figures or the 2nd appraisal.  And then also either subtract the land value or apply a ratio. Enough options for you? :)

2. Again, you have options. You can subtract the cost segregated components from the total basis before land allocation, or you can allocate a portion of the total basis to land first, before applying cost seg results.

Land improvements (the 15-yr property) can be subtracted either from the improvements basis or from the land value. The latter is more beneficial because land is not depreciable. I believe there is no consensus on which is the right method.

3. For the second closing, all costs are usually treated as amortizable loan costs and are not added to depreciable basis.

4. Yes, with a twist. If you had a cash-out refi, the portion of interest corresponding to the cash-out is deducted against the business/property for which it was used. As long as you kept the moneys separate and traceable.

Example: you refi a $100k loan against Property A into a $150k loan and use $50k to rehab Property B. Then 2/3 of the interest is deductible against A and 1/3 against B.

5. There are two schools of thought on interest, and good luck getting us accountants to agree on this one.
A. All interest is always deductible.
B. HM interest occurred before placing the property in service and should be added to its basis.

Also two schools of thought on HM fees
A. HM fees occurred before placing the property in service and should be added to its basis.
B. The initial fees were amortizable loan costs that were refinanced and became deductible at the time of refinance.

6. Basically the same answer is #4. If separate and traceable to a specific property - yes.

I will try to get to your other 2 questions later.

[Joe Roberts]

@Dave Toelkes

Thanks for the info, much appreciated! A couple points to continue the discussion/clarify. 

2. Thanks for the info. So without a cost-segregation study, I will still be able to depreciate my 5yr (free standing appliances), 15yr(landscaping and fence) and 27.5yr(majority of the renovations) renovations along their normal straight-line depreciation?

4. I didn't make this clear but paid for the property and renovations with cash. So what you are saying is that once I refinance, I should be able to deduct the interest payments if I use the refinanced $ for Property #2. The twist is that I deduct the interest on the Schedule E of Property #2, not #1. 

@Michael Plaks

Thanks for answering my questions! I was hoping I would get you or one of the other super knowledgeable CPAs on here to join the conversation! Absolutely understand the CPA disclaimer, this is for my own education :). 

I look forward to your thoughts on DMSH. I got a very detailed line-item invoice from my GC which breaks down everything into labor and materials. It was a pretty heavy renovation but if I can break out line items less than $2500 for individual UOPs to deduct under DMSH that would be great. 

The knowledge I am trying to gain about DMSH will also impact how I do BRRRRs in the future, so thanks!

[Dave Toelkes]

@Joe Roberts

Since you are asking specifically for CPAs to respond, I will step aside.

[Joe Roberts]

@Michael Plaks Was wondering if you had any more thoughts on the De Minimis Safe Harbor questions?