Investing 102

[Vegas69]

I've had really good luck with real estate in Las Vegas and Phoenix, but there have been lucrative opportunities twice in 15 years.

While I'm building my new house, I'm living in home we rented for a few years to convert it to a primary residence. I will still need to pay taxes on the forced depreciation while it was rented, but I'll escape capital gains. My accountant said they probably wouldn't catch it, but I don't play games with the IRS. I pay what I owe them.

I do agree though, the forced depreciation really hurts if you hold long term. You get in a place where you are almost forced to 1031 exchange to avoid taxes. I wonder if the taxes must be paid on the depreciation when it's passed on to your estate?

[GregWeld]

Originally Posted by Vegas69

I've had really good luck with real estate in Las Vegas and Phoenix, but there have been lucrative opportunities twice in 15 years.

While I'm building my new house, I'm living in home we rented for a few years to convert it to a primary residence. I will still need to pay taxes on the forced depreciation while it was rented, but I'll escape capital gains. My accountant said they probably wouldn't catch it, but I don't play games with the IRS. I pay what I owe them.

I do agree though, the forced depreciation really hurts if you hold long term. You get in a place where you are almost forced to 1031 exchange to avoid taxes. I wonder if the taxes must be paid on the depreciation when it's passed on to your estate?

#1 -- the estate tax laws have changed dramatically in the last few years..... In MOST cases there are no estate taxes (they start at 5 million). If you set up a proper will - with trusts etc - then you can give your spouse 5MM - and your kids 5MM each etc - with no taxes. Of course there are complications to any and all tax planning strategies..... and only a professional in the field can guide you on that.


#2 -- Securities (stocks) assets are passed thru at the STEP UP value. I.e., the day they exchange hands (from dead guy to living guy) - the cost basis for the living guy is the value on that day (the day they pass hands).

However --- PROPERTY passed thru via an inheritance is taxed at the original cost basis. So if "Dad" paid $100,000 for the rental house in 1965 -- and you inherit it and then sell it asap.... you're paying taxes on the difference in value from $100K to what you sell it for. In other words -- there's no going back and having to recapture or pay taxes on Dad's deductions etc.

[SSLance]

Originally Posted by GregWeld

However --- PROPERTY passed thru via an inheritance is taxed at the original cost basis. So if "Dad" paid $100,000 for the rental house in 1965 -- and you inherit it and then sell it asap.... you're paying taxes on the difference in value from $100K to what you sell it for. In other words -- there's no going back and having to recapture or pay taxes on Dad's deductions etc.

I'm not sure that is 100% correct...probably based on how the "PROPERTY" is defined or classed before death.

I've always been taught that Death always accelerates basis if the transfer of property is direct. For example, if my Father owns a personal residence house and I am listed on the deed as TOD (Transfer on Death), when he passes away the property automatically becomes mine at current market value as a basis the day he passes away.

This is assuming my fathers entire estate is under the 5 mil cap as far as inheritance tax is concerned. If over that cap, pretty much everything changes.

Rental property that has been depreciated might have to be treated differently though. I wouldn't be shocked if either Capital Gains tax on the gain or Deprecation recapture income tax would need to be paid by the heirs if they ever sell the property.

I do know this, income producing property that has not been depreciated (ie: farmland with no equip or structures) passes thru to heirs at an accelerated basis.

[Vegas69]

I do recall that if the beneficiary of the estate holds onto real estate for a certain amount of time, (Maybe a year?) the tax situation can change for the worse.

[GregWeld]

RE: Inheriting depreciated rental property




You will not need to worry about past depreciation on your inherited property. You will just use your stepped up basis (FMV of property on date of inheritance) and this new basis will be used for depreciation. You will be able to depreciation these inherited assets in full over the property's useful life. For example, use the full 27.5 year, S/L for the rental house (less land) and the start date will be the date when the rental property was transferred to you.

For any prior capital improvements, these will be included in the stepped up basis on the inherited property so do not depreciate them separately.

For any appliances, since they are considered "new" to you, you will just use the new FMV of these items and depreciate them over the new useful life at the date the asset were transferred to you.

[SSLance]

Originally Posted by GregWeld

RE: Inheriting depreciated rental property




You will not need to worry about past depreciation on your inherited property. You will just use your stepped up basis (FMV of property on date of inheritance) and this new basis will be used for depreciation. You will be able to depreciation these inherited assets in full over the property's useful life. For example, use the full 27.5 year, S/L for the rental house (less land) and the start date will be the date when the rental property was transferred to you.

For any prior capital improvements, these will be included in the stepped up basis on the inherited property so do not depreciate them separately.

For any appliances, since they are considered "new" to you, you will just use the new FMV of these items and depreciate them over the new useful life at the date the asset were transferred to you.

Yep, that's what I thought...death accelerates basis...

[GregWeld]

There are MANY ways to invest in rental real estate....

I, for one, have ZERO interest in managing a rental. I don't want to know about the water heater that quit working on Sunday afternoon.

I invest in LLC's that buy larger commercial apartment complexes - they do all the management.... I collect a check every 6 months for my shares. The last one I invested in ($900K) pays me $60K a year... I get the offsetting depreciation just as I would if I owned it personally.... and we recapture the depreciation upon the sale of the property (again, just like you would on any rental).

I got a statement with the last "dividend" check --- showing the value of my investment is over $1.9MM now. The rental market in the Seattle area has been ON FIRE.... and as such (after an extensive remodel of the property) they've been able to substantially increase the rents.

Just throwing this out there for those - that like me - have no interest in managing a rental. There are many firms in every area of the country that do this kind of income property management. You just have to ask your attorney or accountant.... They'll know someone.

Typically a share goes for somewhere between $50K and 100K per share. Sometimes they'll sell a half share. You do have to be an "accredited investor" to invest in this type of deal -- they're totally illiquid -- and you have zero control of when the property is sold.... so your money may be invested for a very long time (as in YEARS) and there's nothing you can do about it. So like any investment -- it should be a small percentage of your investable dollars. Remember the 5% rule!!

[Flash68]

Originally Posted by Vegas69

While I'm building my new house, I'm living in home we rented for a few years to convert it to a primary residence.

Love this strategy!

One I often used to read about was 1031 exchanging up and up over the years into more valuable properties and then at the very you trade a large apartment complex (likely holding) into your dream mansion SFR, then rent it out for a year before moving in to then recapture that 2 of out of last 5 primary residence designation. I think it still holds true as a viable option but that was awhile ago.

[Vegas69]

Yep, I had similar thoughts at one time as well. While I have utilized a 1031 before, I bought this one with Camaro money.

You know how those custom projects go. They always cost more than you thought they would up front. So I decided to utilize the primary strategy for 2 years while we build. It's worked out very well for our stage with Hugh and living simpler.

I have a very simple philosophy that has served me well so far. If a house doubles in value, I sell it. I'm glad I didn't utilize a 1031 on a number of them as I would of been forced to move up in value with poor markets on the horizon. It would've cost me far more than the 15% capital gains and I was only 2-5 years into the depreciation cycle. In fact, the 1031 I did utilize ended up costing me when I exited a market a bit late.

At this point my plan is to wait until the next recession and buy when the market is the most pessimistic. I don't mind moving in and out of markets as long term rentals mean bad tenants and major repairs at some point. Now, I only buy if the numbers make sense. I don't make the numbers work. If I get caught, I want the choice to hold long term. That's the real key to real estate investing. Can you wait until the timing is right worst case? If not, don't buy it. Unless you are a big risk taker and I'm not. I don't mind being the tortoise.