At the end of 2017, Congress passed and President Trump signed the Tax Reform and Job Act (“TRJA”) of 2017. It is the most sweeping change to real estate investing in the past 30 years. In the past an owner had two options. He could depreciate the improvement over 39 years or elect to Cost Segregate and take some of the improved value over 5, 7, 15, or 39 years. In addition, he could elect to take 50% bonus depreciation of any improvement with an economic life of 20 years or less in the year of acquisition. Now, an owner can take all of the depreciation (100%) of any improvement segment with an economic life of 20 years or less in the year of acquisition. In addition, he can exempt 20% of any income generated by the investment if it is held in a pass through entity like a Limited Partnership (LP) or a Limited Liability Company (LLC).
But first you need to see if you qualify as an Active and Material Investor. What does this mean?
An active and material investor by IRS standards is someone who spends 750 hours a year or more or real estate related activities. So, let’s assume that you have a full time job and you purchase a property for investment…….Would you Qualify? NO YOU WOULD NOT!! You would be subject to the passive loss rule that states that you are limited to $25,000 in write offs of depreciation and interest expenses in any one year. If your deductions are higher, you would be required to carry-forward any losses to future years.
But what would happen if your spouse was not employed in a regular job and she was the manager of the investment. Would she qualify? Probably Yes!! If you file a joint tax return, you can be considered Active and Material…..GOOD THING!!!!
Next, when you purchase a property you need to have a Cost Segregation Study performed by a recognized Cost Segregation Firm. The firm will segment the different assets into the 5, 7, 15, and 39 year segments. In this case, the value of improvements with less than 20 years can be written off in the year of acquisition using Section 179 of the IRS code. Let’s go through an example:
Price of Property: $4 Million
Cost of Land: $1 Million
Value of the Improvement: $3 Million
Value of Improvements into the appropriate segments
|5 Years||20% (20% X $3 Million)||$600,000|
Value of Improvements of 20 years of less: $1,050,000
If you are in the 24% tax bracket (have an adjusted gross income of $164,000 to $315,000), then the value of the deduction is ($1,050,000 X .24) = $252,000. This amount becomes a tax credit to wipe away any taxes due on not only investment income, but on Earned Income (W-2) and Portfolio Income (Stocks and Bonds) as well. So where can you find an investment that pays a before tax return net of all expenses (Net Operation Income (NOI) and receive a $252,000 bonus? Nowhere!!!!!