Martha said:
But any rental tax loss exceeding $25,000, or if the taxpayer's income is too great to take the loss, the loss must be "suspended" for use in a future year, or when the property is sold to offset capital gains.
Lemme make sure I understand this.
Let's say a rental property has a house value of $100K depreciating on MACRS at a 27.5-year rate, which would depreciate the house by about $3600/year. Let's assume that depreciation is the only "loss" (rents & other expenses are a wash). A high-income landlord wouldn't be able to deduct that $3600 so it rolls over & piles up year after year.
After 10 years the house is depreciated to $64K for MACRS purposes. If its value appreciated at 3% it'd also have a resale value of $134K. That would imply a cap gain of $134K-64K of $70K, but luckily that accumulated depreciation jumps back in and knocks another $36K off the cap gain to result in a cap gain of $34K.
It's as if the home started at $100K and was sold for $134K. In other words, the depreciation couldn't be used and didn't count. True, depreciation capture wasn't held against the landlord as it would have been held against a lower-income landlord. However the $34K cap gains are still taxable. Nothing's been avoided.
I guess you're saying that after you FIRE your income will drop below the $100K limit and you'll be able to use the piled-up depreciation to wipe out your cash flow and get some losses. That sounds great if tax brackets are higher, but if tax brackets stay the same or get lower (I know, unlikely to come from Congress) you'd have paid taxes now to avoid taxes later-- a wash at best.
The kicker is that even without Congress, FIRE is likely to knock one's income & tax rates down into the 15% bracket or even lower. If you're paying taxes at the 25% or higher rates now and reducing your taxes in the 15% bracket later then it's not saving you any money. True, you weren't able to take the depreciation because of your income, but it's certainly not saving any money.
Meanwhile a lower-income landlord with an AGI of $99K would have been depreciating the property against their income at a 25% tax savings or better. Reducing 25% taxes with depreciation now and paying a 25% recapture years down the road allows that savings to be banked in the meantime-- real money saved in a real bank.
In any case, following the rules because you're constrained by them doesn't seem to be much of a strategy. If you never sell the homes, good on you. Eventually (after 27.5 years) you won't have to worry about depreciation. But then you'll be in the same situation as any other landlord, facing massive cap gains and depreciation recapture just like the rest of us. Except that lower-income landlords been taking depreciation and reducing their taxes in a higher bracket than you have, and that's definitely the kind of savings that can be taken to the bank.
I hope I have a detail wrong here, because if I'm right then darn. After nine years of depreciation and no end in sight, I was hoping to find a way around the depreciation-recapture & 1031-exchange issues.
Slarty said:
The assumptions behind my strategy is that appreciation will be very low for very long and interest rates will go up and inflation will go up and drive up rents. Also, the rental market is at a 40+ year low and will only go up from here and make it easier to find lower risk tenants as new generations cannot afford to buy homes due to inflated prices and increased interest rates.
I hope that's workin' for ya in your area. Our rents only benefited from market demand, not inflation. When new rentals were built in the area, rents dropped regardless of inflation. Rental rates have risen with demand but they certainly haven't kept up with property appreciation (e.g. property taxes).
And while the market may be at a 40-year low, again the renter is more concerned with affordability. If they can't afford to buy homes due to high prices, they probably can't afford rent increases either. As landlords like TH bail out of the rental market because of higher yields on CDs than on rentals, that reduces the available supply of rentals and drives the prices up. Hopefully there'll be tenants who can afford that. If not there's gonna be a bunch of unhappy landlords who can't raise rents and are stuck with rising expenses... but supply & demand will eventually bring that all into equilibrium.
I guess my view is that rentals depend on the neighborhood, not on the CPI or historic rents. It doesn't matter how the nation's numbers look if the local neighborhood is on the downward spiral of the cycle. Those assumptions may work for certain properties at some times but I'd be surprised if they work consistently across all properties in a landlord's portfolio.