THE BASIS POINT

Not all of us get yacht & plane tax breaks, but here’s a housing tax perk you must know

 
 

The Rich People Tax Break outrage came right on cue for tax season this year. Nothing is better for clickbait and social snark, but outrage and snark too often outweigh pragmatism. So instead of piling on at the end of tax season this year, The Basis Point humbly offers a housing tax tip so you can do it like the rich folk next year. Below is a quick briefing on these 1031 Exchange rules for 2023. I mean, it’s Financial Literacy Month, right? But first, a word on Rich People Tax Breaks.

I’M NOT A BUSINESSMAN. I’M A BUSINESS, MAN.

ProPublica did a story on how owners of private planes and boats get to use them as tax breaks.

In simplest terms, boats and planes are businesses.

Think of it like Jay Z famously rapped in 2005: I’m not a businessman. I’m a business, man.

Listen here, after the TurboTax ads of course.

The point is that giant purchases like that are used for business.

So people who don’t just turbo-prepare their taxes use expenses on these assets to lower their taxes.

ProPublica is right that the tax code maybe shouldn’t be so lenient with these assets, and they’ve done deep, credible coverage on this topic (link below).

But just because it pisses most of us off doesn’t mean the tax code is totally broken.

And more important:

If you can take benefits within existing tax code, you need to take them.

That’s what they’re there for.

Don’t let outrage outweigh pragmatism even as you hope the IRS sinks the yacht crowd.

Tax benefit on homes is less pie-in-the-sky than private planes or yachts.

So let’s look at a tax break called the 1031 Exchange that lets you defer all capital gains on a rental home.

IRS yacht finding yacht tax loophole, yacht tax deduction, and yacht tax writeoff at sea, 1031 exchange rules - The Basis Point

1031 EXCHANGE RULES 2023

A 1031 Exchange is a game changer in the long game of investing in rental property.

It allows you to defer capital gains taxes when selling a rental home as long as you buy a new rental home with the sale proceeds of the one you’re selling.

If you buy a new rental for the same or greater price as the sale and reinvest sale proceeds into the new property, you can defer all capital gains.

You must identify the new property within 45 days of closing the old one, and close on the new one within 180 days.

It’s one of the best benefits to regular people in the tax code.

Remember: you’re a business, man.

And your rental home is a mini business you run.

So, it would play out like this if you bought a rental home.

You find a location where you want to buy.

You decide if you want to use the property sometimes in addition to renting it.

If so, you need to ensure the county allows for short term rentals.

Some counties only allow rental intervals of 30-days or longer.

You buy the property with a non-owner occupied mortgage.

This will require at least 15% down, but usually it’s more.

It’s best to plan for 20%+ as your down payment on a rental.

And mortgage rates for rental homes are about 0.5% to 0.75% higher than for homes you live in.

You do get to count rental income to qualify for a rental property loan.

You buy the property.

While you own the rental home, you file Schedule E to calculate tax benefit or cost each year.

If rental home income exceeds expenses, that income is taxable.

If you have losses after subtracting depreciation* and expenses (mortgage interest, property tax, and all expenses associated with managing and improving that rental home) from total property income, you can deduct this loss from your income (to arrive at an overall lower tax payment in a given year) if your adjusted gross income (AGI) is less than $150,000.

If your AGI is greater than $150,000, your deductible amount (that would result from net losses on your rental home) accrues for the years you own the rental, and can be used to offset capital gains when you sell.

So the benefit can be the same if your AGI is more than $150,000, but your annual benefits are deferred until later.

Then, when you sell the rental home, you’d pay capital gains taxes on whatever net gain you have.

Unless you followed the 1031 exchange rules.

Again, the 1031 exchange rules say you can defer all capital gains at sale if you:

– Buy a new rental home of the same or greater value.

– Identify that new rental home within 45 days and close within 180 days.

– At closing, put all proceeds from the sale of the existing rental into the new rental.

There are firms that specialize in 1031 exchanges who know all the rules and handle the deal for you.

And you don’t need to be rich to afford a 1031 exchange team and tax advisor to handle all these details.

To get started, 1031 exchange firms are your best resource to learn all rental home deal nuances.

Nuances include answers to questions like:

Can you eventually be exempt from capital gains if you did a 1031 exchange then later converted a rental into a primary residence?

The answer to this question is yes, but there are details.

Your realtor should have a good 1031 exchange team for you.

But if not, and you need a good 1031 exchange team, let me know.

And finally, I must shout out for this post’s hilarious artwork above, done by our creative and publishing leads Dennis and Robyn.

Best yacht name ever. 🙂

___
Reference:

Private Planes & Yachts Aren’t Just Rich People Toys. They’re Huge Tax Breaks. (ProPublica)

1031 Exchange rules for tax benefits on rental homes (TBP)

Most U.S. homes cost $375,700 right now. Do you qualify for a loan? (TBP)

IRS briefing on 1031 Exchange rules for 2023 (IRS)

* You can depreciate the value of the home itself, not the land it sits on, since land does not depreciate. You get the land vs. home value from your county assessor’s office records. In most U.S. counties, the home itself will be worth more than the land it sits on, but in geographically constrained areas like San Francisco for example, the home-to-land value proportion may be closer to 50%/50%. You divide the home value by 27.5 years, and you get to subtract that that amount once per year from your total rental property income (in addition to subtracting all other costs associated with the rental property as noted above) to arrive at your taxable gain or loss. As with all tax matters, a tax pro will help determine this for your tax filings.

 

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