On yesterday's post about leverage, you said: "And the benefit of not paying recapture or cap gains when I sell the investment properties. "

How do you plan on not paying recapture and cap gains when you sell rental properties, and how is that impacted by leverage?

There are a lot of moving parts so here's a watered down and simplistic explanation.

All of the passive losses accumulated over the years for the properties are carried over to the next year. These losses can only be released when the properties are sold (provided they meet the specific requirements as to how they are sold).

Aside from passive losses that resulted from leveraging the properties there are also the losses for the loans. Paying off a mortgage is not deductible. However, the fees to acquire that loan are. So assume you have a 10 year loan that cost $12,000 in fees. You can deduct $1,200 /year. If you sell after 3 years the remaining $8,400 are applied to your adjusted cost basis.

NC, thanks for the taking the time to spell it out.

I'm still not getting it, though. Passive losses that exceed the amount you can deduct in a single year come either from operating expenses and/or depreciation. The only way to truly have a non-cash loss (i.e. a paper loss) with real estate is via depreciation of the asset and/or other capital assets. Since your depreciable total is fixed at the time of purchase (i.e. what you paid for item X and/or house Y), you can never receive more in tax savings than what you lost paying for the bill/item/service. It's always a wash, EXCEPT when considering depreciation when your property isn't really wearing out. This is why I have steadfastly maintained for years on this board that depreciation is a TAX concept not based in reality. It's the one time you get something for nothing, literally.

Loan fees. You paid $12,000 cash to save $5,400 ($12,000 * 45%) in recapture and cap gains. Paying the bank $1 to avoid sending Uncle Sam 45 cents. Not a net positive.

All expenses (maint, utilities, supplies, management, insurance, property taxes, etc) are the same. To be considered a deductible loss all of that was paid at some point. For every $1 spent, your deduction is, at most...getting you a 45 cent tax savings.

Timing is irrelevant. Doesn't matter if you take the deduction in year 1 or year 10. Save dollars now vs. save dollars later. You paid $1 at some point for something to save 45 cents later. Sure, take that tax savings to help lessen the bite of the expense from the profits, but in no way does leveraging make that better in terms of actual dollars remaining in your pocket.

Only depreciation of an asset that doesn't lose value (or better yet, increases) nets out positive in terms of $ in your pocket.

To be fair, if there's something I'm not "getting", I'll need to see a specific example with specific numbers. It can be a fictional example, but it has to make sense to show me how leveraging ends up being a net positive in this scenario.

SID:

"Only depreciation of an asset that doesn't lose value (or better yet, increases) nets out positive in terms of $ in your pocket."

Yes, technically it is a matter of semantics. There is no way around not paying Uncle Sam his due. Well, there is but I'm not willing to risk it.

I guess I just look at the bottom line. After EVERYTHING how much do I net. And due to leverage I am left with a complete wash. At worst it's 95% of total proceeds.

I understand your perspective but I think you are ignoring or discounting some real benefits to leverage that go well beyond tax benefits.

The returns are higher and the risk is lower. If the property/investment goes south I still have the cash to start over

Cash Flow:Leverage allows for a larger portfolio which means greater cash flow and greater equity. The COC return on a leveraged property will always be higher than one purchased with all cash.

Time value of Money: the concept that a dollar today is worth more than a dollar in the future due to inflation and interest rates.

Taxes: Not only when you cash out but annually until you cash out.