The Ridgeview Report
The 4 Key Tax Strategies We Utilize In Real Estate
At Ridgeview Property Group, we invest in multifamily real estate in the pursuit of long-term cash flow. In addition, we benefit from the great tax-minimizing strategies that real estate offers. Today, we're diving into 4 essential tax strategies that we utilize.
1. Depreciation: Turning Wear and Tear into Tax Benefits Depreciation allows property owners and investors to recover their property's cost over time through annual deductions. This helps account for the natural wear and tear properties go through, even as their value appreciates. You can't depreciate the land, but the building itself is fair game. Spread the deduction over 27.5 years for residential properties and 39 years for commercial ones. Remember, you need to use the property for business or income-generating purposes to claim depreciation.
Depreciation In Action:
Imagine you've invested in an apartment building with a total cost of $3,000,000. This cost includes both the building and the land it's on. The first step is to allocate the value between the building and the land. Assuming the land value is around $600,000, this leaves the building's value at $2,400,000 ($3,000,000 - $600,000).
For apartment buildings, the IRS considers a depreciation period of 27.5 years under the General Depreciation System.
Now, let's calculate the annual depreciation deduction:
Annual Depreciation Deduction = Building Value / Depreciation Period
Annual Depreciation Deduction = $2,400,000 / 27.5
Annual Depreciation Deduction ≈ $87,273
In this case, you'd be able to deduct approximately $87,273 from your rental income each year as a depreciation expense. This deduction applies to any real estate income you have.
2. Cost Segregation: Accelerate Your Tax Savings A cost segregation study allows property owners to take advantage of bonus depreciation. Instead of waiting decades for deductions, you break down your property into its components – carpets, appliances, plumbing, landscaping – and give them shorter depreciation periods. Completing a cost segregation study allows you to increase your tax savings, especially in the initial years of ownership. This isn't a DIY job. You'll need a tax expert to complete the study and navigate the details to unlock the full potential of your property's value. Bonus Depreciation In Action: Imagine you've invested in an apartment building with a total cost of $3,000,000. Traditional depreciation for residential properties typically extends over 27.5 years. However, a comprehensive cost segregation study reveals components within the building that can be reclassified with shorter depreciation periods. Upon completing the study, you identify $900,000 worth of assets, including carpets, appliances, and specialized lighting, that can be reassigned to shorter depreciation periods. Instead of depreciating the entire $3,000,000 over 27.5 years, you can now depreciate a portion of it over 5 years for specific components. Here's an example of the numbers:
Original Building Value: $3,000,000
Reclassified Components Value: $900,000
Remaining Building Value: $1,500,000 ($3,000,000 - $600,000 - $900,000)
Thanks to the cost segregation study, you can apply bonus depreciation to the reclassified components. Bonus depreciation lets you deduct a significant portion of the asset's cost in the first year of ownership. Let's assume these reclassified components qualify for an 80% bonus depreciation rate.
Bonus Depreciation Deduction = Reclassified Components Value × Bonus Depreciation Rate
Bonus Depreciation Deduction = $900,000 × 0.8
Bonus Depreciation Deduction = $720,000
In this case, you can claim a $720,000 bonus depreciation deduction, in addition to the regular depreciation deduction based on the building value. This substantial upfront deduction can provide immediate tax benefits and significantly reduce your taxable income for the acquisition year.
Bonus Depreciation In Action:
This strategy's effectiveness is evident in the Champlin portfolio, which closed in December 2022. Thanks to a cost segregation study, investors received a K1 the next spring showing a taxable loss equal to 45% of their total investment.
3. Capital Gains Tax Discount: How Real Estate Gains Are Taxed Less Than Income
The IRS offers a capital gains tax discount for long-term investments held for more than a year. This means lower tax rates on your gains.
As of September 2021, the capital gains tax rate is set at a maximum of 20%. This is a remarkable discount compared to the regular income tax rates, which can reach as high as 37%. If you earned $200K in income from real estate, and your friend earned $200K from their W2 job that same year, even though you made the same income, their taxes would be $74K, and yours would be $40K. The W2 income was taxed 85% more!
4. 1031 Exchange: Upgrade your Portfolio
The 1031 exchange, named after a section in the IRS Code, allows you to swap one investment property for another, all while deferring capital gains and depreciation recapture taxes. In simpler terms, you get to upgrade your property without immediately dishing out a chunk of your gains in taxes.
Here's How It Works: When the opportunity presents itself, Ridgeview Property Group may sell a property and 1031 exchange into another property. All investors retain their equity and are now owners of a larger and newer asset. Even though the previous property was sold for a profit, because the funds went towards the purchase of another real estate asset, there is no immediate tax implication.
In the world of real estate investing, timing and strategy can make all the difference. The 1031 exchange allows you to build your portfolio, grow your equity, and keep more of your gains in your pocket.
*Remember, tax laws can be complex and ever-changing. It's always a good idea to consult with a tax professional to ensure you're making the most of these strategies for your unique situation.*
Market News
Depreciation Strategies in Neumann's Real Estate Ventures An article by TheRealDeal focuses on Adam Neumann's extensive real estate investments and highlights his potential use of depreciation strategies to alleviate his tax burdens. In reference to one of Neumann’s real estate acquisitions the article quotes “ By depreciating his newly acquired holdings, Neumann could slash his taxable income by tens of millions of dollars every year for decades to come.” This article emphasizes the value of tax strategizing and shows how expert navigation of depreciation avenues can significantly impact tax liabilities and financial outcomes for investors like Neumann. Neumann's approach mirrors that of many property owners who seek to maximize their tax benefits by utilizing tactics like bonus depreciation and shorter depreciation periods for specific property elements. Source: TheRealDeal. Depreciation Man: Adam Neumann’s real estate binge to ease tax bill https://therealdeal.com/new-york/2022/01/21/depreciation-man-adam-neumanns-real-estate-binge-to-ease-tax-bill/
Tips and Tricks
Term: Cost Segregation Study
A cost segregation study is a detailed analysis performed on a property to identify and reclassify its components into shorter depreciation periods for tax purposes. The goal of a cost segregation study is to maximize tax benefits by accelerating depreciation deductions and optimizing cash flow for property owners.
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