Author Topic: Depreciation tax benefit, how I love thee  (Read 3172 times)

Bearded Man

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Depreciation tax benefit, how I love thee
« on: May 30, 2015, 12:06:59 PM »
Is it just me or is depreciation a hidden gem? By my calculations, between 401k, HSA, IRA and depreciation deductions for what will soon be 5 rentals, I will get 15K of my money back every year. Most of that benefit is from the rentals, with the 401k coming in second, the IRA third and the HSA fourth.

Of course some of that money has to get reinvested back in to keep the places looking nice, but still, I'm getting a ton of money back every year to do it with, just for a few minutes of tax planning.

The more I invest in real estate the more I'm convinced this is the way to go. Principal pay down, cash flow, appreciation, being able to "buy equity", tax benefits. Oh Real Estate, how I love thee.
« Last Edit: May 30, 2015, 12:10:59 PM by Bearded Man »

CashFlowDiaries

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Re: Depreciation tax benefit, how I love thee
« Reply #1 on: May 30, 2015, 12:50:28 PM »
I feel the exact same way.  I absolutely love real estate too for all the reasons you mentioned above.  There is a science to buying the right properties though.  You cant just buy any house and rent it out. Its all about running the numbers and making sure they are cash flow positive. I'm closing on my 5th investment property on monday and im super stoked about it.

waltworks

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Re: Depreciation tax benefit, how I love thee
« Reply #2 on: May 30, 2015, 01:16:20 PM »
You are aware that if you ever sell the properties, you will have to pay back all that depreciation money, right?

It's great tax deferral but unless you plan to hold the properties forever (or pass on to heirs in some cases) it's not free money.

-W

DarinC

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Re: Depreciation tax benefit, how I love thee
« Reply #3 on: May 30, 2015, 01:27:04 PM »
1031 exchanges are the usual method of keeping taxes deferred. They're a pain though, because you need to purchase the replacement within 45 days. This isn't too bad if you have the replacement lined up and an offer accepted on it, but if you don't have that kind of capital it can be tough.

Arktinkerer

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Re: Depreciation tax benefit, how I love thee
« Reply #4 on: June 01, 2015, 08:11:02 AM »
I'm looking at the reverse side of this as I approach retirement.  Maybe one of you has some recommendations?

When you sell, you not only have to pay back the depreciation, you pay back "depreciation recapture" at 25%.  Doesn't matter that this is long term capital gain or that inflation really chewed up that gain.  So yes, you do great in that you get to depreciate and count it against your current tax bill but you will pay back at this higher rate if you ever want out.

New rules on depreciation of repairs is also a problem for us.  Accountant says, as a general rule, anything over $500 must be depreciated under the new rules.  Not only is the paperwork a pain, but if you have to stretch the payback over 27.5 years inflation, low as it is, will still make this almost like just pouring your money down a hole.  Why bother even keeping track?  You would be better off if you just limited the deduction to $499 and ignored the rest of the cost.  Would you rather get $499 expensed this year or $800 over the next 27.5 years?

What are your strategies for depreciating expenses and/or avoiding depreciation recapture if you exit the rental business?


arebelspy

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Re: Depreciation tax benefit, how I love thee
« Reply #5 on: June 01, 2015, 02:48:03 PM »
Ark: A lot of short term stuff like that (like, say carpet) is depreciated over 5 years (or sometimes 7 or 15), rather than 27.5 or 30.  Talk to your accountant about cost segregation.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

daverobev

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Re: Depreciation tax benefit, how I love thee
« Reply #6 on: June 01, 2015, 02:56:56 PM »
Ark: A lot of short term stuff like that (like, say carpet) is depreciated over 5 years (or sometimes 7 or 15), rather than 27.5 or 30.  Talk to your accountant about cost segregation.

Or read the instructions when filling out your paper tax return. Or read them just for fun.

Bearded Man

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Re: Depreciation tax benefit, how I love thee
« Reply #7 on: June 01, 2015, 02:58:28 PM »
That begs the question, how much of the depreciation money do you actually end up investing into improvements or repairs? Seems like you get to keep a lot of it even after expenses, no?

daverobev

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Re: Depreciation tax benefit, how I love thee
« Reply #8 on: June 01, 2015, 03:01:08 PM »
I'm looking at the reverse side of this as I approach retirement.  Maybe one of you has some recommendations?

When you sell, you not only have to pay back the depreciation, you pay back "depreciation recapture" at 25%.  Doesn't matter that this is long term capital gain or that inflation really chewed up that gain.  So yes, you do great in that you get to depreciate and count it against your current tax bill but you will pay back at this higher rate if you ever want out.

New rules on depreciation of repairs is also a problem for us.  Accountant says, as a general rule, anything over $500 must be depreciated under the new rules.  Not only is the paperwork a pain, but if you have to stretch the payback over 27.5 years inflation, low as it is, will still make this almost like just pouring your money down a hole.  Why bother even keeping track?  You would be better off if you just limited the deduction to $499 and ignored the rest of the cost.  Would you rather get $499 expensed this year or $800 over the next 27.5 years?

What are your strategies for depreciating expenses and/or avoiding depreciation recapture if you exit the rental business?

You buy a house for $100k, depreciate it over a number of years to $80k, then sell for $130k.

You will pay "income tax" on $20k and cap gains on $30k. Seems fair enough to me. Not sure what the 25% you're talking about is. It'll just be your marginal tax rate for the year you sell.

jwright

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Re: Depreciation tax benefit, how I love thee
« Reply #9 on: June 02, 2015, 09:40:53 AM »
I'm looking at the reverse side of this as I approach retirement.  Maybe one of you has some recommendations?

When you sell, you not only have to pay back the depreciation, you pay back "depreciation recapture" at 25%.  Doesn't matter that this is long term capital gain or that inflation really chewed up that gain.  So yes, you do great in that you get to depreciate and count it against your current tax bill but you will pay back at this higher rate if you ever want out.

New rules on depreciation of repairs is also a problem for us.  Accountant says, as a general rule, anything over $500 must be depreciated under the new rules.  Not only is the paperwork a pain, but if you have to stretch the payback over 27.5 years inflation, low as it is, will still make this almost like just pouring your money down a hole.  Why bother even keeping track?  You would be better off if you just limited the deduction to $499 and ignored the rest of the cost.  Would you rather get $499 expensed this year or $800 over the next 27.5 years?

What are your strategies for depreciating expenses and/or avoiding depreciation recapture if you exit the rental business?

You buy a house for $100k, depreciate it over a number of years to $80k, then sell for $130k.

You will pay "income tax" on $20k and cap gains on $30k. Seems fair enough to me. Not sure what the 25% you're talking about is. It'll just be your marginal tax rate for the year you sell.

Actually, straight-line depreciation recapture (Section 1250 recapture) is taxed at 25%, not your marginal rate.  It is actually beneficial for high earners, since the marginal tax brackets can be 39.6% plus the Medicare net investment income tax. 

Excess depreciation (if you break out different items to a shorter life as suggested above) may be subject to ordinary income recapture.  Talk to your accountant.

jwright

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Re: Depreciation tax benefit, how I love thee
« Reply #10 on: June 02, 2015, 09:46:48 AM »
I'm looking at the reverse side of this as I approach retirement.  Maybe one of you has some recommendations?

When you sell, you not only have to pay back the depreciation, you pay back "depreciation recapture" at 25%.  Doesn't matter that this is long term capital gain or that inflation really chewed up that gain.  So yes, you do great in that you get to depreciate and count it against your current tax bill but you will pay back at this higher rate if you ever want out.

New rules on depreciation of repairs is also a problem for us.  Accountant says, as a general rule, anything over $500 must be depreciated under the new rules.  Not only is the paperwork a pain, but if you have to stretch the payback over 27.5 years inflation, low as it is, will still make this almost like just pouring your money down a hole.  Why bother even keeping track?  You would be better off if you just limited the deduction to $499 and ignored the rest of the cost.  Would you rather get $499 expensed this year or $800 over the next 27.5 years?

What are your strategies for depreciating expenses and/or avoiding depreciation recapture if you exit the rental business?

The new rules are actually more lenient; there was no de minimis amount in the past.  A hammer is an asset; an audit professor once told us a pencil is technically an asset,  because they are used for ongoing lives and future benefits.  A lot of accountants I know had an informal $100 or $500 limitation; now the IRS has legitimized the higher, $500 amount.

Make sure that the items you are depreciating are actually assets.  Repairs do not have to be capitalized.  If you patch up your roof for $1,000 that is all deducted.  Only a brand new roof would be depreciated.  A lot of times painting is a repair expense.  Also, as noted above, make sure you are assigning the proper class life to the assets - most flooring, appliances, and furniture have shorter 5-7 year lives and could qualify for bonus depreciation.

Bob W

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Re: Depreciation tax benefit, how I love thee
« Reply #11 on: June 02, 2015, 10:03:59 AM »
Curious if anyone knows off the top of their heads  --

When I die does a rental property pass to my heirs at the purchase price basis or a stepped up basis equal to the current market value?

I can't see if I own real estate in my town and my kids live here that I would ever want to sell it.   Just pass it on.

Or would it be better to loan the money to the kids to buy the property now from a tax point of view.   (will not be over the 5 Mill deal)

dandarc

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Re: Depreciation tax benefit, how I love thee
« Reply #12 on: June 02, 2015, 10:19:18 AM »
Curious if anyone knows off the top of their heads  --

When I die does a rental property pass to my heirs at the purchase price basis or a stepped up basis equal to the current market value?

I can't see if I own real estate in my town and my kids live here that I would ever want to sell it.   Just pass it on.

Or would it be better to loan the money to the kids to buy the property now from a tax point of view.   (will not be over the 5 Mill deal)
Looks like they would get a stepped up basis, from the first few google results.  Looks to me like they can even depreciate the house again, assuming they keep it as a rental.

arebelspy

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Re: Depreciation tax benefit, how I love thee
« Reply #13 on: June 02, 2015, 10:27:16 AM »
When I die does a rental property pass to my heirs at the purchase price basis or a stepped up basis equal to the current market value?

Stepped up basis.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

daverobev

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Re: Depreciation tax benefit, how I love thee
« Reply #14 on: June 02, 2015, 01:42:05 PM »
I'm looking at the reverse side of this as I approach retirement.  Maybe one of you has some recommendations?

When you sell, you not only have to pay back the depreciation, you pay back "depreciation recapture" at 25%.  Doesn't matter that this is long term capital gain or that inflation really chewed up that gain.  So yes, you do great in that you get to depreciate and count it against your current tax bill but you will pay back at this higher rate if you ever want out.

New rules on depreciation of repairs is also a problem for us.  Accountant says, as a general rule, anything over $500 must be depreciated under the new rules.  Not only is the paperwork a pain, but if you have to stretch the payback over 27.5 years inflation, low as it is, will still make this almost like just pouring your money down a hole.  Why bother even keeping track?  You would be better off if you just limited the deduction to $499 and ignored the rest of the cost.  Would you rather get $499 expensed this year or $800 over the next 27.5 years?

What are your strategies for depreciating expenses and/or avoiding depreciation recapture if you exit the rental business?

You buy a house for $100k, depreciate it over a number of years to $80k, then sell for $130k.

You will pay "income tax" on $20k and cap gains on $30k. Seems fair enough to me. Not sure what the 25% you're talking about is. It'll just be your marginal tax rate for the year you sell.

Actually, straight-line depreciation recapture (Section 1250 recapture) is taxed at 25%, not your marginal rate.  It is actually beneficial for high earners, since the marginal tax brackets can be 39.6% plus the Medicare net investment income tax. 

Excess depreciation (if you break out different items to a shorter life as suggested above) may be subject to ordinary income recapture.  Talk to your accountant.

Well, I learn something new about US taxes every day. At least it won't be a nasty surprise if/when I come to sell!

Arktinkerer

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Re: Depreciation tax benefit, how I love thee
« Reply #15 on: June 04, 2015, 09:04:57 AM »
I'm looking at the reverse side of this as I approach retirement.  Maybe one of you has some recommendations?

When you sell, you not only have to pay back the depreciation, you pay back "depreciation recapture" at 25%.  Doesn't matter that this is long term capital gain or that inflation really chewed up that gain.  So yes, you do great in that you get to depreciate and count it against your current tax bill but you will pay back at this higher rate if you ever want out.

New rules on depreciation of repairs is also a problem for us.  Accountant says, as a general rule, anything over $500 must be depreciated under the new rules.  Not only is the paperwork a pain, but if you have to stretch the payback over 27.5 years inflation, low as it is, will still make this almost like just pouring your money down a hole.  Why bother even keeping track?  You would be better off if you just limited the deduction to $499 and ignored the rest of the cost.  Would you rather get $499 expensed this year or $800 over the next 27.5 years?

What are your strategies for depreciating expenses and/or avoiding depreciation recapture if you exit the rental business?

The new rules are actually more lenient; there was no de minimis amount in the past.  A hammer is an asset; an audit professor once told us a pencil is technically an asset,  because they are used for ongoing lives and future benefits.  A lot of accountants I know had an informal $100 or $500 limitation; now the IRS has legitimized the higher, $500 amount.

Make sure that the items you are depreciating are actually assets.  Repairs do not have to be capitalized.  If you patch up your roof for $1,000 that is all deducted.  Only a brand new roof would be depreciated.  A lot of times painting is a repair expense.  Also, as noted above, make sure you are assigning the proper class life to the assets - most flooring, appliances, and furniture have shorter 5-7 year lives and could qualify for bonus depreciation.

What actually triggered this for us last year was a sewage line.  Tree roots penetrated and it had to be replaced.  About $2000 total.  Did this improve the house?  Well, the new line was not clay tile and so yes.  It also replaced the old line.  Accountant said it had to be depreciated.  From a value standpoint, how many buyers or renters would bother to ask what kind of sewer line you have?  Can't raise the rent because I have a new sewer line.  Can't say the property value went up because of it.  No one is going to say the house is worth $2000 more but it darn sure would be worth a lot more than $2000 less if the sewer line was broken!

Had a meeting with the accountant yesterday and he said the limit was expected to rise this year to at least $2500.  Much more reasonable number I think.