All Forum Posts by: Account Closed

Real Estate Investors! Keep firing questions at me. I have 25+ years of experience in the real estate industry and can help you tremendously from a tax knowledge perspective.

Catherine -

Many thanks for writing the following question. Here's some information which I hope you may find meaningful:

1)

Renting a property to a family member at a rate significantly below market value may raise red flags with the IRS, as they might consider it a personal arrangement rather than a business one.

To qualify for tax deductions, it's crucial to treat the arrangement as a legitimate business transaction. Ensure that the terms of the lease, including the rent amount, are reasonable and comparable to market rates.

If your brother is only covering specific expenses and not paying market rent, the IRS may view it as a personal arrangement rather than a rental business. In such cases, you might not be eligible for certain tax deductions related to rental properties.

2)

When you have multiple properties in an LLC, you should maintain proper accounting practices to allocate expenses appropriately.

General expenses such as home office expenses and supplies may need to be prorated among the properties based on a reasonable method. You should consult with a tax professional to determine the most appropriate allocation method. 

It's essential to keep detailed records of income and expenses for each property separately to ensure accurate reporting. Home office expenses might be deductible if the home office is used exclusively and regularly for the business. However, the rules around home office deductions can be complex, and eligibility depends on specific criteria.

Michelle - Thanks very much for writing.

The cost segregation study and tax savings benefit for an investment property can vary based on several factors, including the property type, location, and specific components within the building. Typically, a cost segregation study identifies and reclassifies certain assets to shorter depreciation periods, allowing for accelerated depreciation deductions and increased tax savings.

As a rough estimate, the tax savings from a cost segregation study can range from 15% to 30% of the reclassified property value. So, for a $300,000 investment property, you might be looking at potential tax savings ranging from $45,000 to $90,000 in the first year. For a $500,000 property, the range might be $75,000 to $150,000 in potential tax savings.

It's important to note that these are general estimates, and the actual savings will depend on the specific details of the property and the results of the cost segregation study. Consulting with a tax professional or a firm specializing in cost segregation studies can provide a more accurate assessment based on the unique characteristics of your investment property.

Feel free to reach out with any further questions.

Thanks.

As a specialized real estate CPA, I'm here to provide expert guidance on your most complex tax matters, from navigating 1031 exchanges and cost segregation studies to optimizing your rental property deductions and handling multi-entity structures. Whether you're a seasoned real estate investor or just starting out, fire some questions at me and let me provide you with some insight that I'm hoping will be helpful to you in your investing journey!

Feel free to connect with me.

Your understanding is generally correct, but let me break it down to make sure we're on the same page:

1. Depreciation Recapture:
   • You correctly calculated the depreciation recapture as $12,500 (25% of $50,000).
   • The remaining capital gain subject to the long-term capital gains rate is $75,000 ($400,000 - $325,000 + $50,000 depreciation recapture).
   • After paying the depreciation recapture tax, you can use the net accumulated losses of -$40,000 to offset a portion of the remaining capital gain. So, you would only pay the 15% capital gains rate on the remaining $35,000 ($75,000 - $40,000).
2. Unused Passive Activity Losses:
   • If you still have unused passive activity losses after offsetting the entire capital gain, you can carry forward these losses to future years.
   • Passive activity losses can generally be used to offset passive income in future years. If you have other passive income from real estate or other passive activities, you can use these losses to offset that income.
   • If you don't have sufficient passive income to offset with the losses, you can carry forward the remaining losses to future years until you have passive income to offset or until you dispose of the last of your passive activities.
3. Offsetting Other Income:
   • Passive activity losses are generally not allowed to offset non-passive income, such as wages or dividends.
   • However, when you completely dispose of all your passive activities, you may be able to deduct any remaining unused losses against non-passive income. This is known as the "final disposition" rule.

In summary, after paying the depreciation recapture tax, you can use the remaining passive activity losses to offset a portion of the capital gain, and any unused losses can be carried forward to offset future passive income or potentially non-passive income after the final disposition of all passive activities.

When it comes to rental property renovations, expenses are typically categorized as either current expenses or capital expenses. Current expenses are usually deductible in the year they are incurred, while capital expenses may be recovered over time through depreciation.

Safe harbor rules may provide a simplified method for determining whether certain expenses can be immediately deducted rather than capitalized. These rules can allow you to deduct certain costs for improvements if they meet specific criteria.

If you're undertaking a large-scale renovation that would typically be considered a capital expense, it might be subject to depreciation rules. However, if you later undertake a small project that qualifies for a safe harbor and meets the criteria for an immediate deduction, it might be possible to deduct that expense in the year it was incurred.

Again, it's crucial to consult with a tax professional who can provide advice based on the specific details of your situation and the tax laws in your jurisdiction. Tax laws can be complex and subject to change, so getting professional guidance will help ensure that you make informed decisions regarding your rental property expenses.

It's great that you're looking to diversify your investments and potentially venture into real estate. However, using a self-directed individual retirement account (SDIRA) or an e-QRP (enhanced qualified retirement plan) for real estate investments comes with certain complexities and considerations. Here are some factors to help you make an informed decision:

1. SDIRA vs. e-QRP:
   • SDIRA (Self-Directed Individual Retirement Account):
     • Allows for a broader range of investment options, including real estate.
     • Provides more control over investment decisions.
     • Requires custodial services, and there may be fees associated with the SDIRA provider.
     • Strict rules and regulations to ensure compliance with IRS guidelines.
   • e-QRP (Enhanced Qualified Retirement Plan):
     • Similar to a 401(k) but with enhanced features for greater flexibility.
     • Generally, more streamlined than SDIRA with fewer administrative requirements.
     • Allows for real estate investments, business investments, and more.
     • May offer more control and fewer restrictions compared to SDIRA.
2. Financing Considerations:
   • Both SDIRA and e-QRP can be used for financing, but the terms and conditions may differ.
   • Check with your chosen custodian or plan administrator to understand the borrowing rules and any potential penalties.
3. Tax Implications:
   • Understand the tax implications of using retirement funds for real estate investments.
   • Consult with a tax professional to ensure compliance and to minimize any adverse tax consequences.
4. Market Conditions:
   • Consider the current real estate market conditions in the location where you plan to buy the beach house.
   • Evaluate potential risks and rewards, especially in the context of your investment horizon.
5. Long-Term Strategy:
   • Since you're planning to work for another five years and potentially sell the house later, ensure that your investment aligns with your long-term financial goals.
6. Interest Rates and Economic Conditions:
   • Monitor interest rates and economic conditions, as they can impact the timing and profitability of your real estate investment.
7. Professional Advice:
   • Consult with financial advisors, tax professionals, and legal experts to get personalized advice based on your specific financial situation and goals.
8. Due Diligence:
   • Perform thorough due diligence on the property, renovation costs, potential rental income, and local market trends.

Remember that real estate investments, especially with retirement funds, require careful planning and adherence to regulations. Given the complexity of your situation, seeking advice from financial professionals who specialize in real estate and retirement planning is crucial.

As a specialized real estate CPA, I'm here to provide expert guidance on your most complex tax matters, from navigating 1031 exchanges and cost segregation studies to optimizing your rental property deductions and handling multi-entity structures. Whether you're a seasoned real estate investor or just starting out, fire some questions at me and let me provide you with some insight that I'm hoping will be helpful to you in your investing journey.

Real Estate Investors - 

Keep in mind! When venturing into real estate investment, implementing effective tax strategies is paramount for optimizing financial returns and minimizing tax liability. Key considerations include leveraging depreciation benefits, as residential and commercial properties can be depreciated over 27.5 and 39 years, respectively. Maximizing deductions for mortgage interest is crucial, offering a substantial reduction in taxable income. Investors may explore cost segregation studies for commercial properties, accelerating depreciation by identifying components with shorter useful lives.