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proposed tax change: deduct fixed asset immediately

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It has been widely reported that the tax reform plan being contemplated in Congress includes a change that would allow businesses to deduct the full amount of fixed assets immediately, rather than depreciating them. 

This seems to be a loophole , at least for rentals. If I have 100k a year in net rental income, I can buy a 100k house with a 25% mortgage, even if it were slightly cash flow negative, and zero out my taxes for the year, even though I still have a nice chunk of income for that year. I can repeat this , year after year, and never pay taxes on my income.

Does this make any sense? 

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My guess is that real estate is going to be excluded from this depreciation reform (if any reform at all ever happens). ... (more)

rascott (May. 12, 2017 @ 9:58a) |

weird. I thought that was the point 

rufflesinc (May. 12, 2017 @ 9:59a) |

There are arguments for 1031 that aren't covered by immediate expensing. RE lobbies will want it to remain, and Trump, b... (more)

marginoferror (May. 13, 2017 @ 3:26p) |

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You'd have to recapture the depreciation when you sell as ordinary income.

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stanolshefski said:   You'd have to recapture the depreciation when you sell as ordinary income.
  But that number has no bearing on the amount of cash flow that wasn't taxed in the many decades prior to the sale . Hell , my business model doesn't depend on capital gains on the rentals , so I could just keep deferring the taxes forever and die never paying a cent on my income

This change would be epic for my rental business, but it doesn't make any sense!
The Tax Foundation estimated that immediate expensing would cost the Treasury $2.2 trillion over the first decade. Over time, the amount declines as taxpayers stop taking depreciation deductions. Eliminating the interest deduction would offset some, but not all, of that 10-year loss, while retaining the deduction would create a huge revenue hole.

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Or maybe I just keep taking cash out of the houses and die , leaving the IRS with almost no equity in the houses.

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This is out of my realm, so forgive me if this is a non-issue: Would there be any difficulties obtaining a mortgage with a "zero" income? With a normal mortgage, they want to see paystubs and tax returns, and with only rental income, do they go solely off of tax returns and thus they'd see zero income and reject you? Perhaps this is why you mentioned "25% mortgage"....because you'd have to find some creative (ie: high rate) financing options.

Also, given your example of 25% mortage, your PI on that for a $100k house would be almost $2100/month. Add in taxes, insurance, and maintenance, consider what you would be able to rent it for, and you may be more than "slightly" cash flow negative. Do that for a few years and it may start to snowball pretty fast.

Edit: 
Does this make any sense?
Given that our current president is into property investment, it would make a lot of sense.

 

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LordKronos said:    Would there be any difficulties obtaining a mortgage with a "zero" income? 

 

  there are a lot of rental lenders out there that lend on the projected rent rather than your existing income.
Also, given your example of 25% mortage, your PI on that for a $100k house would be almost $2100/month.
check your math again 

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Ruffles, he's just like Donald Trump.

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check your math again 
  
100k @ 25% over 30y = $2085/month according to google

You just said 25% mortage. Perhaps you didn't mean 25% interest, which is why I questioned it. I thought you were acknowledging you'd have to do some extreme borrowing. But I guess you meant a 25% LTV ratio or a 25% down mortgage?

Like I said...this is not my area of expertise.

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bluegreenturtle said:   Ruffles, he's just like Donald Trump.
  I didn't write, lobby for, or testisfy in favor of this legislation

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LordKronos said:   
. But I guess you meant a 25% LTV ratio or a 25% down mortgage?

 

  Even during the 70s interest didn't hit 25%

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rufflesinc said:   
LordKronos said:   
. But I guess you meant a 25% LTV ratio or a 25% down mortgage?

  Even during the 70s interest didn't hit 25%

  
But we aren't talking about a family buying their own home to live in. We are talking about someone buying a cash flow negative property every year. Plenty of people are paying 25% on high risk loans, and I wasn't sure if you were somehow acknowledging this may be considered high risk and difficult to finance and saying "even if I had to pay outlandish interest rates"

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LordKronos said:   
rufflesinc said:   
LordKronos said:   
. But I guess you meant a 25% LTV ratio or a 25% down mortgage?

  Even during the 70s interest didn't hit 25%

  
But we aren't talking about a family buying their own home to live in. We are talking about someone buying a cash flow negative property every year. Plenty of people are paying 25% on high risk loans, and I wasn't sure if you were somehow acknowledging this may be considered high risk and difficult to finance and saying "even if I had to pay outlandish interest rates"

  barring a change in the market due to this rule, there won't be a need for double digit rates on secured financing. 

my reference to "cash flow negative" just refers to the market 's current and projected state in my area 

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The idea of using nonrecourse loans as a tax planning strategy isn't new and doesn't require that immediate expensing be allowed. There is a lot of both official and unofficial guidance on how the loans are to be treated. Because it's primarily based on depreciation, for the most part the lines of cases have been based on depreciation and not expensing. So you are correct that if full expensing were allowed it would create a temporary problem (unclear how temporary) in treatment of nonrecourse mortgages. I personally think the courts got it wrong the first time though, so maybe it's time for them to revisit it.

Underlying your point though is that any significant change in the tax law is likely to create side effects. A simpler tax code would be nice, but a lot of those changes would only allow the code to remain "simple" for a limited period of time until the tax planners come up with methods to reduce taxable income that the new rules create. In this case, the rules would probably have to be rewritten if we switch to a more cash-flow based tax (e.g. expensing) and we don't like the effects the depreciation-era rules have on the cash-flow based tax. This is, IMHO, why simplification is so difficult even if you had a consensus about how you want the system to work.

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IIRC when I've gotten financing they add back depreciation on a rental so that didn't count against the underwriting.


I'm not sure on the whole process but this seems to confirm it:

https://www.fanniemae.com/content/guide/selling/b3/3.1/08.html

"When Schedule E is used to calculate qualifying rental income, the lender must add back any listed depreciation, interest, homeowners’ association dues, taxes, or insurance expenses to the borrower’s cash flow."

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In that same set of rules, I believe they want to remove the deduction for interest expense. So the actual deductions over time will be lower, not higher, but you will get a nice timing benefit.

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Rajjeq said:   In that same set of rules, I believe they want to remove the deduction for interest expense. So the actual deductions over time will be lower, not higher, but you will get a nice timing benefit.
  How do you arrive at that conclusion? Yes if you stop buying houses...

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Remember you can't depreciate the land. So your $100k house would not get you 100% of a $100k deduction. Maybe 90k?

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jerosen said:   Remember you can't depreciate the land. So your $100k house would not get you 100% of a $100k deduction. Maybe 90k?
  Is that still true in this legislation? I mean, they are basically ditching depreciation completely, and calling it expensing 100%.

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rufflesinc said:   
Rajjeq said:   In that same set of rules, I believe they want to remove the deduction for interest expense. So the actual deductions over time will be lower, not higher, but you will get a nice timing benefit.
  How do you arrive at that conclusion? Yes if you stop buying houses...

  I mean over the lifespan of each house. You get the same deduction per house as under current rules, but no interest.

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rufflesinc said:   
jerosen said:   Remember you can't depreciate the land. So your $100k house would not get you 100% of a $100k deduction. Maybe 90k?
  Is that still true in this legislation? I mean, they are basically ditching depreciation completely, and calling it expensing 100%.

  They aren't going to allow depreciation of land.

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Rajjeq said:   
rufflesinc said:   
Rajjeq said:   In that same set of rules, I believe they want to remove the deduction for interest expense. So the actual deductions over time will be lower, not higher, but you will get a nice timing benefit.
  How do you arrive at that conclusion? Yes if you stop buying houses...

  I mean over the lifespan of each house. You get the same deduction per house as under current rules, but no interest.

  but under the current rules, the depreciation of the houses I buy later will be after i'm dead. how do you get the advantage of deduction depreciation on your taxes once you're dead?

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rufflesinc said:   
Rajjeq said:   
rufflesinc said:   
Rajjeq said:   In that same set of rules, I believe they want to remove the deduction for interest expense. So the actual deductions over time will be lower, not higher, but you will get a nice timing benefit.
  How do you arrive at that conclusion? Yes if you stop buying houses...

  I mean over the lifespan of each house. You get the same deduction per house as under current rules, but no interest.

  but under the current rules, the depreciation of the houses I buy later will be after i'm dead. how do you get the advantage of deduction depreciation on your taxes once you're dead?

  
Do you plan to live over 14 years?      Thats the break even point between depreciation over 27.5 + interest deduction on a 4% loan versus just deducting expense.

 

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jerosen said:   
rufflesinc said:   
Rajjeq said:   
rufflesinc said:   
Rajjeq said:   In that same set of rules, I believe they want to remove the deduction for interest expense. So the actual deductions over time will be lower, not higher, but you will get a nice timing benefit.
  How do you arrive at that conclusion? Yes if you stop buying houses...

  I mean over the lifespan of each house. You get the same deduction per house as under current rules, but no interest.

  but under the current rules, the depreciation of the houses I buy later will be after i'm dead. how do you get the advantage of deduction depreciation on your taxes once you're dead?

  
Do you plan to live over 14 years?      Thats the break even point between depreciation over 27.5 + interest deduction on a 4% loan versus just deducting expense.

 

  if this rule is implemented, i plan to keep buying houses and cashing out and deducting until im dead

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bluegreenturtle said:   Ruffles, he's just like Donald Trump.
  except he's feverishly posting on FW instead of Twitter.

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rufflesinc said:   
jerosen said:   
rufflesinc said:   
Rajjeq said:   
rufflesinc said:   
Rajjeq said:   In that same set of rules, I believe they want to remove the deduction for interest expense. So the actual deductions over time will be lower, not higher, but you will get a nice timing benefit.
  How do you arrive at that conclusion? Yes if you stop buying houses...

  I mean over the lifespan of each house. You get the same deduction per house as under current rules, but no interest.

  but under the current rules, the depreciation of the houses I buy later will be after i'm dead. how do you get the advantage of deduction depreciation on your taxes once you're dead?

  
Do you plan to live over 14 years?      Thats the break even point between depreciation over 27.5 + interest deduction on a 4% loan versus just deducting expense.

 

  if this rule is implemented, i plan to keep buying houses and cashing out and deducting until im dead

  Define "cashing out".

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Rajjeq said:   
rufflesinc said:   
jerosen said:   
rufflesinc said:   
Rajjeq said:   
rufflesinc said:   
Rajjeq said:   In that same set of rules, I believe they want to remove the deduction for interest expense. So the actual deductions over time will be lower, not higher, but you will get a nice timing benefit.
  How do you arrive at that conclusion? Yes if you stop buying houses...

  I mean over the lifespan of each house. You get the same deduction per house as under current rules, but no interest.

  but under the current rules, the depreciation of the houses I buy later will be after i'm dead. how do you get the advantage of deduction depreciation on your taxes once you're dead?

  
Do you plan to live over 14 years?      Thats the break even point between depreciation over 27.5 + interest deduction on a 4% loan versus just deducting expense.

 

  if this rule is implemented, i plan to keep buying houses and cashing out and deducting until im dead

  Define "cashing out".

  cash out refi

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Even presuming you had enough cash to keep this rolling, you could still have issues with the passive activity loss rules. https://www.irs.gov/publications/p527/ch03.html#en_US_2016_publi...
 

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Rajjeq said:   Even presuming you had enough cash to keep this rolling, you could still have issues with the passive activity loss rules. https://www.irs.gov/publications/p527/ch03.html#en_US_2016_publink1000219119
The cash would be from the 100k net income, and i'd only need 25%. I don't see how passive activity loss comes into play as i'd be deducting against rental income

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Ah I missed that part. I'm still not sure it maths out over time if you consider the lost interest expense deduction on all these additional houses. Plus it would require an increasing cash commitment between the annual equity piece and the snowballing cash flow negativity. Any downturn could also ruin your plans pretty badly, axing your refis.

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my original scenario was the most straight-forward way. You can juice it up any number of ways.

For example, you could hunt for properties where the seller is willing to seller-finance at an inflated price in exchange for little or no interest (I am not sure how IRS views lower than market interest). The seller gets the benefit of taxation on installment sale , you get a larger deduction and no interest deduction loss.

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That would probably be problematic as either tax evasion or OID income. Plus it would raise your real estate taxes.

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Rajjeq said:   
rufflesinc said:   
Rajjeq said:   In that same set of rules, I believe they want to remove the deduction for interest expense. So the actual deductions over time will be lower, not higher, but you will get a nice timing benefit.
  How do you arrive at that conclusion? Yes if you stop buying houses...

  I mean over the lifespan of each house. You get the same deduction per house as under current rules, but no interest.

  Timing is important. Immediate expensing decreases the effective tax rate on your gain to 0%.

Policy-wise it means the government is taking a part in your investment. Whether that's a good thing or a bad thing I don't know, but the government would basically be a 15% silent partner (assuming a 15% rate) in your capital investment.

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If you are never going to sell then does it really matter if you take the depreciation all at once? Instead of buying one house every year for the next 27 years you could just buy all 27 this year and depreciate them the regular way.

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gnopgnip said:   If you are never going to sell then does it really matter if you take the depreciation all at once? Instead of buying one house every year for the next 27 years you could just buy all 27 this year and depreciate them the regular way.
  The latter would be a lot harder , no?

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gnopgnip said:   If you are never going to sell then does it really matter if you take the depreciation all at once? Instead of buying one house every year for the next 27 years you could just buy all 27 this year and depreciate them the regular way.
  Yes. If you expense the full cost in Y1 you get the benefits of reducing your income in Y1 which means you pay less in Y1. Obviously, personal tax characteristics play a role in this - if you have no income in Y1 or are in a lower tax bracket than you'd be in Y2 for example, you'd rather not take the full benefit in Y1. However, this generally isn't the case as most of the tax generating entities have enough profit to decrease their tax.

In any change, you can come up with ways in which it may not be beneficial, but if you have tax due in Y1 that could be wiped out by expensing an asset and you don't lose any of that expensing amount, it's better to wipe out tax in Y1 all else being equal.

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Rajjeq said:   That would probably be problematic as either tax evasion or OID income. 
  Tax avoidance. avoidance. avoidance.

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It seems this rule is an even bigger loophole than I thought if you combine it with the real estate professional rule allowing for deductions against active income

Consider a married couple with one high earner making $200k and the other spouse is stay at home. The stay at home spouse becomes a RE agent and puts in 750 hours a year, "working" as an agent. Then each year, the couple buys a $200k property , heavily leveraged. Boom, no income taxes, because they are married, the income of the working spouse can be offset by the passive loss.

Now maybe the working spouse makes $500k. The other spouse still only has to put in 750 hrs as a RE agent. They buy $500k in properties. boom still no taxes

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rufflesinc said:   It seems this rule is an even bigger loophole than I thought if you combine it with the real estate professional rule allowing for deductions against active income

Consider a married couple with one high earner making $200k and the other spouse is stay at home. The stay at home spouse becomes a RE agent and puts in 750 hours a year, "working" as an agent. Then each year, the couple buys a $200k property , heavily leveraged. Boom, no income taxes, because they are married, the income of the working spouse can be offset by the passive loss.

Now maybe the working spouse makes $500k. The other spouse still only has to put in 750 hrs as a RE agent. They buy $500k in properties. boom still no taxes

my fingers are crossed, as this is the situation im in.

it makes for an interesting tax scheme...if someone is in the highest tax bracket, they could almost do a tax rate "arbitrage" by buying a house for investment, expensing it that year, then selling it the next year and only paying a capped 25% rate on the depreciation recapture. just one idea.

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solarUS said:   
rufflesinc said:   It seems this rule is an even bigger loophole than I thought if you combine it with the real estate professional rule allowing for deductions against active income

Consider a married couple with one high earner making $200k and the other spouse is stay at home. The stay at home spouse becomes a RE agent and puts in 750 hours a year, "working" as an agent. Then each year, the couple buys a $200k property , heavily leveraged. Boom, no income taxes, because they are married, the income of the working spouse can be offset by the passive loss.

Now maybe the working spouse makes $500k. The other spouse still only has to put in 750 hrs as a RE agent. They buy $500k in properties. boom still no taxes

my fingers are crossed, as this is the situation im in.

it makes for an interesting tax scheme...if someone is in the highest tax bracket, they could almost do a tax rate "arbitrage" by buying a house for investment, expensing it that year, then selling it the next year and only paying a capped 25% rate on the depreciation recapture. just one idea.

  It's hardly a deal when you consider the ~10% roundtrip cost of buying and selling.

Skipping 6 Messages...
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rufflesinc said:   if this change occurs, wouldn't it eliminate the need for 1031 change if you want to sell a property and buy a different one? would the capital gain be covered by the deduction of the new property?
  There are arguments for 1031 that aren't covered by immediate expensing. RE lobbies will want it to remain, and Trump, being a RE person...

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