goal::
project::⚒️ Saving on tax
Summary
- When rental activity is considered non-passive (or active) losses can be deducted against ordinary income
- Typically rental activity is considered passive unless you are,
- Real estate professional status (REPS)
- 750+ hours in real estate
- More than 50% of your working time in real estate
- OR Short term rental (STR) loop hole
- Average stay is less than 7 days
- Vacation home is not used for personal use
- for greater than 14 days or 10% of time house was rented (i.e., days used/days rented)
- Using home while doing work is not considered personal use
- renting under fair market value is considered personal use
- renting to immediate family (brothers etc.) is considered personal use
- In both cases you need to materially participate in the rental
- 7 ways to ensure you materially participate
- 3 common ones
- Need to spend 100 hours and more than any body else (OR)
- 500 hours (OR)
- your participation was substantially all the participations
- What activities count towards materially participating?
- real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental operation, management, leasing, or brokerage trade or business.”
- https://semiretiredmd.com/material-participation-for-a-vacation-rental/
- You can materially participate in some rental and choose to group such that other out of state rentals can also come under the same bucket
- You can materially participate in one year where you expect net loss ( with big depreciation) and go back to passive next year
- Typically, depreciation for rental property is done over 27.5 years
- (Purchase price? - land value)/27.5 years
- Land cannot be depreciated (same goes for work done on land like landscaping etc)
- And this depreciation can be used against W2 or business incomes if you qualify for REPS or STR loop hole
- You can do a cost segregation study to identify items that can be depreciated faster
- e.g., carpets, roof etc.
- Typically, up to 30% of your purchase price can be identified for accelerated depreciation
- With bonus depreciation, you can take a big chunk of that accelerated depreciation in first year
- 100 % in '22, 80% in 23, and so on until it phases out to zero in 2027
- At that point regular accelerated depreciation still holds?
- Even if bonus depreciation comes against passive income it is suspended and carried forward and you can use it to offset sales rather than doing 1031 exchange
- So when using STR loophole with material participation and bonus depreciation you can offset your W2 and based on your tax rate it could mean getting almost the equivalent of your down payment back
- e.g purchase price 500k with 100k down payment (20%)
- bonus depreciation of 30% = 150k deduction (100% in 2022 ...)
- 150k deduction translates to 51k federal savings ( at 34% marginal rate) and 13.5 state tax savings + local taxes
- Property tax deductions are not capped at 10K like your primary residence
- If personal use clause gets triggered,
Depreciation Recapture
- Money depreciated will be recaptured when you sell the property
- Purchase price 100k
- Depreciated 30K (adjust cost basis = 100 - 30 = 70k)
- Selling price 150K
- You need to pay tax for profit ( 150 - 70k adjusted cost basis)
- Capital Gains 150 - 100 - 50
- Depreciation recapture - 30K
- Even if you do not claim depreciation as long as you are allowed depreciation IRS will recapture
- Depreciation recapture will be done at ordinary income up to a maximum of 25%
- if you are in the higher marginal bracket, there is tax arbitrage by deferring the taxes using bonus depreciation
- Depreciation recapture can be avoided by,
- Doing 1031 exchanges for like property or DST (delaware statutory trust?)
- When passing to heir after death dep. recapture is eliminated as the property is passed on with step up basis ( i.e. new cost basis at time of death or within 6 months)
References
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