All Forum Posts by: Andy D.

Lathan, I'm possibly stating the obvious but - as you seem to be a "newbie" (not a bad thing!) - I shall therefore say this: please bear in mind that this is how I do it. Doesn't mean that there are not other ways of doing it or that others actually think that they are doing it better than I do. It also more likely than not depends on the size of your operation. We have people here who own hundreds of units which is a totally different beast. I use legal entities, so I actually do have seperate accounts for these but the point remains the same as within such an entity I still do not have seperate accounts for Capex, repairs etc.

If you're only getting started: don't overcomplicate things. Do make sure that you have your business income/monies seperated from your personal funds (i.e. you should at least get 1 more bank account next to your non-real-estate personal checking account). Keep proper records of what is going on and try to visualize the numbers by whichever means appeal to you. I use Excel. Others use Quickbooks or any other of those tools out there available online etc. Good luck!

Correct. This is how I approach this. Now, since I have owned several properties for many years now this really isn't relevant anymore for me as everything kind of "blends together". I have money set aside, the source having been from various properties. Therefore, when I now go ahead and buy another property I already have funds "for this property set aside" since I have money to spend if push comes to shove.

However, to answer your second part, yes, I then start saving money from that new property to add to the funds in my already existing "money pool" (sounds great, right?? ;-) ), increasing my reserve fund to at least have enough money available to fix whatever might come up on, say 2-3 properties. Would it be sufficient if I had to replace 3 roofs at the same time? Not really, I would have to tap into other funds such as my "next down-payment fund". But if this were to happen, well, then I'd have to replenish that fund asap and hold off on buying something until I am back on track. That's the risk of running a business. Not everybody is an Apple or Google with billions of dollars just sitting there waiting to be spent...

And no, I don't have separate (bank) accounts for the various types of expenses. From a bookeeping point of view one could of course do that but actually having several bank accounts, well, at least I don't see the point in that. So these funds just sit in an account, happily cuddling with each other, waiting to be - no, not spent on expenses but preferably invested to increase my rate of return! :-)

If you have several legal entities then of course you want to have separate bank accounts for each entity but that is a different story which is probably not relevent here.

@Lathan Cram As some have said here these figures are mainly for analyzing a deal.

Then again, expenses are real so there needs to be money available to pay those bills. Therefore, strictly speaking, you would need to have that cash sitting in an account even before buying the property for which you ran the numbers. Because, in theory, on day 1 after closing the HVAC could die, together with the water heater having a leak, the range no longer working and the carpet having received a beautification from a dropped bucket of pink paint, sprayed all over the place. Your whole spreadsheet calculation of x% for whatever is totally useless at that point since you need the money now to fix what what needs fixing.

So long story short: one should always have reserves to cover (un)expected expenses. Running a spreadsheet with certain percentages for certain expected expenses simply helps you to figure out how much actual money you should set aside for this - after you own the place. But you should have a cushion prior to entering the REI realm.

On another thread someone was asking about buying a $650k building with an annual income of some $35k. Assuming that this person does not have plenty money sitting in a bank account this would probably be a bad idea since that person has no buffer to pay for anything that might occur on day 1 or 2 or 3...

It's all about first impressions...!

Since we can only guess how exactly you have everything set up, especially with regard to the tax filing I can only second that you should talk to your CPA as I believe you are possibly doing something wrong here.

@Alik Levin Since you mention Schedule C: are your LLCs (at least the top one) really set up as corporations for tax purposes?

Generally, capital gains are not treated as income in the sense of monies coming in from rent, W2 or self employment or even interest/dividends. So there is no "long term income" (I shall not touch upon the treatment of qualified dividends). This alone should answer your question. ;-)

Adding to it: you pay your taxes on an annual basis which equals a calendar year (at least as a private person). So it doesn't matter if all your taxable income gets paid to you on the 20th of January or on the 28th of December or somehow spread over that period.

@Oleg Kio With respect to your post about the aspect of improvement not being relevant when safe harbor applies: I agree with you there. With my above explained limitation: if something can be expensed and does not have to be depreciated as an integral part of a building then it should not matter if the new item is an improvement or not.

Replacing a 15 year old simple range with one that has a self cleaning oven with 10 different functions and has a glas cooking field and basically also does the shopping for you all in one is clearly an improvement over that 15 year old one which always burned the turkey on the one side. Yet, a range is not integral to the buildling and therefore can be expensed. With the new rules we now do not need to think about it being an improvement or not.

This is how I understand it, but again, I'm not a CPA, nor should anyone take this for granted. Consult your tax advisor to confirm.

Sorry for this long post but topic of taxes is never an easy one!

@Oleg Kio While I certainly agree that these rules are meant to make it simpler for small tax payers, one should not forget that the "normal business" these rules are most likely primarily aimed at is not real estate business involving buildings but rather your typical mom & pop shop selling or producing whatever. I believe one should read anything related to this topic, like what you had quoted above, with that in mind.

I'm by no means a (US) tax expert but one thing I know is that once it comes to buildings, depreciation is what every cost related to this building has to - prima facie - be tied to. Claiming an expense related to buildings (and the associated business of course) is generally an exception. Related to this we then have the constraints with regard to the topic of "improvement", making it even more difficult (just like @Justin Fox example above shows) . But that aside, even if an expense clearly does not lead to an improvement/betterment (say, you bought the replacement item used, making it pretty much the same thing you had before but now working again - status quo ante) one would still need to take into consideration whether the new purchase is connected to an item that is/becomes an integral part of a building/structure.

Let me try to explain my thinking with an example: I guess we all agree that we cannot expense a building. Every building has a roof. I guess we also agree that we would need to depreciate a roof, rather than expense it, right? For giggles, lets assume you could get a new roof for $2499 including labour. Would you, Oleg, now go ahead and expense that roof under DMSH or whichever variant this could be put under re expensing? I certainly wouldn't as the roof is an integral part of the building. Heck, it's very much connected to the buidling and making the building useless if it wouldn't be there. My understanding is that in such a situation the roof becomes tied (literally) to the buildling and therefore inelligible for being an expense for tax purposes. It will have to be depreciated/capitalized, irrespective of any safe harbour rules that might exist. I'm pretty sure this is not up to debate. But maybe someone really knowledgeable can confirm this.

Taking the above roof example, I'm now looking at your example of windows. To me the logic is the same: a building without windows is useless, it's uninhabitable. Windows are an integral part of the building. Windows therefore should not be allowed as an expense but would need to be depreciated over their meaningful life time (as per IRS rules). Again, someone please confirm.

Somewhere I actually read (can't remember the source, though, but I believe it was actually an IRS example) that if you were to buy a new motor for an HVAC unit you could not expense (but have to depreciate) that motor as it itself is an integral part of the HVAC which, in turn, itself is an integral part of the building. Again, a building without an HVAC would - at least in the so called "civilized" world - be considered uninhabitable. It's therefore integral to the building's use. Since the motor is needed for the HVAC to function, the motor of the HVAC itself is an integral part and therefore to be depreciated. At least this is what I remember to having read, and to me it makes sense.

So the question is - the way I understand it - whether something is an integral part to a buildling or not. If not: expense allowed (within the limits of safe harbor etc, of course). If yes: capitalization/depreciation. Looking at a fridge/stove/ceiling fan, all items of that sort are neither (really) attached to the buildling nor are they required for the buildling to provide its primary function: shelter. And now for the fun questions: water heater. It's clearly attached to the building, or rather its guts (= pipes), yet quite easily removed. Hhm. Does a building still provide its main function when there is no water heater? I, personally, believe it would. You still have running water (which is, generally, crucial, for obvious reasons), it's just not warm. I would, therefore, expense a water heater and not depreciate it.

So I repeat what I said at the beginning of this post: the new relaxed rules with respect to expensing are - most likely - limited to items that are not an integral part of something that has to be depreciated (such as a building) as these safe harbor rules were not meant to change the principle of depreciation vs expensing. Nonethelesss, I'm looking forward to clarification by the IRS! Until then I'm playing it safe.

Huh? What do you mean by "claiming rental income"? It's income that you yourself - assuming you're not running the business in a corporation that is its own tax subject - have to declare in your personal tax return. It adds to your overall income from e.g. W2 (obviously?). There are, of course, rules related to this specific type of income (and the associated [deductible] cost) as well as specific forms such as, most importantly, Schedule E. That is - re your point about DTI - how you document rental income.

I should emphasize that you should definitely involve an REI savy CPA (before the year you start the business is over!) as there is much more to this than just "income". You will be running a business and you do not want to mess with the IRS by doing it wrong when it comes to taxes. Good luck!