All Forum Posts by: Karl S.

Hi @Michael Plaks, thanks for the explanation. Yes you are right I would be able to depreciate less in the future given the initial cost segregated bonus depreciation, and perhaps even start making accounting gains. However, I imagine there would be several ways to combat this: (1) generate expenses when this begins to happen, perhaps by reinvesting / remodeling the properties, etc. (2) at some point (hopefully much less than 27.5 years from now) I'll reach a scenario where I can't feasibly or don't feel like creating large enough losses. Then I retire from W2 job, drop down several tax brackets, and enjoy the cashflow and pay my (much lower) taxes, and let my eventual depreciation recapture disappear with inflation over time (or never happen if step up basis holds). I even wonder if I can have my eventually very high Roth IRA buy these assets from me if they still end up being tax inefficient (but this feels like a stretch). Let me know what you think.

@Eamonn McElroy thanks for the reply. Zooming out I recognize there is a two pronged test. Both prongs require activities that one must materially participate in. I am not asking about the two prongs, rather, zooming back in, I am asking how to qualify a remote rental investment as a materially participating activity.

I posted earlier on trying to reduce my W2 income with REI, and got mostly positive responses to my idea.

Now I wanted to get an opinion of a few CPAs and investors on how to qualify as RE professional when mainly investing out of state, where one would hire PMs to do much of the day to day work. I read the rules closely, especially the material participation tests, and am trying to see what would make the out of state activity qualify as materially participating. 

Out of the 7 ways to qualify, I find two practical ways:

(1) Spend 500 hours on the activity. I guess that would include flying to the location, purchasing properties, managing any remodeling, figuring out loans / refis, hiring PMs, etc. It would also include managing PMs, perhaps taking on some work that can be done remotely like reviewing tenant applications, collecting / reviewing bids for fixes, etc. My question is what volume of properties (how many doors, how many properties) would be needed to qualify, ballpark, if I needed 500 hours completely out of state.

(2) Spend 100 hours on it and more than anyone else. I guess if you have a few properties, you can have a few PMs and argue you spent more time than any single PM (especially if you take on some PM work that you can do remotely). This would be much easier to meet on a time basis (the rest of 650 hours can then be spent locally to meet the test), but may be hard to argue you spent more time than any PM. I wonder if you can include it on a PMs contract to only spend 100 hours, after which you or a PM company would assign another PM if needed, etc. This is probably too much work, but I wanted to see if anyone is using this method or has experience defending it.

(3) Going back to (1) and (2), combine that activity with some local investments where you are the PM, helping you get the hours. My understanding is this is certainly classified as the "same activity" as the out of state investments. My question is, would PM'ing properties for others (as a self employed contractor) could also classified as the same "activity"?

Thank you.

Thank you all for your replies. One question I wanted to ask the group is what would be reasonable load to qualify for RE professional. My spouse could manage my parent's properties (there are 3 in bay area) plus whatever we buy. I imagine if its not local it would be hard to justify the hours, unless there's a trick I don't know about.

@Lee Ripma I checked and in Sacramento area seems land is about 20% of value, so still reasonable to get decent depreciation. My house in bay area is >80% value in land, but that's on the high side, I think in some areas its possible to get at least 60% house value, but still not great for depreciation. 

@Jesse Daconta Interesting, but I thought the RE professional has to spend at least 100 hours and more time than anyone else on the business, so syndicates would be out. Is that not correct? Can you claim depreciation against W2 being part of a syndicate? I would definitely prefer that.

@Yonah Weiss and @Justin Cecil, thanks for the tips.

@Justin Cecil I believe 1031 does not shield from depreciation after a cost segregation, but perhaps CPAs here can confirm. 

@Katie L. I think I make too much. Also if I only show losses for some time does it make sense to do anything but LLC? I haven't gotten that far yet so haven't thought about it. All of this is still theoretical to me.

I'd like to get feedback on a strategy I want to pursue. I work in Silicon Valley and make well into the maximum tax bracket. I wanted to pursue REI both as a way to invest extra money (already maxed all other tax advantages accounts) and a way to further reduce my tax burden.

My understanding is that if my spouse (not employed) becomes an RE professional, and if we perform a cost segregation study on a purchase, we can deduct approximately ~25% of the purchase price from my W2. This would only work on Federal tax, not FICA or California tax as the state does not participate, but it is still 37%, and may be more in the years to come.

The strategy would be something like this:

year 1: buy multifamily for ~$1M, cost segregate, deduct

year 2: buy multifamily for ~$1M, cost segregate, deduct

year 3: buy multifamily for ~$1M, cost segregate, deduct

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stop at some point and enjoy having cash flow + $100k of cash savings a year due to reduced taxes.

Spouse is onboard and would do most of the work buying these properties, and managing them if they are reasonably local.

Exit strategy would be don’t exit. Keep the assets for my kids and take advantage of stepped up basis, or at least sell a long time from now at a highly reduced tax burden due to inflation.

Is anyone doing this? Any pitfalls to this strategy to watch out for?

The other question is location. My father lives in Sacramento and is a general contractor. So the reasonable choices I see are:

1. Bay area: Close and easy to manage, cash flow negative and speculative, non-diversified from our assets and my job.
2. Sacramento area: Cash flow neutral-ish, have a trusted person to help in rehab if needed as part of BRRRR, too far to property manage for spouse to get RE professional hours? (that's is question)
3. Out of state somewhere: good cash flow, but need to setup a whole team, but could spouse still qualify as RE professional?

What would you do in my situation? Thanks.