Can multiple rental property losses be written off against other properties or income? What are the pros and cons of putting investment property in an LLC? How do you get the best tax breaks on rental real estate? How does real estate depreciation work? What do you need to think about when turning your primary residence into a rental property? Is a home equity line of credit (HECM or reverse mortgage) a good idea? Also: a complicated property inheritance, and self-funding long-term care insurance.
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- (00:47) Can Multiple Rental Property Losses Be Written Off Against Other Properties or Income?
- (02:09) Real Estate Tax Strategy Spitball (Captain K from Indy)
- (10:18) Considerations When Turning Primary Residence Into Rental Property (Bill, Palm Desert)
- (13:53) Should We Take Out a Home Equity Line of Credit HECM Reverse Mortgage? (JT, Colorado)
- (18:03) How to Handle a Complicated Property Inheritance? (Steve & Denise)
- (24:15) How Much Money Do We Need to Self-Fund Long-Term Care? (James, AZ)
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Today on Your Money, Your Wealth® podcast 370, taxes and real estate: can multiple rental property losses be written off against other properties or income? What are the pros and cons of putting investment property in an LLC? How do you get the best tax breaks on rental real estate, and how does real estate depreciation work? What do you need to think about when turning your house, your primary residence, into a rental property? Is a home equity line of credit or HECM or reverse mortgage a good idea? The fellas also discuss a complicated property inheritance, and for something completely different, how much is enough to self-fund long term care insurance? I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.
Can Multiple Rental Property Losses Be Written Off Against Other Properties or Income?
Joe: Hey Al, question here from your real estate webinar, it’s like “If you own multiple rental properties and you have a significant loss on one property, can the loss be written off against income from the other properties or other income?”
Al: The answer is yes on that. There’s two kinds of losses that you could have potentially on a rental property. One is just the ongoing losses from your rental property. In other words, your rental income, minus your expenses, minus depreciation creates a loss and maybe a significant loss. That’s considered a passive loss. That passive loss can be used against any other property that has income. So the answer is yes, you can net those two together. The other way you can have a significant loss is if you sell a property at a loss, a little bit hard nowadays because properties have gone up so much in general. But let’s just say you had a loss on a property. You get to take all of that loss and you can use that against other passive income and it’s fully available actually against other income as well. I’ve oversimplified it because if you group the properties, there’s different rules and just be aware of that. But in general, yes, anytime you have a loss on a rental property, you can use that loss against other income from rental properties.
Real Estate Tax Strategy Spitball (Captain K from Indy)
Joe: We got a write in from Captain K from Indy. “Dear YMYW. Thank you for your webinar on Alternative Retirement Income in Real Estate, February ‘22. I’m thinking of buying an investment oceanfront condo in Florida and having my renters help me pay the mortgage. I plan on putting 20% down on the condo loan, my cash-on-cash will be about 12.3%. What are the pros and cons of putting the condo in an LLC? What are the best ways to get tax breaks and how does the depreciation of real estate work on your income in taxes? I’ll give you the numbers below to see if I can stay in that 12% tax bracket. And I’m 67 yo, retired physician, drive a 2017 Chevy Cruze, have a basset hound for pets for over 35 years.” He’s had a basset hound for 35 years?
Al: Well, probably more than one, I’m guessing.
Joe: “Coors Light is my drink of choice.” Boom. Captain K. “I’m happily married, and, yes, she is smoking hot.” All right. Good for you, buddy. “At age 69, I plan on living on $100,000 per year, $83,000 from Social Security in fixed income, and $70,000 from my brokerage account. My accountant told me about YMYW several years ago.” Oh, the accountant.
Al: How about that, huh?
Joe: “Thank you Joe and Big Al for the spitball. And P.S. Andi, thank you for keeping Joe and Al in check.” Okay. So let’s first- So he wants to buy a condo? Oceanfront condo.
Al: Right. In Florida.
Joe: In Florida. Wants to pay $500,000 for it. He’s going to put 20% down. And he thinks he’s going to get 12.3% cash-on-cash.
Al: Got it. His first question, what are the pros and cons of putting the condo in an LLC? So the pro is simply that if that condo is in the LLC and something goes horribly wrong with that condo, then the damages are generally limited to the equity in that condo to whoever is suing you instead of all your personal assets. Now, again, we’re not attorneys, and there’s probably ways to get around this if you’re like grossly negligent, I would think. But that’s why you do an LLC is to limit your exposure to something goes horribly wrong on your property. Someone falls off a balcony and dies. That would be an example of that. And that’s your fault. Are your personal assets at risk? Maybe, depending upon what you did or didn’t do with securing that balcony, or maybe the screws were loose? Right. I don’t know. That’s why you do an LLC.
The cons are you got to set up an LLC and generally you hire an attorney. It costs you $1500 or more to do this. And depending upon the state you’re in, you may have annual filing. California, you have to file. California, you have to pay $800 per year. In Florida, I’m sure is a lot more pro friendly on that. So maybe it’s not so bad, but that’s- those are pros and cons. It’s the same question. What are the best ways to get tax breaks? And how does depreciation on real estate work for your income and taxes? So the tax breaks, whether you’re an LLC or not, it’s the same. So I don’t think an LLC is going to increase your tax break. So essentially, it’s pretty simple. It’s rental income, minus rental deductions is your profit, but then you also subtract depreciation. And depreciation is the building part of your condo divided by 27 and a half years. So if it’s $500,000 and let’s just say the land part’s $100,000 just to make up a number. $400,000 divided by 27 is probably $15,000, $16,000 a year. That’s an extra deduction that you get. So you may be able to minimize your taxes from this income.
Joe: Right. It’s just another, I guess, expense.
Al: It’s treated as an expense. And what that does, though, is that reduces your cost basis, right? Reduces your current profit, but reduces the cost basis so that when you sell the property, you’ll have a higher gain because you’ve been taking a piece of that value each year.
Joe: Well, then you have the depreciation recapture as well when you sell it.
Al: You do.
Joe: So you’ve got to recapture it. So you get a tax break today, but then you have to recapture the tax break that you get in the future when you sell it.
Al: Unless you do a 1031 exchange or you die. Those are two ways out.
Joe: He’s got a little bit more. He goes, “here’s my numbers. I have one pre-approved, 30-year, 5% mortgage that equals $3,000 a month. Realtor said the rental income averages between $55,000 and $65,000 a year. Mortgage, including PI, is $2100. Taxes $300, HOA $600, equals $3100 a month.” So he’s like, hey, you know what? I’m going to get $3100 a month or my cost is $3100, and I’m going to get a little bit more than that.
Al: So let’s just say $60,000 a year of income and expenses are, in this example about $40,000, let’s just say, $20,000 of profit. Now that doesn’t include maintenance and fix up and vacancy. And I’m guessing that with this amount of income for this price, he’s probably doing AirBnB or BrBo, which requires a lot of time and effort. So if that’s what you’re doing, do you really want to do that? Maybe you do. I actually do that with our condo in Hawaii and I enjoy it. But anyway, it’s a bit of work.
Joe: I do that with my condo in the desert, but I hire someone to do it. I do not enjoy that.
Al: You don’t enjoy it?
Joe: No. And I gladly pay someone to do that crap. But it’s oceanfront. I don’t know. It sounds pretty good. I mean, on paper, everything sounds really good until you buy the property and then everything else blows up. Right?
Al: Right. So oceanfront in Florida? Hurricanes? Do they have those out there? Sometimes? Just be careful.
Andi: He also asks whether he can stay in the 12% bracket.
Joe: Well, sure. I mean, he doesn’t have much income. $20,000 is based with his income and he’s going to have standard deduction. He’s also got depreciation that’s going to write off some of that $20,000. It could even be less than that. And if there’s vacancies and there’s more expenses and there’s everything else that could wipe out 100% of the income. A lot of real estate income is sheltered through all of that.
Al: Through expenses and depreciation is accurate. So yeah, based upon what we know, yeah, he could very potentially be in the 12% bracket as a married couple. That would be roughly – call it $105,000 of income roughly before the standard deduction to stay in that 12%.
Joe: So yeah. All right. Well, good luck with that. Hopefully, come and visit you there in Florida, a little oceanfront.
If you missed Big Al’s webinar last month on Alternative Retirement Income Sources: Real Estate and Beyond, click the link in the description of today’s episode in your favorite podcast app to go to the show notes. You can watch the replay there, and download 10 Tips for Real Estate Investors and our brand new 2022 Tax Planning Guide. For more personalized, one-on-one help, click Get an Assessment in the podcast show notes and schedule a free financial assessment. One of the experienced financial professionals on Joe and Big Al’s team at Pure Financial Advisors will help analyze your specific situation, your retirement needs and goals, your tax liability, your ability to tolerate risk and help you develop a comprehensive financial plan to reduce your taxes and make the most of your retirement.
Considerations When Turning Primary Residence Into Rental Property (Bill, Palm Desert)
Joe: Hey, “I listen to Your Money, Your Wealth® while doing laundry,” chooses Mich Ultra, occasionally. “I live in Palm Desert. Any financial or tax considerations if we decide to turn our Palm Desert condo into a rental property? It’s currently our primary residence.” So Bill writes in there, Big Al. So let’s say I have a rental and I want to convert it to-
Al: It’s a residence.
Joe: It’s a primary that I’m converting to a rental. This was a popular strategy that people were trying to avoid the capital gains tax. And saying, hey, I have a rental property now. I’m going to live in it and then I’m going to sell it and take the 121 tax exclusion and so on and so forth. So what- ?
Al: So, yeah, so let’s explain that. So if you sell your primary residence and if you lived in it two out of the last 5 years, you have to own it and live in it, two out of the last 5 years. Then you get a $250,000 gain exclusion, which is $500,000 gain exclusion if you’re married. So if you convert this property into a rental property, you basically have 3 years to have it be a rental. Because then at that point you’re going to need to sell it, if in fact you are wanting to sell it to get that $250,000 or $500,000 exclusion. So that’s a huge consideration there. But what you were alluding to, Joe, is some people actually, if the gain was big enough, they convert it to a rental. They sold it within that 5-year period, and they took some of their gain off the table, $500,000 worth if they’re married and that was tax-free because of the exclusion. And then all the rest of the gain, they deferred into another rental as a 1031 exchange. And it’s not commonly known, but you can do both of those rules with a single property. That’s a really clever rule if you have a property with a big gain, you don’t want to pay the tax currently and you want to buy another property. You defer part of the gain and to the other rental and take some off the table just in terms of the exclusion on the principal residence.
Joe: Yeah, I guess, Bill, you know, there’s a lot of different, I guess, ideas and strategies in regards to- depends on what your goals are again. But if it’s your primary residence now and you’re going to convert it to a condo and you want to sell it in a couple of years and get some rents, you could still take advantage of the 121 exclusion. If you’re going to just convert it into a condo and rent it out for the next 20 years-
Al: – then you lose that exclusion.
Joe: Even though it started out as a primary?
Al: Yes. Unless you move back into it, which you could.
Joe: Yes, yes, yes, yes.
Al: And 20 years from now, you’ve got to move back into it and then own and live in it for another two years. So that’s possible. You still have depreciation recapture on the period of your rental. But that does work. If it was a residence first and you convert it to a principal residence, the rules are totally different. There’s a pro-rata amount.
Joe: Well no, what you said doesn’t make sense. You said if it was a principal residence that was converted to a principal residence.
Al: Sorry. If it was a rental property first that was converted to a principal residence, then that two out of 5 years, it can still work, but it’s a prorated benefit. It’s not the entire benefit.
Joe: And that’s based on rule changes back in-
Al: – like 2009 or something.
Joe: Well, yeah, you would still get some of the 121 exclusion on that amount.
Should We Take Out a Home Equity Line of Credit HECM Reverse Mortgage?
Joe: Got a question here on a HECM, Alan. “I would love to hear what you think about taking out an FHA HECM.” Remember the good old Wade Pfau, talking about HECM?
Al: Yeah. He kind of resurrected that whole concept.
Joe: Yes. It’s basically a reverse mortgage. Home equity conversion mortgage, to be exact. I believe, is what that stands for.
Al: I think so.
Joe: “At the beginning of retirement at 62 to help ensure for health care and longevity risk (see Wade Pfau’s article)- “
Al: There you go.
Joe: We had Wade Pfau on our show.
Al: We did, a couple times.
Joe: Yes, we did. Very smart individual.
Al: Yeah. Super smart.
Joe: “Instead of doing it much later as a last resort when money runs out or spending the lot- “ So I guess I get the gist of his question is, yes, I think it makes sense. I mean, I don’t know-
Al: Well the only thing, there’s costs involved.
Joe: Yeah, but I mean-
Al: And the- see these loans- you can- there’s different flavors. You can have it just be a line of credit and just draw on it if you need it. And so it’s there. So that’s one way to go.
Joe: And that line of credit increases each year as you age.
Al: That’s right.
Joe: So at age 62, you take out this line of credit, right? There’s costs associated with taking out the line of credit. But then the line of credit grows at a certain rate, depending on where the HECM market is or the reverse mortgage market is. So each year- so you take this thing out at age 62 and then at 65- let’s say your home equity conversion mortgage is $300,000 at 62. And then at 65, it could be $350,000. At age 70, it could be $400,000. And so it’s just still a line of credit that you’ll never, ever have to pay back. You know, if you pass, someone will pay the money, but you don’t necessarily have to because it’s basically a reverse mortgage.
Al: Yeah, well, you will have to pay it back if you sell your home.
Al: Or if you go to a nursing home or something like that, you’ve got to do it then.
Joe: But I like that strategy. I’m like so many far- I mean, I’m like 30 years from that age. So –
Al: 30? Really? How’s your math there, buddy?
Joe: 62. But it’s like 40 years from now, I will have to make that decision.
Al: If you’re 12.
Joe: But, yeah, I like it. We had Wade Pfau on. He talked about the pros and cons of that. That was a few years ago.
Al: One of the reasons why Wade Pfau likes it is because of the sequence of returns risk, which basically means that the market may go down while you’re trying to create a retirement income because you’ve already retired from your assets. And what he said is, you know what, the market goes down, don’t pull money out of your account because it would be hard for it to recover. Pull some money out of this reverse mortgage line of credit. And so if you do that, then you keep your portfolio intact. There were other things, too. I mean, he talked about using money to pay taxes on Roth conversions and things like that. So yeah, I don’t think it’s a bad idea either, but there’s cost to do that. So just be aware of that.
Joe: Yeah, it depends on your liquidity. If you have other cash or depending on how much you spend and what your investment portfolio looks like, you might not need it. Others probably it might make sense to at least take a look at it.
Al: And you can always get it later too if you didn’t get it now.
Need a spitball of your real estate strategy, your taxes, or your retirement plan? We want to feature YOU here on Your Money, Your Wealth. Send your situation, your money questions, your comments, or stories. click the link in the description of today’s episode in your favorite podcast app to go to the show notes, then click Ask Joe and Big Al On Air to send them in as an email or a priority voice message, and Joe and Big Al will answer them right here on YMYW. Tell your friends to listen! While you’re there in the podcast show notes don’t forget to watch video of Joe and Big Al answering your podcast questions, subscribe to the YMYW newsletter, and read the transcript of today’s episode.
How to Handle a Complicated Property Inheritance? (Steve & Denise)
Joe: Here’s a question for you, Big Al. “We have a situation where my wife’s mother, and her mother’s two siblings inherited a property in Chula Vista.” That’s South San Diego, for those of you that are keeping score. “No outstanding mortgages on the $1,500,000 property, trust is through Union Bank.” All right. So a little 3rd party trustee. “When my wife’s mom passed about 11 years ago, my wife and her two siblings started receiving monthly income, $1500 dollars rental, $500 each. The other family members in her mom’s family wanted to continue on with this property, but my wife and her two siblings wanted to be cashed out.” All right. So we have, how many total people here?
Al: I think as I read this, mom had two siblings, so they each got 1/3. And now when mom passed away that went to –
Joe: – his wife and her two siblings.
Al: Well, it went to the mom’s kids, maybe. 3 kids. I think that’s what this is saying.
Joe: So Mom was getting $1500. “My wife and her two siblings started receiving Mom’s $1500 rental and they split it 1/3, $500 each.” Okay. And so her mother’s two siblings inherited a property. Got it. Mom died. The mother-
Al: Mom had two siblings, and their mom died and her share went to her 3 kids.
Joe: Yes. Okay. Makes sense.
Al: Almost have to diagram this.
Joe: I know. “There are many reasons why, but mostly we are at retirement age and want to cash out for personal choices. And also we have never had a relationship with that side of the family.” “They’re out of state” (in quotes).
Al: You never see them.
Joe: We don’t really care for that side of the family, it’s that side, not the good side.
Al: We’re not going out there to visit them.
Joe: Oh, they’re on that side. “We don’t want our daughters to have to worry about how to handle all of this down the road with many, many cousins, etcetera, etcetera.” It’s many, many, so- this could be that side. “Is there anything you would suggest we do to make this happen smoothly and hopefully inexpensively? Interested in your opinion on this. My wife and her siblings were recently told they could have cashed out when their mom passed, but we were not given that option from the trust controller. Best regards.” This is kind of an interesting situation where they inherited some cash that’s in a trust that’s managed by a third party. They have other people that are beneficiaries of the trust that are on that side of the family. Where they don’t want to be a part of anymore. How do they get the hell out of this thing?
Al: Well, they inherited property, not cash.
Joe: Well, they’re getting cash from the inherited property-
Al: Correct. Correct.
Joe: – or any trusts managed by a 3rd party trustee, which is-
Al: That’s right. And so they would prefer just to get cashed out of their property value so that they’re no longer in this deal.
Al: And I get it. So I own a property in Hawaii that’s a leasehold, which means I don’t own the land. And so it’s a trust that I pay the monthly land lease payment. And I think, as I understand the trust, which was originally descendants of the original missionaries. I mean, there are hundreds and hundreds of owners in the trust. And so in a case like that, in a case like this, I think it boils down to what the trustee decides. I think you go to the trust document and you see what are your rights as a beneficiary. Can you- are they required to buy you out if you request or not? Another thing is just ask them, would you be willing to cash me out? Maybe they are. Maybe they aren’t. It depends if they have the financial wherewithal to do that. And if they don’t, maybe they would pay you, do it on a note. Which maybe it’s the same as payment. So that doesn’t really do anything.
Joe: The first step is to go to Union Bank and talk to the 3rd party trustee.
Al: Talk to the trustee, find out what your rights are as a beneficiary. Can you cash out?
Joe: Say we want to simplify our lives. This has been great. We’re really grateful for the cash flow. But we have other financial goals that we would like to get more capital.
Al: And if you’re not allowed to cash out-
Joe: Then you’d go to your-
Al: You go to the other beneficiaries and say-
Joe: Then you’re going to have to talk to that side.
Al: You might have to go visit them.
Joe: You might have to. And then see all those crazy cousins. And just say, hey, listen, we would like to cash out.
Al: Are you interested?
Joe: Are you interested in purchasing this? So then-
Al: Maybe they are, maybe they aren’t.
Joe: Maybe we could get the cash and then you get the full cash flow and we’re out and we’ll make life really simple and easy. I think those are your options.
Al: And maybe if there was an opportunity for you to cash out, maybe there would be an opportunity for your kids to cash out if you can’t do it. I think if that’s your concern is you don’t want the kids that- and if owning this property with 20 other people and I get that, it gets kind of complicated after a while. Maybe they can cash out. That’s why you have to go to the trust and find out what your rights are as a beneficiary.
Joe: I wonder if the trust goes into perpetuity.
Al: Isn’t there a limit on trusts?
Joe: It depends on how it’s drafted.
Al: 99 years or something? We’re not attorneys, so we don’t know what we’re talking about. All I know is check with the trustee, get a copy of the trust, find out what your rights are as a beneficiary. I’d start there.
How Much Money Do We Need to Self-Fund Long-Term Care? (James, AZ)
Joe: Okay. We got another one. “As a general rule, what dollar amount should a couple have before they consider self-funding long-term care?” As a general rule- is there a general rule?
Joe: Long-term care is super expensive. So $1,000,000. Gosh.
Al: That’s a hard one to answer because every case is different.
Joe: Every type of care is going to be different depending on what happens.
Al: It’s funny, wouldn’t you say that this is a relatively common statement what I’m going to make, is the people that can afford long-term care insurance actually have enough income and money to not have to pay for the insurance?
Joe: Sure. Right. I mean, it’s insurance, right?
Al: Because it’s expensive.
Joe: It still makes sense to look at it here, too, because it’s leverage. So maybe you spend over your lifetime $70,000 in premiums and then you’d get a $300,000 tax-free benefit to pay for care if you needed it.
Al: If you need it.
Joe: If you don’t need it-
Al: It’s just like any insurance, right?
Joe: That’s right.
Al: That’s the whole point. But I guess it’s important for people to know that long-term care insurance is not an unlimited benefit. So a certain payment that you make each month for X number of years gives you a pool of money that you have to use to get for long-term care.
Joe: Right. You could select a $100 a day benefit, $200 a day benefit, $250, $300. I mean, you can kind of pick and choose because the longer the benefit or the deeper pockets of benefit that you get, of course, the premiums are going to go pretty high. So I think you look at a plan to say, hey, if something were to happen to me and my spouse or my spouse and I, what’s the next steps? Where’s the money going to come from? Who’s going to take care of who? Are you going to have- is one person going to be the caregiver? That’s pretty tough to deal with. And if the one of the spouses- let’s say the husband goes down and then you look at the female spouse, is that- I mean, that’s not really fair to her. So there’s got to be quality of life on both sides here. So you don’t necessarily look at purchasing long-term care insurance for yourself. You kind of look at it as purchasing for your spouse.
Al: So I think another way we like to say this is, is everyone should have a long-term care plan. Not everyone needs long-term care insurance and in fact, it is quite expensive.
Joe: So I know that’s not a great answer, James, but I appreciate the question.
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