Surprised on tax benefit after first year as landlord!

[capitalG]

Just finished my taxes after our first year as a landlord and even though we ran a lot of numbers before taking the dive, I’m still surprised by how much it impacted our taxes. Yes, being a landlord comes with its share of headaches - we already have had to deal with a couple issues - but the tax benefit seems unreasonably good. Did anyone else have the same discovery after the first year of renting?

capG

[Kennedy]

If you have a mortgage and have less than $150,000 of modified adjusted gross income, you can deduct a substantial amount of losses (maybe $25,000). The losses are achieved early on from mortgage interest and depreciation. However, keep in mind that when you sell the place (and not exchanged), you have to recapture the depreciation at 25% and pay any capital gains on appreciation.

[Momus]

Once you make over 150k, there are nothing to deduct against your ordinary income. If you don't have something like 20 properties, you can't possibly take 3 hours/day or 14 hours a week active work (750h/yr) to work on your rental property to qualify for the deduction.

You can only offset your loss and depreciation to your rental income and carry over remaining loss forever until you sell the property, then you get hit by depreciation recapture. However, you can do 1031 exchange, or give it to your heir to avoid paying a lot of taxes.

[togb]

I was pleasantly surprised by how having a rental property is going. I've got what I consider good cash flow, and with the depreciation on top of taxes, interest, very little of that cashflow is getting taxed.

Now that nasty issue of depreciation recapture is a deterrent to selling, for sure. I need to research whether it can be avoided by moving into the house and making it a primary residence for a couple years. It's definitely a house I could live in, and that might make sense at some point. I know if it lived in it the capital gains would be avoided, just not sure on depreciation recapture.

Of course the other option is 1031 exchange, and I don't know much about it. Just that you need a lawyer to ensure you get it right, and it costs a couple grand for the paperwork. Always good to have options.

[Dale_G]

I'll be interested if the depreciation recapture goes away by living in the home for a few years after the last rental. My son recently sold a home in this situation. I haven't done the research yet, but I am expecting that the depreciation will be fully recaptured.

Dale

[riverguy]

Most likely it's a poor rental if your taxable income is negative without one time items.

[Slacker]

Unless the rules recently changed, depreciation recapture and capital gains taxes apply apportioned based on number of years as rental vs number of years as a primary residence. The only exclusion is if you had lived in the house for a couple years and sell it before you hit 3yrs of it being a rental (2 out of 5rule) or in some other limited cases like military orders.

So say you had a property as a primary residence for a year, then rental for 6 years and move back in for 3 years and then sell it. If I remember correctly, you'd pay 60% of the capital gains tax and depreciation recapture for the 6 years you rented it out (even if you failed to claim depreciation). I'm sure someone will correct my errors eventually, but that should give a starting point for considering these issues.

[capitalG]

Interesting that depreciation seems to be the driver for tax deductions. We live in a HCOL area and the Trump tax cut changes made to property tax/mortgage interest would have limited our deductions while we lived in the condo - as a rental, those now become expenses and, in a sense, we can now fully deduct them.

capG

[gd]

I was surprised at how little was taxable. I expect to be similarly surprised at how much is taxable when the property is sold.

[informal guide]

I rented out a house for more than 20 years that I'd originally purchased as a residence. Last year I sold it. I knew that would be expensive, but I am really feeling the financial costs now - -real estate sale commission, fix up costs, transfer taxes and a host of miscellaneous closing related costs. My mortgage balance was for around 40% of the sale price. The capital gains taxes and recapture of depreciation are whoppers! After paying Federal and state income taxes and the mortgage, I ended up with just 20% of the gross sale price to redeploy.

There were good reasons to sell it, but holding on to it until my death would have been financially beneficial!

[Iorek]

Unless the rules recently changed, depreciation recapture and capital gains taxes apply apportioned based on number of years as rental vs number of years as a primary residence. The only exclusion is if you had lived in the house for a couple years and sell it before you hit 3yrs of it being a rental (2 out of 5rule) or in some other limited cases like military orders.

So say you had a property as a primary residence for a year, then rental for 6 years and move back in for 3 years and then sell it. If I remember correctly, you'd pay 60% of the capital gains tax and depreciation recapture for the 6 years you rented it out (even if you failed to claim depreciation). I'm sure someone will correct my errors eventually, but that should give a starting point for considering these issues.

My recollection, which may also be wrong or may in effect be very similar, is that you are supposed to document fair market value every time you change use (from residence to rental or vice-versa) and apply depreciate recapture or capital gains exclusion to those values (as if in effect you had different properties).

There see tremendous subsidies/tax shelters in the tax for landlords. Congress had been reducing them gradually but the real estate developer president changed course in that area.

[Dale_G]

I owned apartment building for more than 20 years. Sure depreciation is good, but it only delays the taxes. In the meantime some people are thinking they are making money when they aren't.

I never saw any tremendous subsidies/tax shelters. Now if your rents don't cover costs (not counting any measly payment of principal) and you don't mind running the operation of at a loss, then so be it.

Dale

[StandingRock]

Depreciation is a big one.

[AlphaLess]

If you have a mortgage and have less than $150,000 of modified adjusted gross income, you can deduct a substantial amount of losses (maybe $25,000). The losses are achieved early on from mortgage interest and depreciation. However, keep in mind that when you sell the place (and not exchanged), you have to recapture the depreciation at 25% and pay any capital gains on appreciation.

Can you explain, "recapture the depreciation at 25%"?

[AlphaLess]

Just finished my taxes after our first year as a landlord and even though we ran a lot of numbers before taking the dive, I’m still surprised by how much it impacted our taxes. Yes, being a landlord comes with its share of headaches - we already have had to deal with a couple issues - but the tax benefit seems unreasonably good. Did anyone else have the same discovery after the first year of renting?

capG

Post is too abstract. Care to make it a bit more concrete?

[AlphaLess]

There see tremendous subsidies/tax shelters in the tax for landlords. Congress had been reducing them gradually but the real estate developer president changed course in that area.

Care to mention some in more concrete terms?

[Slacker]

If you have a mortgage and have less than $150,000 of modified adjusted gross income, you can deduct a substantial amount of losses (maybe $25,000). The losses are achieved early on from mortgage interest and depreciation. However, keep in mind that when you sell the place (and not exchanged), you have to recapture the depreciation at 25% and pay any capital gains on appreciation.

Can you explain, "recapture the depreciation at 25%"?

Upon sale of a rental property, all of the depreciation claimed while you were operating the property as a rental business may be taxable if you sell it for more than the depreciated value.
Say the FMV claimed was originally $200K
You then depreciate for several years for $50K of depreciation leaving the home at an expected value of $150K
Now you put it on the market and are able to sell it for $250K. This is proof that the property didn't actually depreciate and you will have to pay back that $50K of depreciation at a 25% rate (so you owe $12.5K in depreciation recapture taxes). Then you'd have to pay capital gains taxes on the $50K over the original FMV of the property.

I hope I got this correct. Not a tax professional and haven't sold any rental properties yet so I could be off on a detail or two, but that should give the general idea.

[heyyou]

but the tax benefit seems unreasonably good.

Risk and reward, you've found the reward, wait for the risk to appear.

[megabad]

I generally agree with your assessment of real estate being disproportionately advantaged by our current tax code. As do many very very wealthy real estate investors. Depreciation recapture is not an issue if you don't sell. Either buy and hold or 1031 exchange your properties.

[GAAP]

Just keep in mind that the benefit of depreciation today is balanced by the reduction in cost basis when you sell -- TANSTAAFL...

[AlphaLess]

If you have a mortgage and have less than $150,000 of modified adjusted gross income, you can deduct a substantial amount of losses (maybe $25,000). The losses are achieved early on from mortgage interest and depreciation. However, keep in mind that when you sell the place (and not exchanged), you have to recapture the depreciation at 25% and pay any capital gains on appreciation.

Can you explain, "recapture the depreciation at 25%"?

Upon sale of a rental property, all of the depreciation claimed while you were operating the property as a rental business may be taxable if you sell it for more than the depreciated value.
Say the FMV claimed was originally $200K
You then depreciate for several years for $50K of depreciation leaving the home at an expected value of $150K
Now you put it on the market and are able to sell it for $250K. This is proof that the property didn't actually depreciate and you will have to pay back that $50K of depreciation at a 25% rate (so you owe $12.5K in depreciation recapture taxes). Then you'd have to pay capital gains taxes on the $50K over the original FMV of the property.

I hope I got this correct. Not a tax professional and haven't sold any rental properties yet so I could be off on a detail or two, but that should give the general idea.

Ok, I see what you are saying.

So there are two components: depreciation needs to be recaptured at sale time.
Second: recaptured depreciation is taxed at 25%.

To continue your example. Say, you bought the house at $200K (cost basis).
Then, you depreciate it to ZERO.
Then you sell for $250K.

So $200K is depreciation recapture, and $50K is capital gains.

You are saying that depreciation recapture is taxed at 25%.