All Forum Posts by: William C.

@Nathaniel C. Can’t you just provide your insurance company with tenant’s renters insurance policy info and allow insurance companies to hash it out? I think it’s reasonable for tenant to pay deductible if it really was their fault, if that’s allowed by your policy, but seems weird to me that you could expect tenant to know hanging a picture in that one spot would cause a leak. If tenant was warned not to hang anything there without using those sticky wall hangers, or if they used something not meant for home use, then maybe.

I would require the tenant to file the claim with their renters insurance.

If they don't have renters insurance, then I would file a claim with my insurance and the tenant would be responsible for reimbursing me for the deductible. 

If my insurance rejects the claim, then the tenant is responsible for the entire cost. I would allow a payment plan, but I won't spread the payments more than six months. A better option is for the tenant to take out a personal loan, pay me in full, and make payments to the bank.

 This is a good point and not one I thought of.  If payment has been received from the insurance company there's nothing to collect.  The time to get tenant insurance involved (if they have it, we require it) would be before the claim is filed.

@Nathaniel C.

I assume you have put them on notice. Did you also notify their renters insurance?

If you collected an insurance claim you would only be able to collect your out of pocket (ie deductible).

I would absolutely collect that from them if they were properly notified

If you collect the 10K from the renter will you reimburse that 10K to the insurance company?

To me it seems like you've been paid already, and are these the type of renter you can collect 10K from?

If they had 10K they'd probably buy a house- most renters are poor.

Would a court allow you to collect twice- make a windfall profit on this mistake in renter judgment?

Just my 2 cents.

@William C. This can go so many ways depending on so many factors.

1031 cannot defer cost seg deprecation recapture (only straight-line depreciation).

This needs to be modeled out with 1031 or outright sale and recapture percentage.

This post does not create a CPA-Client relationship. The information contained in this post is not to be relied upon. Readers should seek professional advice.

@William C. that's a great question and it shows you're planning smart by thinking ahead about the tax implications. I've worked with a lot of investors who’ve done cost segregation, and the recapture part is always something that can catch you off guard if you don't think it through.

Let’s break this down step by step..just like when I helped a buddy of mine who had a similar situation a couple of years ago, only he was dealing with a multi-family unit, not a single-family home. The math won't be exact since I’m just a Realtor (licensed in Arizona and a couple of other states) and not a CPA, but I can definitely give you a rough scenario from what I’ve seen.

1. Initial Depreciation:
You mentioned a cost segregation study that resulted in $80k of passive losses. This means you accelerated a lot of the depreciation upfront.  residential real estate is depreciated over 27.5 years, but since you took the bonus depreciation, you pulled a lot of it into the first year.

2. Depreciation Recapture:
When you sell, the IRS wants some of that depreciation back. Depreciation recapture on real estate is taxed at a flat 25%. So, if you claimed $80k in depreciation over the years (even if a chunk was in year one due to bonus depreciation), you’d owe recapture taxes on that.

Let’s run a basic example:

• $80k depreciation recapture @ 25% = $20k in taxes.

3. Capital Gains:
Now, you bought the property for $700k and put in $25k in renos, so your adjusted basis is $725k. If you sell it for $800k, you have a capital gain of $75k ($800k - $725k).

Capital gains taz is usually lower than ordinary income tax, but since you don’t qualify for the 2 out of 5-year exemption, you’re looking at paying full capital gains taxes. Based on your personal tax rate of 30%, this would be:

• $75k gain @ 30% = $22.5k in taxes.

4. Total Tax Liability:
So, you’re looking at a total tax bill of $20k (recapture) + $22.5k (capital gains) = $42.5k.

Funny thing is, I had a client back in Phoenix who was in almost the exact same situation. He was debating whether to sell or roll into a 1031, and it took us a couple of long coffee chats to weigh the pros and cons. He ended up going the 1031 route and hasn’t looked back since.

Another like-kind propert could really help you keep your momentum going without taking such a tax hit all at once. I’ve worked with folks in both Austin and Scottsdale who did just that and continued to build cash flow over the years.

So while the recapture and capital gains can hit hard, there are options to consider. I’d definitely recommend talking to a CPA who can run your exact numbers and make sure you're thinking of all the angles. Good luck, Nathaniel! It’s smart you’re thinking about this now instead of scrambling when it’s time to sell. 

Pat / Jasper
Turning investment visions into reality in Phoenix, AZ - Ranked #1 for residential real estate growth and opportunity by PwC

Hey Nathaniel, 

In this scenario, when selling the property for $800k, depreciation recapture would be a key consideration. The cost basis is the $700k purchase price plus $25k in renovations, totaling $725k. The cost segregation study generated $80k in passive losses, meaning a portion of that would be recaptured as ordinary income (at a 25% federal rate). The difference between the sales price ($800k) and the adjusted cost basis ($725k minus $80k of accelerated depreciation) is $155k. The $80k of depreciation recapture will be taxed at 25%, and the remaining $75k capital gain will be taxed at the capital gains rate (likely 15-20%). Your combined personal tax rate of 30% could apply to state and federal taxes depending on jurisdiction. A 1031 exchange could defer both capital gains and depreciation recapture taxes if you reinvest in another like-kind property. Depending on if this is your primary residence or not can alter the strategy but that's the gist