Retirement Planning Strategy: Real Estate Question

[GM Points]

I have been thinking about a strategy to help with the first 5 to 10 years of retirement.

We currently own our primary residence (we purchased it 18 years ago) and a vacation rental (we purchased it 10 years ago). My plan/idea is when I reach the age of 55 is to sell my personal home and transfer the property taxes to a beach area home within a similar price range (we live in CA).

We would live in the new to us beach city home for 5 years then retire and move into our vacation home in AZ. Turning our primary residence into a rental and our vacation rental into our primary residence.

This is where I am a little confused. I am trying to calculate the future depreciation of the beach city home's depreciation value once I start renting it out. The idea was is to keep the property tax basis the same (similar to my current primary home taxes since CA limits property tax increases to 2% per year) but on the other hand increase the tax write-off due to a higher purchase amount.

My current residence was purchased for around $400,000 and is currently worth about $850,000. Let's say we sell it for $900,000 in a couple years and we purchase a small home in a beach city for around $900,000. We live there for 5 years and the home is now worth $1,000,000. What do we use for the depreciation value once we place the home in service as a rental? Do we use the original purchase price minus the land value ($900,000 - land value $200,000 = $700,000) or do we use the value once the property is placed in service five years after purchase ($1,000,000 - land value $200,000 = $800,000). Also does the transferred property tax basis change any of these calculations?

Thanks...

 

[RetireeRobert]

Your property tax basis is a "California" thing and not at all related to the federal IRS basis of rentals in figuring depreciation. They are two totally different animals (that do not interbreed).

As far as I remember, your federal IRS rental real estate depreciation basis is your "cost" of purchase plus cost of any improvements made. So in your example it would be the $900,000 less value of the land, or net cost basis of $700,000. To the extent you can find some justification at time of purchase to find a lower value for the land and a larger value for the house itself, that would allow you greater depreciation amounts on the house.

Hope this helps. Others here on the forum may have more helpful--and current--information.

 

[pjigar]

You will be well served taxwise if you sell a primary home. Gain upto $500 for a couple are tax free. My Cardinal rule of rental: Always buy rental at a drivable distance.

 

[pb4uski]

.... My current residence was purchased for around $400,000 and is currently worth about $850,000. Let's say we sell it for $900,000 in a couple years and we purchase a small home in a beach city for around $900,000. We live there for 5 years and the home is now worth $1,000,000. What do we use for the depreciation value once we place the home in service as a rental? Do we use the original purchase price minus the land value ($900,000 - land value $200,000 = $700,000) or do we use the value once the property is placed in service five years after purchase ($1,000,000 - land value $200,000 = $800,000). Also does the transferred property tax basis change any of these calculations?

Thanks...

$700,000... what you paid for the residence building that was 5 years later converted to a rental... if the fair value at the time of conversion to a rental was less than what you paid then that is what your basis would be.

To my knowledge the transferred property tax basis does not impact the IRS basis calculation at all.. a totally separate thing that is only used for property taxes. It may impact your basis for Ca income tax... I dunno anything about that.

https://www.thetaxadviser.com/issues/2008/jul/convertingaresidencetorentalproperty.html

 

[GM Points]

Your property tax basis is a "California" thing and not at all related to the federal IRS basis of rentals in figuring depreciation. They are two totally different animals (that do not interbreed).

As far as I remember, your federal IRS rental real estate depreciation basis is your "cost" of purchase plus cost of any improvements made. So in your example it would be the $900,000 less value of the land, or net cost basis of $700,000. To the extent you can find some justification at time of purchase to find a lower value for the land and a larger value for the house itself, that would allow you greater depreciation amounts on the house.

Hope this helps. Others here on the forum may have more helpful--and current--information.

Thank you...

 

[pb4uski]

You will be well served taxwise if you sell a primary home. Gain upto $500 for a couple are tax free. My Cardinal rule of rental: Always buy rental at a drivable distance.

+1 A valid consideration... in the scenario the OP described the $100k of appreciation would be tax free.

 

[GM Points]

$700,000... what you paid for the residence building that was 5 years later converted to a rental... if the fair value at the time of conversion to a rental was less than what you paid then that is what your basis would be.

To my knowledge the transfrred property tax basis does not impact the IRS basis calculation at all.. a totally separate thing that is only used for property taxes. It may impact your basis for Ca income tax... I dunno anything about that.

https://www.thetaxadviser.com/issues/2008/jul/convertingaresidencetorentalproperty.html

With my past rental located in CA and the current vacation rental located in AZ, I used my property tax bill to give me the improvement fixtures (building) and the land value for depreciation. So where would I find this information once I transfer the property tax value from the residence to the new beach city residence? Maybe the appraisal?

Thank you for the reference.

https://www.thetaxadviser.com/issues/2008/jul/convertingaresidencetorentalproperty.html

When a personal residence is converted to business use (or for use in the production of income), its starting point for basis for depreciation is the lower of (1) the adjusted basis on the date of conversion, or (2) the property’s fair market value (FMV) at the time of conversion (Regs. Sec. 1.168(i)-4(b)).

 

[RetireeRobert]

With my past rental located in CA and the current vacation rental located in AZ, I used my property tax bill to give me the improvement fixtures (building) and the land value for depreciation. So where would I find this information once I transfer the property tax value from the residence to the new beach city residence? Maybe the appraisal?

An appraisal might give it to you. You could also get say three different realtors to give you current market appraisals, but specifically ask them to value both the land and house components. You could also get market data on similar "bare land lots" from sites such as Zillow, Trulia, Redfin, and also maybe your area's Multiple listing Service to be able to separate out the land value from a "total" value of house and lot which realtors would give you.

 

[GM Points]

I found this reference...

There are three primary methods to determine the improvement ratio. You can use all three each time you purchase a property or just use the one that you find easiest. Regardless of which method you use, make sure to document your approach and your findings. You don't want to be caught with your pants down during an audit. The three methods are:

Property Tax Card
Buyer/Seller Appraisals
Replacement Cost and Land Sale Comps

https://www.therealestatecpa.com/blog/depreciation-improvement-value