All Forum Posts by: Dave Toelkes

No point trying to make adjustments for tax changes that may never happen.  Some of the items in your list (such as net passive loss allowance, steppped up basis upon inhertiance, and section 1031 exchanges) have been in the federal tax code so long that any attempt to delete them may face fierce opposition.  Some others, such as accelerated depreciation should not be much concern because it does not eliminate the opportunity to take a valid depreciation expense over the class life of the depreciable item.  QBI is a recent addition to the tax code, and only applies to a real estate investor if there is net taxable income.  If you are already taking advantage of the $25K net passive loss allowance, the QBI deduction does not apply to you anyway.  

I believe the most likely changes to the tax code will increase the corporate tax rate, increase capital gains tax rates, and modify the marginal income tax brackets.  We may also see an increase (or eliminaten) of the income cap on social security taxes.  Changes to the tax code are inevitable because our government can't keep increasing the national debt indefinitely.  

President Clinton made moderate changes in the tax code to increase government revenues and at the same time reduced the size of the federal goverment.  At the end of Clinton's second term, we had a surplua which Bush 43 gave away in the form of a tax cut rather than pay down the national debt, and put us back on the path of ever increasing deficit spending which has not abated to this day.

@Kasper Rune Søgaard

First, let's get the terminology correct.  You don't have profit until you sell the property.  You have net rental income which is also called cashflow, and, you have net taxable income.

To calculate your net rental income, or annual cashflow. start with your gross rental income then subtract your out of pocket costs of ownership and rental operation (principal payments, mortgage interest, property taxes, hazard insurance, and other expenses) to get $39,989 using your numbers.  

Your taxable income before depreciation takes your cash flow and adds back your principal payments to get $63,018.  Subtract your depreciation expense to get your net taxable income of $32,109.  In the 25% bracket, the tax on your net taxable rental income would be $8027.

If you take a $30,909 depreciation expense each year for 10 years prior to sale, you would pay a 25% depreciation recapture tax on the $309,090 allowed depreciation in addition to the long term capital gains tax on $350,000 profit due to appreciation.  Don't forget that the increase in your land value is also subject to capital gains tax when you sell the property.

@Matthew Swearingen

Your intent is to use this property as an investment rental.  It is an investment property, not a second home.  To finance as a second home is mortgage fraud.  If $400/month cashflow after all expenses means that you have $400 monthly cashflow after you pay the monthly loan payment, then why run the risk of being forced to live in a federal gated community for five years just to save one percentage point on the interest rate in exchange for $2 - $5 more monthly cashflow?

if cash flow is your concern, finance for the longest term the lender offers. ARM loan is attractive now while the rates are low, but when rates go higher (and they will) you may wish you had locked in a fixed rate from the geginning. Get the 30 year fixed rate loan, and pay extra toward the principal each month if you really want to pay off the mortgage sooner. Although, with your tenant covering all of your ownership and operating costs, what is the urgency for paying off the loan faster? Interest only loans are your last resort. You have enough cash flow to support a fully amortized loan. Why just pay interest only for ten years, just to have the full principal amount still due and payable over the next 15 years at a higher interest rate? If you belong to a credit union, you may get better loan terms than from a bank.

Whether you use your equity line or your savings depends upon how long it would take you to replace the savings or to pay off the equity line. My rule of thumb about using my HELOC is to draw only as much as I can afford to pay off in three years. No matter which you use, what will be your source of emergency funds?

@Moses Lin

If your rental expenses completely offset your rental income, giving you a net taxable rental income of zero, then you still have a positive cash flow from your rental operation. The lender will adjust for your depreciation expense and view this as net rental income which will be added to your other income for the DTI calculation.

Unless I have misinterpreted your scenario, I don't see this as a problem when you are trying to qualify for another loan.  

No, it is not silly. Your state of residence is one that does not tax personal income.  If you did live in a state that had a personal income tax, then you would have to pay income tax to your state on all sources of income just as you do for federal income taxes.  This would mean that your resident state would tax all your rental income from your out of state properties.  

The story you hear about California is true for California residents, but not true for the taxpayer that lives in another state but invests in CA.  In this instance, CA will tax only the income that investor earns from his CA investment property but not all his income from everywhere else. 

However, just owning an out of state property in a state with an income tax does not always have a state tax consequence.  For example, if you owned rental property in my state of SC, SC would tax your SC net rental income.  But, if your expenses plus depreciation makes your net taxable income zero or negative on your SC property, you would not have to pay any income tax to the state of SC, although you would still have to file a state nicome tax return.

@Joe Roberts

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

This is pretty standard language in professional property maanagement agreements.  Your asset protection for this indemnification provision it so make sure you have a large liability rider on your insurance policy.  talk with your local real estate atturney and your insurance agent about typical judgement amounts and the amount of liability coverage you might need.

If your LLC is a pass-through entity, you have the same tax consequence for the flip property regardless of whether the "profit" stays in the LLC or is withdrawn. Best to purchase your buy and hold properties in your own name, outside the LLC.

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.

This is a question best addressed by your attorney.