? What is best
Without having been there I would not be able to provide specific data as it would apply.
Please base reply on the following.
Vestor acquires 5 properties total, 1 every 2 years. Vestor is occupying the first purchase as residence fulltime.
Personal income from wage slavery 45K per year.
All 5 properties rentals held 10 year term.
All properties purchased below 250K.
All sales to be below 250K.
? What is best a, b, c. !
a) Depreciate properties for the tax savings provided each year. Recapture depreciation at sale.
b) Rent only and do not depreciate properties. At end of 10 year period sell property 1 tax exempt sale personal residence. Move in to property 2 as residence for 2 years and sell. Repeat for property 3,4,5.
c) Same as (b), only depreciate each property.
To summarize, ? is it better to take the depreciation or not. ? How would a creative investor make this call !
Regards
Vestor
Quote:What is best a, b, c. !
a) Depreciate properties for the tax savings provided each year. Recapture depreciation at sale.
b) Rent only and do not depreciate properties. At end of 10 year period sell property 1 tax exempt sale personal residence. Move in to property 2 as residence for 2 years and sell. Repeat for property 3,4,5.
c) Same as (b), only depreciate each property.Vestor,
Let's assume that all five properties are purchased for the same amount, and therefore, each has the same initial cost basis. Let's also assume that each property appreciates at the same rate and is sold for the same price.
In asking which option is best, I will interpret "best" to mean which option results in the least tax liability, or, the most money left in your pocket at the end of your holding periods for all properties.
Here is how I would rank each option in descending order of preference.
Option C. Taking a depreciation expense during your period of rental use offsets rental income and may offset other ordinary income as well. Serially converting each property to your principal residence for two years prior to the sale, takes advantage of the capital gains exclusion available on the sale of your principal residence. The only tax liability on the sale of each property in this strategy is depreciation recapture for the four rental properties.
Option B forfeits the depreciation expense during the rental use period for each investment use property, much to your detriment. Serially, converting each rental to your principal residence for two years prior to sale provides the same capital gains exclusion opportunity you had in Option C. The difference in this scenario is that you are still liable for depreciation recapture on the depreciation you should have taken, but you did not reap the benefit from having taken it. Here you get penalized for not using the tax code to your maximum advantage.
Option A is not really clearly defined. So let me assume that in option A you occupy the first house as your primary residence, and operate the other four as rental properties until all five properties are sold after ten years. In this option, you have a capital gain tax on the profit from the sale of the four rental properties and depreciation recapture on the depreciation taken (or that should have been taken) during the rental use period. Only one property qualifies for the capital gains exclusion.
Please note that the purchase price and sale price do not have to be under $250K to take advantage of the capital gains exclusion. Your profit on the deal needs to be $250K or less to avoid capital gains taxation on the sale.
Dave,
Thanks for the post.
I understand the 250k is a limitation on gain and not the sales price. I was trying to simplify a post that grew larger than I had originally intended.
Also you are correct, my intent is to understand how to keep as much of this hard earned cash as possible.
My original thought was to keep it simple and not depreciate my rentals, and to ultimately sell as tax exempt sale keeping all gains tax free.
I had a feeling that it would be best to depreciate all rentals to offset rental income, and other taxable income to a later date, possibly retirement and a lower tax bracket.
Reading your reply is it correct that if I use/classify a property as a rental then the IRS presumes depreciation even if I do not take it on tax return.
That is a revelation.
Regards
Vestor
I am NOT an expert on this, but here is one thought.
Buy it as a rental property, hold it for 10 years (or however long you want). 2 years before you want to sell it (for profit), go ahead and sell it to your wife for the same price that you originally bought it for (ie, $0 capital gains). Live in it for 2 years, and then sell it as a primary residence.
Any comments on this approach?????
Hibby,
? How about going a step farther !
Say you made a lot more money than her and needed some offset for your income. With your train of thought sell to your wife at a loss.
WO~ WO~ WO~!!!!!
I follow your logic, but I think it is on the edge of the envelope as to what can be done within IRS rules and Legal restrictions. Also wouldnt this just transfer the equity and affect her gain's/ cost basis etc... when she sells.
I would think that the IRS, CPA, and your Lawyer would advise against this.
Your wife is like yourself legally, unless you purchased the property as sole and seperate property and had your wife sign a seperate disclaimer deed at purchase.
BTW.... These are my opinions and I am not a CPA or Lawyer.
IMHO...The points you have raised in your post need the expert guidance of Legal counsel and tax expert.
Regards
Vestor
Quote:I am NOT an expert on this, but here is one thought.
Buy it as a rental property, hold it for 10 years (or however long you want). 2 years before you want to sell it (for profit), go ahead and sell it to your wife for the same price that you originally bought it for (ie, $0 capital gains). Live in it for 2 years, and then sell it as a primary residence.
Any comments on this approach?????
hibby76,
I am not an expert on related party transactions. Take a look at IRS Publication 544, with special emphasis on the section that addresses Sales and Exchanges Between Related Persons.
As I interpret the rules, the profit on the sale to a related person is determined by the property's FMV (not the cost basis, or below market sale price), AND the profit is taxed as ordinary income even if a capital asset is involved.
It seems that the IRS has already thought of this strategy and has written rules into the tax code to thwart this plan. As I said, I am not an expert, and I could be completely misinterpreting some already complex, confusing language.
As an afterthought, even if the property were sold to a related party for a zero capital gain, there will still be depreciation recapture to deal with.
The intent of your plan is to shield the profits from capital gain tax. This is done already by converting the rental to a primary residence for at least two years prior to sale. Up to $250K of profit (per taxpayer) can be excluded from capital gains taxation, but depreciation recapture can not be avoided.[ Edited by DaveT on Date 02/22/2003 ]
Dave,
Thanks for the post.
May I ask this again as Hibby made a post after this and you may have not read it.
My original thought was to keep it simple and not depreciate my rentals, and to ultimately sell as tax exempt sale keeping all gains tax free, and not having to deal with recapture.
I had a feeling that it would be best to depreciate all rentals to offset rental income, and other taxable income to a later date, possibly retirement and a lower tax bracket due to lower income levels.
? Reading your reply is it correct that if I use/classify a property as a rental then the IRS presumes depreciation even if I do not take it on tax return. ?
? Also generally I understand from the posts that it would be best to depreciate all rental property to offset current income and recapture/sell at later date when income levels are lower.
? Is this correct.
Thank You
Vestor
Quote:? Reading your reply is it correct that if I use/classify a property as a rental then the IRS presumes depreciation even if I do not take it on tax return. ?
? Also generally I understand from the posts that it would be best to depreciate all rental property to offset current income and recapture/sell at later date when income levels are lower.
? Is this correct.
Vestor,
To question 1. Yes. You cannot avoid depreciation recapture; you only increase your tax liability by not taking the depreciation deduction you are entitled to. Remember, depreciation recapture is calculated on the depreciation you actually took, or should have taken, whichever is greater.
To question 2. The profit on the sale of investment property is subject to capital gains taxes. Capital gains tax rate is keyed to your holding period and your marginal tax bracket. So, yes, you will have a lower capital gains tax if the sale occurs when your marginal tax bracket is 15%, than when your bracket is higher. If you are always going to be in a marginal tax bracket higher than 15%, then your capital gain tax rate is 20% no matter how high your marginal tax bracket gets. Depreciation recapture is fixed at 25% regardless of your marginal tax bracket.
Nice try, but that will not work, especially if you file joint tax returns (there are other reasons it won't work, but that is for another post).
Taxjunkie
Taxjunkie,
?Care to elaborate !
The intent is to learn, please reply with the details.
Vestor[ Edited by Vestor on Date 03/01/2003 ]
There are a number of related party rules under the Treasury regulation issued under Internal Revenue Code 121 (i.e., the Code Section addressing the $250,000 exclusion). I am not trying to be evasive, but those rules are rather complicated and to fully explain them would involve a very very long post. Trust me on this one or do some research under Code Sections 121, 1001, and 267.
Taxjunkie
How about: keep the properties as rentals, live in the one you like, depreciate the H out of them, pay off the loans (tenants do that) then if for some weird reason you don't like cashflow 1031 exchange them for something esle you do like.
BTW: ten years is a long time, are you just going to stop at 5 houses?
BTW again: if you need cash borrow against your equity, tax free, and the tenants will pay those loans off too. Nice of them huh?
I have a simple question as a newbie to RE. what does Depresiation Recapture mean. Do you have to pay this money back?? I obviously dont understand??
You depresiate against your house to help lower your taxable income. Am I right about that?? If this is true then what does the above mean?? (Depresiation Recapture) Thanks!!
Dizzy,
Check out this article, How Depreciation is Recaptured, then if you still have any questions, start a new thread in this forum.