Real Estate and Taxes: What You Should Know Before You Buy

Speaker 1 – 00:00
The tax universe in general, a loss is a loss, whether you categorize as a passive universe loss or an active
universal loss. If you’re a novice looking at a TikTok video, I did this Airbnb and it saved me hundreds of thousands
off my taxes. Unfortunately, like, there’s these awesome strategies, but there’s so much context behind who’s
actually eligible to do them. There’s a lot of details in your eligibility for how much it makes sense depends on your
situation. Active versus passive real estate, professional or.
Speaker 2 – 00:24
Not, seen it messed up dozens of times. Talk to your cpa. We’ll get you in the right direction.
Speaker 1 – 00:28
I believe this is one of the biggest superpowers on the tax code. If you have a married couple, one’s. The other
one’s second superpower is like a. That’s where all the magic happens. There’s a lot of strategies that are
advertised on Tik Tok and other social media channels how real estate can save you millions of dollars. However,
there’s lots of rules and lots of audit risk. So today we’re going to cut through the noise and show you how to do
this legitimately and how to maximize your tax savings. Well, Nick, tell us what exactly. When I view real estate and
the tax universe in general, I generally think of, like, two universes. So there’s the active universe, where you have a
high income W2 physician or executive, and then there’s this passive universe.
Speaker 1 – 01:17
So can you just give us a quick breakdown of the difference between the two? Because I think this is if. If you’re a
novice looking at a tick tock video of I did this Airbnb and it saved me hundreds of thousands off my taxes. I think
we need to preface this. The baseline of those two universes and how they can intersect based upon the elections
that we’re going to talk about today are crucial.
Speaker 2 – 01:37
Yeah, absolutely. So really, I mean, passive losses aren’t going to do too much for you. If you are recognizing a
passive loss, which means you’re not really. That’s all real estate. Unless we get into this real estate professional
election that we talk about today, a passive loss you’re not going to be able to use to offset your wages. You know,
if you’re a bit. If you’re a business owner, if you’re a shareholder of an S corp or a partner in a partnership, you’re
not gonna be able to use those losses to offset that type of income. It’s not allowed unless your income is below
$150,000. Okay, then you’re allowed to use some of that passive loss to offset that income.
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Speaker 2 – 02:11
All right, but we’re, when we’re talking million, $2 million of wages, you cannot use those real estate losses unless
you are real estate pro. That’s the passive trap. Those losses aren’t wasted. They’re carried forward indefinitely
until you sell the property, until you recognize passive income. But in that year you recognize it, you’re not going to
get much benefit out of it.
Speaker 1 – 02:30
Yeah, so let’s go through a couple examples. I think there’s. Real estate can be the most beneficial if you have other
real estate. Right? So like let’s say you have a property that’s paid off and it’s a commercial real estate building and
it’s producing like a million a year of net profit. Right. And so, and then let’s say that’s like your side hustle, so
you’ve got like your million dollar W2 on the side. Then let’s say you buy another brand new building. It needs a lot
of work. That new building you can depreciate. I want you to tell me like what are all the deductions you can take?
But the reality is that new building is immediately beneficial because that, in that example, that million dollar profit,
that first building, that’s in that passive universe, that passive income.
Speaker 1 – 03:10
And so any kind of losses on the new building, the improvements, the depreciation, all this stuff that’s also in that
passive universe. So that can offset passive losses, can offset the passive income. Right. So one, all if in that
example, and I have four examples in mind, so in that first example, what are all the ways with the new building? I
know depreciation, I know improvements. What are all the ways that we can generate passive losses for that
person to offset that million dollars of passive income?
Speaker 2 – 03:39
Probably the number one, the biggest thing is doing a cost segregation study which I think we’ll talk about a little
bit later on in the video, that will take the property from being, you know, strictly 27 and a half or 39 year property to
being 5 year, 7 year, 15 year and 27 and a half or 39 year Property. You might ask what the benefit of that is. You
can take some bonus depreciation on that five, seven and 15 year property that would allow you to write off a
significant portion of a new building purchase. Okay. And again we’ll talk about that more a little bit later.
Speaker 1 – 04:09
All in. Instead of the, what is it, 30.
Speaker 2 – 04:11
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So commercials, 39 and residentials 20, 27 and a half okay, so let’s say you buy a building for $500,000. Okay. A
house or something that you want to rent. We’ll say the building value of it’s 80%. The land value is 20%. Right. So
your building is depreciated $400,000 over 27 and a half years. The mental math, I’m not going to do that.
Speaker 1 – 04:33
That’s not very much per year, you know, 14,545. So yeah, 14,000 per year.
Speaker 2 – 04:39
Per year.
Speaker 1 – 04:40
That’s not really going to do much against that million dollars of your profit from the.
Speaker 2 – 04:43
Correct.
Speaker 1 – 04:44
Gotcha, exactly.
Speaker 2 – 04:45
Versus if you do this cost seg, which is really more for commercial, non residential, you might get a couple hundred
thousand dollars of write off in that first year.
Speaker 1 – 04:54
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Let’s talk on a percentage basis. So let’s say that first building someone is, has purchased the $5 million building.
It’s paid off now it’s netting a million dollars of profit. So let’s say they purchase another $5 million building. What’s
reasonable? I’ve heard like even sometimes 40 to 50%. So they can get like a two or two and a half million dollar
deduction.
Speaker 2 – 05:13
Yeah, I’ve seen up to like two and a half million in that scenario. So 50%, you might be able to more reasonably
expect 25 to not, you know, get your expectations too high.
Speaker 1 – 05:23
So in that example though, if they’re able to, let’s say the cost segregation was able to. 40% of the 5 is 2 million.
And that person’s not a real estate professional, that 2 million, they’re not going to want to take in year one
because they only have a million of passive income to offset. So they would take out of that 2,1 million of that
carry forward it again to the next year. The next million the next year. Yeah. Right. Because you, and you could carry
forward, I guess.
Speaker 2 – 05:48
Yeah. Really the probably the most beneficial thing to do would be to take that 2 million in the first year still.
Because what that would do then is it would create that million dollar passive loss carry forward. The other option
would be and I don’t usually recommend this is you can elect out a bonus depreciation at that point.
Speaker 1 – 06:03
Okay.
Speaker 2 – 06:04
But now you’re taking that loss over five years, seven years instead of having it all upfront to carry forward the next
year. Okay. So that’s kind of the difference. You can do either or depending on how your situation, you know, one
might better. Typically in my experience, the taking the full a hundred percent depreciation bonus Depreciation and
carrying forward the loss has been the best.
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Speaker 1 – 06:24
Absolutely. Okay, so let’s talk. Second example I want to talk about is instead of approaching this like the every rule
I think the we have real life stories we can go through. Right. So here’s a client, adjusted GROSS Income about 2.9
married, filing jointly. So you know federal taxes after and they have this is made up of like some, mostly W2, some
1099 incomes, federal taxes of like 950 grand basically or state taxes of 90 grand. It’s a lot of tax. I mean that’s
almost, it’s over a million dollars of tax. Right. So then you have Social Security of Medicare, etc. So these two
physicians in this example, one physician, one’s a business owner, both have full time jobs. Yeah. So they recently
approached me about like hey, were a friend and that’s. We’re going to go to scenario three.
Speaker 1 – 07:15
The friend is a physician, the spouse was stay at home mom. The kids are just out of the house now. So now the
spouse is getting into real estate. So in scenario one we talked about the passive income versus passive loss
scenario two we’re going to talk about two W2 active professionals. So if they go purchase a building and they’re
making this 2.9 million dollars of adjusted gross income, they purchase this 5 million dollar building hypothetically
they do a cost LLC. They have 2 million dollar loss. That 2 million dollar loss isn’t going to help their 2.9 million of
active income because neither of them can take. First of all they have no other passive income. Like all their
wealth is like.
Speaker 1 – 07:52
Well technically I mean they have a non qualified account which could help but they’ve got lots of 401ks private
investments, Roth IRA back to a Roth IRAs, a healthy brokerage account. But in general that $2 million deduction is
going to stay in this passive universe and it’s not going to transfer over the active universe.
Speaker 2 – 08:13
Correct.
Speaker 1 – 08:14
So they’re still going to pay the same amount of taxes forward. So my understanding the, this $2 million loss would
go on their tax return as a carry forward but it wouldn’t save them at their top 37% federal practice it would start
chipping away. If they had capital gains in the stocks, they could get the next $2 million of that out tax free. Right.
Because those offset dollar for dollar.
Speaker 2 – 08:37
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No capital gains can’t be offset with the passive because even though it is passive in nature, it’s a different type of
passive.
Speaker 1 – 08:44
So if they sold the building for Loss?
Speaker 2 – 08:47
Yes.
Speaker 1 – 08:47
Then it would. Okay, gotcha. The $2 million of the passive loss is not going to help this active $2.9 million income
at all. It’s not going to save them at all. They’re still going to be on track to pay a million dollars in taxes.
Speaker 2 – 08:59
Exactly.
Speaker 1 – 09:00
So 2 million dollar loss, they carry forward on the tax return. What happens that or can they ever benefit from that?
Speaker 2 – 09:07
Yeah. So it carries forward indefinitely. Okay. There’s no time, there’s no 20 year limit, 10 year limit, 5 year limit. So
you can carry forward for however long until you use it up. How do you use it up? Well, you start to get passive
income. You start. So maybe that property starts to turn a profit the next year. Right. Maybe it shows 200 grand in
net income of taxable income. You can use up 10% of that $2 million carry forward to get that down to net zero.
The other way would be say in five years you’re like, screw it, I want to get out of the real estate game. I don’t want
to be in it. It’s a headache. I don’t feel like dealing with the tenants, whatever. If they sell the property that opens up
that $2 million loss to be.
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Speaker 1 – 09:44
Taken, they sell it for five. They’re basically selling it for three at that point.
Speaker 2 – 09:49
Correct.
Speaker 1 – 09:49
So now we have a capital loss that could offset a capital gain in their stock account.
Speaker 2 – 09:53
It will actually be an ordinary loss.
Speaker 1 – 09:55
An ordinary loss, yeah.
Speaker 2 – 09:56
Okay, correct.
Speaker 1 – 09:57
A short term or long term loss. Or those can all offset stocks if they’re long term, short term. Right. Those, that
universe. A loss is a loss can offset a gain. And from an investment perspective. Yeah, I understand that correctly.
Yeah, yeah, okay, for sure.
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Speaker 2 – 10:11
But from a real estate perspective, that. So say, you know, you bought it for 5 million, you sold it for 5 million,
maybe you took 50 grand of depreciation, you have a little bit of recapture there. So you had a little bit of a gain
there. That two million dollar loss that we’re talking about now, that can be used to offset that $2.9 million in
wages. So that is allowed in the year of disposition.
Speaker 1 – 10:31
That’s a Strategy for number two, they could buy it, hold it for 13 months, take that big cost seg.
Speaker 2 – 10:37
Yeah.
Speaker 1 – 10:38
Then 13 months later, then take it.
Speaker 2 – 10:40
Correct.
Speaker 1 – 10:41
Does it have to be 13 months or does it have to already be held? Yeah. For the ordinary loss, for that strategy.
Speaker 2 – 10:46
Just talked about, it’s the year of disposition. So if you buy, I mean, obviously it has to be reasonable.
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Speaker 1 – 10:50
Can you buy and sell it like a month later you could.
Speaker 2 – 10:53
But what are the odds you’re going to recognize a huge loss?
Speaker 1 – 10:55
Well, if you did the cost segregation. If you did the loss.
Speaker 2 – 10:58
Well, so caught. Yeah. Let me, let me back step here. So you do that to go on.
Speaker 1 – 11:02
Your tax return first.
Speaker 2 – 11:03
Correct.
Speaker 1 – 11:03
And you have to wait a tax depreciation.
Speaker 2 – 11:06
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The asset has to be in service for a year.
Speaker 1 – 11:07
Got it.
Speaker 2 – 11:08
If you sell within a calendar year, you’re not allowed to take depreciation on that.
Speaker 1 – 11:11
Okay.
Speaker 2 – 11:11
So because that you’d have to hold it for at least a year, get that loss on the return, then you can turn around and
sell it.
Speaker 1 – 11:17
Got it. Okay, so that’s good to know. That’s a little loophole for the high income.
Speaker 2 – 11:22
Yeah.
Speaker 1 – 11:23
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Okay, so let’s go to scenario three. So scenario three is you have, let’s just use a. A business owner is making a
million bucks. The spouse was a stay at home spouse, take care of kids. The kids are now off in college. The
business owner has, let’s say a manufacturing business or a something with inventory. So they have a lot of
commercial real estate. They have office space. They have commercial real estate. And let’s say they’re in the
middle of purchasing another building because the business expanded. So this spouse has, let’s just say
hypothetically was a school teacher. Yeah. And if you go back to work making 90 grand a year or they could
become the manager of the real estate. And I think, I believe the rules, correct me if I’m wrong, is this has to be.
Speaker 1 – 12:07
To claim this real estate professional, you have to spend at least 750 hours or more per year. You have to have that
documented. Plus this has to, you have to spend, have spent more time on than anyone else involved with the real
estate. Right. So if you have a property manager that’s spending 751 hours and you’re. 750, it’s not allowed. So you
have to be that person. 700. You have to be the primary. And then it also. Does it have to be the main thing what
you do? So like if you have another job like that can’t be more time than the real estate. Right? Yeah.
Speaker 2 – 12:42
Let me real quick, one second, let me back up to our prior example. So the reason that might not actually be a
good tax strategy is because your basis in that property at the cost shift Sager point would be 2 million less. So
you might be able to take that $2 million loss, but your gain’s gonna be 2 million bucks. If that Makes sense. I just
wanted to better.
Speaker 1 – 13:00
You could pay a gain of 2 million at capital gain rates and then take the $2 million loss of the 37%.
Speaker 2 – 13:05
No. Because the depreciation will be subject to recapture at ordinary tax rates.
Speaker 1 – 13:09
Gotcha.
Speaker 2 – 13:10
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At that point, I believe.
Speaker 1 – 13:12
I believe so. That’s almost a wash. Yeah, it would.
Speaker 2 – 13:14
Almost be a wash at that point.
Speaker 1 – 13:16
Gotcha. Okay.
Speaker 2 – 13:17
In this example, it has to be more than 50% of your time. So it doesn’t have to be the only thing you’re doing. But it
is pretty hard to get to that point if you’re a W2, if you’re a doctor, if you’re an attorney or something along those
lines where you’re working 2000 hours a year because yourself then would need to work.
Speaker 1 – 13:36
In real estate 2001. So now you’re working 80 hours, 81 hours a week.
Speaker 2 – 13:40
Correct.
Speaker 1 – 13:41
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40 hours at your day job. 41 hours. Yeah. Okay.
Speaker 2 – 13:44
Exactly.
Speaker 1 – 13:44
So where this doesn’t work. If you’re like a super high income business owner, physician, executive, hypothetically,
and you’re buying commercial real estate, most likely you’d have to by yourself categorize that as a passive world
which would have very minimal big tax benefits, but very minimal like that year or even ongoing long term not
going to help your pat your huge active income empire that you build. Now if you have a spouse who can dedicate
their working career at least 750 hours or more, you know the rules we talked about. If you’re married, filing jointly,
six half dozen, one the other, it all comes together. Right. So now this spouse can come in your real estate empire
and the cost LLC, the depreciation. So let’s just say this person’s making a million dollars. Spouse one, spouse two
is now the real estate professional.
Speaker 1 – 14:34
The cost seg that we get 2 million year one that can offset that million bucks.
Speaker 2 – 14:40
Correct.
Speaker 1 – 14:40
Now their income zero. And they have a growing real estate empire. Correct.
Speaker 2 – 14:46
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100%.
Speaker 1 – 14:46
Well, this is like a soup. I believe this is one of the biggest superpowers on the tax code. If you have a married
couple, one’s high incoming, the other one’s a real estate professional. And you’re interested in doing commercial
real estate.
Speaker 2 – 14:57
Right.
Speaker 1 – 14:58
There’s really nothing better.
Speaker 2 – 14:59
Couldn’t agree more. The one thing just to mention is that even if your spouse is the one that qualifies for real
estate bro that since it’s a joint return, that allows all the losses. So even if you own that commercial property
jointly, it allows that taxpayer the primary tax.
Speaker 1 – 15:13
It doesn’t matter if the spouse doesn’t have to own it. Could you own it?
Speaker 2 – 15:16
Yes. Correct.
Speaker 1 – 15:17
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So you could own it 100%. Have a prenup agreement.
Speaker 2 – 15:20
Yep.
Speaker 1 – 15:20
You get married, your spouse suddenly comes in. That’s their full time job.
Speaker 2 – 15:23
Yeah. It’s a joint return. It’s a joint basically election at that point. To a degree, even though it’s her election, it’ll
allow the all the losses to be taken.
Speaker 1 – 15:32
Gotcha, sir. That’s huge.
Speaker 2 – 15:33
Yeah.
Speaker 1 – 15:34
Have you ever had a client put on their dating profile looking for us real estate?
Speaker 2 – 15:38
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Right. I have not seen that. But who knows, maybe one day. One thing I do want to mention just because it is super
important. So if you’re going to obviously talk to a cpa, if you want to make this real estate pro election, the biggest
election you need to make outside of the real estate pro election is regulation 1.4699 G. Okay. What that does is
sounds really nerdy. Yeah, it’s. It is. What that does is it groups all your real estate together. Okay. So you only have
to meet that 750 and the greater than 50% test for all your properties. If you don’t make that election, you have to
pass the test for every property. So if you own 5, 6 commercial real estate properties, you would have to pass that
test for every single property.
Speaker 1 – 16:20
Gotcha.
Speaker 2 – 16:21
If you make that election, it lumps it all together. You only got to pass it once.
Speaker 1 – 16:24
You give us an example of that.
Speaker 2 – 16:26
Let’s say, you know, you have four real estate properties. Okay. Your spouse like were talking about, is the main one
kind of running the show. You know, she’s the one doing the 752,000 hours a year doing it. If you do not make this
election, she has to be 750 hours at each property. If you make that election, it’s just 750 and it’s all by your real
estate portfolio.
Speaker 1 – 16:46
That’s a it.
Speaker 2 – 16:47
Yeah. It’s actually a very huge issue with irs.
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Speaker 1 – 16:50
You see. Do you see mistakes?
Speaker 2 – 16:52
I personally have not seen that made, but it is cause for audits. I’ve seen that. Not me personally, but I’ve seen that.
That is a big red flag to the irs. Obviously if you don’t make that election, no one’s going to qualify for that if they
own 4, 5, 6, 7, if not more real estate properties.
Speaker 1 – 17:09
Makes sense.
Speaker 2 – 17:10
Yeah. So it is a huge red flag. So make sure your CPA is making that election for you.
Speaker 1 – 17:15
No question. So we talked about the passive versus passive. We Talked about the two spouses. Neither of them
could qualify. The real estate professional we talked about. The third example was one high income spouse, one
real estate professional. That’s where all the magic happens. You have the high active and you can take this
passive universe and turn it into active losses and you save, you know, literally millions of dollars in taxes per year
if you keep buying real estate. You know, I guess the fourth example, if you have a single high income earning
person and they buy real estate, I mean, what’s the dance? Because I, I do know people that make a million dollars
a year and they have that pretty much on autopilot. Right. So I know. Yeah, he’s in the corporate world and he does
tons of real estate.
Speaker 1 – 17:58
He claims a real estate professional. Mm. And he does have that, you know, that pay stub that shows 40 hours a
week.
Speaker 2 – 18:08
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Right.
Speaker 1 – 18:08
But he also spends, I know, you know, he’s probably working like 20 hours a week and he probably spends like 60
hours a week on the real estate. So it’s totally legit. But if he gets audited. Yeah, she has not yet. What do you think
happens there?
Speaker 2 – 18:21
So that’s where it’s really important to keep good logs, good records.
Speaker 1 – 18:24
There’s no law against working 81 hours a week. I think that would be. His stance is. Yeah, my pay stub here
shows 40 hours a week. Yeah, here’s my logs. I’m working 50 hours a week and he is 100%. But I just would
imagine a lot of people would try to do this and do like 40 hours a week and then spend like one hour a week.
Speaker 2 – 18:40
Right. It all comes down to good record keeping. Right. The irs, they want their money, but they’re fair for the most
part. If you have good records proving that you are doing real estate that much, you’re Maybe not working 40 hours
a week at your day to day job. Even though the pay stub shows it’s. As long as you have good records, emails, keep
a log of the hours you’re working in real estate, things of that nature. It shouldn’t be a problem. It might get
questioned, right?
Speaker 1 – 19:05
Yes.
Speaker 2 – 19:05
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If you have a $2 million W2. But be ready to defend it. Keep the good records and it should not be an issue.
Speaker 1 – 19:12
Got it. Okay, so let’s talk about just rapid fire. This would be applicable for all four scenarios that just under all four
scenarios, a loss is a loss. Whether you categorize as a passive universe loss or an active universe loss is up to
the situational correct awareness that we talked about. So okay. We talked about depreciation. You can accelerate
that with cost segregation. So there’s certain parts of the building that could be a podcast episode in itself. But I, I
would suggest, you know, if you have questions about that, come see us. There’s depreciation. What else is
deductible? So if I like, if I go to improve. Redo the bathroom or put new flooring in or paint.
Speaker 2 – 19:50
Yeah.
Speaker 1 – 19:50
Are all improvements deductible?
Speaker 2 – 19:52
Well, yes, to a degree, but it depends. So if it’s commercial real estate and you make internal improvements to the
property, that is eligible for bonus depreciation.
Speaker 1 – 20:01
Okay.
Speaker 2 – 20:01
Okay. If you do a new roof, if you improve upon the roof, that can be qualified real property eligible for section 179.
Speaker 1 – 20:08
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So all basically in one year. Is it 90% now?
Speaker 2 – 20:11
What’s the 179? You can do a full. There’s some rules depending on it.
Speaker 1 – 20:14
I thought that went down.
Speaker 2 – 20:15
So bonus was being phased down. Okay, she was being phased. That’s coming back to 100% with the new big
beautiful bill.
Speaker 1 – 20:22
Gotcha.
Speaker 2 – 20:23
Those are two advantages you can look into now. If you add an extension onto the building, say your tenant needs
more space, more warehouse space, unless you do another cost sag or you know, have some sort of analysis that
was spread out, that’s going to be that 39 year property.
Speaker 1 – 20:38
Okay, point.
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Speaker 2 – 20:39
Got it. So any improvements are deductible. It’s just a matter of can we take it all year one, can we take it over 39
years which obviously don’t want.
Speaker 1 – 20:47
Or you could take it over like five or seven years in some cases.
Speaker 2 – 20:50
Yeah. If you do that cost seg, you might have some five year, you can elect out a bonus if that’s more beneficial,
things like that.
Speaker 1 – 20:56
Got it. You can kind of bounce around with a high income year, low income year and figure out what makes sense.
Okay. What about interest on the mortgage?
Speaker 2 – 21:04
So yeah, mortgage interest is deductible.
Speaker 1 – 21:06
Okay.
Speaker 2 – 21:07
That is deductible. Real estate taxes, you know, those are deductible.
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Speaker 1 – 21:10
Yep.
Speaker 2 – 21:10
If you’re playing a property manager to kind of run it for you. If you just want to be kind of the owner and hands off
to a degree, obviously that kind of discount or disallows the real estate professional side of it. But if you’re paying a
property manager, if you’re keeping it passive, that’s allowed.
Speaker 1 – 21:25
What about furniture? So if I’m. Let’s say it’s an owner occupied building. So let’s say it’s like it’s five floors yeah, we
got the top floor. Hypothetically, the real estate’s owned in a separate llc. The business is a client of that llc.
Speaker 2 – 21:41
Right.
Speaker 1 – 21:42
How does that work? The furniture? All that kind of stuff is. Am I running that through the business? Am I running
that through the LLC that owns a commercial building as the owner, or can I do either or.
Speaker 2 – 21:52
You could do either or. I mean, it depends on who wants to necessarily foot the bill. As the business owner, it might
make more sense to run it through the business. And basically they’re more so like leasehold improvements at that
point, not necessarily guaranteed.
Speaker 1 – 22:06
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Active universe. Correct. Not that. Real estate professional.
Speaker 2 – 22:08
Yeah, but if you want to keep it under the real estate umbrella, furniture, fixtures, really anything. So there is a.
There’s a number. So 2,500 bucks is kind of the IRS like, safe harbor number for fixed assets.
Speaker 1 – 22:19
Right?
Speaker 2 – 22:20
Any per item? Yeah. So you buy 50 laptops. Right. But each one’s only a thousand bucks. You’re fine. Even though
the invoice shows $50,000. Write that off. Got it. Right. Now you buy a brand new. I don’t even know what I can
think of a desk or something like that cost you ten grand, so you really wanted to get bougie with it. That
theoretically should be capitalized.
Speaker 1 – 22:45
Okay.
Speaker 2 – 22:45
Now, the nice thing is if you have to capitalize now, that bonus depreciation is 100%. It’s not that much difference.
And if you just took. Yeah, yeah, that was the. That’s kind of the nice thing about the bonus. It allows you to still get
that full write off in year one.
Speaker 1 – 22:58
Okay.
Speaker 2 – 22:58
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Even if the asset, quote, unquote, has to be capitalized.
Speaker 1 – 23:01
Okay. So let’s rapid fire. We have some clients that own. They own the business, they own the real estate. Our
recommendation is they pay. So the LLC owns the real estate, and then they make themselves a client of that llc.
Their business pays rent to the llc. My understanding is, like, let’s say, hypothetically, we have a business owner,
they’re paying themselves like a 250W2, and there’s a million dollars of profit. And so now they’re paying rent of
200 grand a year. Yeah. So basically what we’ve done is that 200 grand, if weren’t paying rent, would fall under that
profit, which would get taxed at the highest tax bracket, 37% federal, by paying it into the LLC as rent. Worst case
scenario, they’re paying passive taxes on that. Right.
Speaker 2 – 23:46
Which is the same rate.
Speaker 1 – 23:48
Same rate. Okay. But best case scenario is we have depreciation we have repairs and expenses and we’re. The rent
that goes in there is getting offset by the passive losses.
Speaker 2 – 23:59
Correct.
Speaker 1 – 23:59
They’re paying no taxes on that. Yep. So they’ve taken what would get clipped at 37. So what is the. The number
there? $74,000 in tax they’ve now pushed over here because of all the deductions and stuff we’ve talked about.
Speaker 2 – 24:13
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Yep.
Speaker 1 – 24:14
They just saved 74,000 a year in tax by paying themselves rent. Yes to that.
Speaker 2 – 24:18
Yeah. Assuming you have the deductions, the cost seg, all that stuff. Yes.
Speaker 1 – 24:21
And then that 74 a year comes out tax free until those deductions run out. Yeah, but that’s a huge. I mean, that’s a
really beneficial. If you’re a high profit business owner, you make yourself a client of the llc.
Speaker 2 – 24:31
Right.
Speaker 1 – 24:31
I mean, that’s a. I would say that’s a tax strategy on steroids.
Speaker 2 – 24:35
Yeah. Because that works even if you are passive in real estate. If you’re not claiming this real estate professional,
actually were talking about. Because then that 200,000 is passive income. But you have that cost seg. That shows
that accelerated depreciation. You can write that off.
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Speaker 1 – 24:51
Right.
Speaker 2 – 24:51
The five year, the seven year, the 15 year property, you can get that 200,000 down to zero.
Speaker 1 – 24:56
I’d say the two superpowers here would be the one, high income spouse, the married, filing jointly. Second spouse
is the real estate professional. Yeah. And you just, you know, save. That’s like number one superpower. Second
superpower is like an owner occupied building. You’re not a real estate professional. We got lots of deductions.
And then you create the income through your business that otherwise we get a tax at 37 and now it’s getting
attacked at zero because you have the deductions offset all the. Right. So for sure. I would say superpower
number two.
Speaker 2 – 25:27
For sure. Yeah. One thing just because I’ve seen it in the past in this scenario where you’re a business owner and
the real estate’s owned by you, but in a separate llc, you have to be paying rent.
Speaker 1 – 25:38
Yeah.
Speaker 2 – 25:38
I’ve never seen it necessarily questioned by the irs, but if you get, if you’re the lucky one to get audited and asked,
they will be looking for that.
Speaker 1 – 25:46
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You want to be paying rent. That strategy. Right. Because of the.
Speaker 2 – 25:49
But you do have to. I had some clients in the past who kind of were a little, I.
Speaker 1 – 25:53
Don’T want to say hesitant. They just. The only reason you wouldn’t want to pay rent if you’re a real estate
professional, I guess would be one reason.
Speaker 2 – 26:01
Some people just didn’t feel like, I don’t know, I guess maybe it’s an extra hoop to jump through or maybe.
Speaker 1 – 26:07
They did that other business with the extra profit or somebody selling along those lines.
Speaker 2 – 26:10
But yeah, you should be paying rent to yourself.
Speaker 1 – 26:13
Got it. Okay, let’s talk about a couple other strategies. So getting off the real estate profess. Well, we stay on this.
You know, you see all these TikTok videos. Oh, I did this Airbnb and saved all these taxes. We’ve talked through the
rules. I mean you have to be the real estate professional. You have to create the hours. I know there’s some
different rules around short term rentals with Airbnb. So you can get around the 7:50 if you’re doing short term
rentals, but you still have to pass the test where you have to be the primary person. No cleaners managers can do
more work than you. And so if you’re a W2 busy position doing Airbnb, probably not going to happen. You have a
property manager and a cleaner and IRS is a big. What are you doing here? You just purchased the thing.
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Speaker 1 – 26:54
Like you can’t take this as an active reaction.
Speaker 2 – 26:57
Yeah. And most short term rentals, you know, you throw it on Airbnb, throw it on Verbo and it kind of let them deal
with it, you know?
Speaker 1 – 27:02
Yeah. Yeah.
Speaker 2 – 27:03
And then you, they either have a cleaning crew or you have a cleaning crew. Either way.
Speaker 1 – 27:07
Can’t tell you how many Tick Tock videos I’ve been sent from clients. I’m like, then I can’t open the thing because I
don’t have a Tick Tock account. And so it’s like I gotta send it to a friend. Like that’s like has Tick Tock and then, but
it’s. Yeah, unfortunately, like there’s these awesome strategies, but there’s so much context behind who’s actually
eligible to do them.
Speaker 2 – 27:28
Yeah.
Speaker 1 – 27:28
And so we’re gonna, I, we’re gonna do another podcast episode about audit and like the IRS is hiring more people
to perform audits. I think this is going to be really attacked. So if, yeah, we encourage you to do this if it’s legit. But
if you’re that high income physician and just doing this, like because you saw a video, we’d steer clear at all costs.
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Unless it’s you have a spouse that can dedicate their, that can be that real estate pro. Exactly. Y.
Speaker 2 – 27:50
And definitely, I mean, talk to your cpa. Come talk to Us, we’ll get you in the right direction.
Speaker 1 – 27:55
Absolutely. Okay, so this next one we’re going to talk about 1031s and step up. So 1031 exchange, let’s say you
have a property bought for 5 million and 30 years ago and you’ve just banged it absolutely to the ground. So like
your basis is just used up because you’ve deducted everything you possibly can. Right. So let’s say your basis is
like 100 grand now. So if you go to sell that thing, you have to realize this 4.9 million dollar capital gain. Ouch.
Whereas if you just wait and die, if you’re the kids, they would get a step up in basis. And so that’s also another
superpower and why you see a lot of people sitting on real estate. But let’s say it’s a building you really don’t want
anymore. You can still do the wait and see approach through what’s called the 1031 exchange.
Speaker 1 – 28:42
So Nick, give us the rundown of how that works. And I know there’s specific time frames and rules around that as
well.
Speaker 2 – 28:47
If this sounds like something you want to do, talk to someone. Okay. I’ve seen it messed up dozens of times.
Basically what happens is it has to be, say you have an investment property like you were saying, and you find a
new investment property that you really like or you just want to be done with that initial one. Okay. You can
basically transfer your basis remaining into that existing one into the new one, not pay any tax on the gain if it’s
done correctly.
Speaker 1 – 29:12
So the $5 million property, your base is 100 gains, 1.4, 4.9. You sell it and get it into the new property for 5 million.
Your basis is still, you still have the same issue still the hundred thousand, but you didn’t pay taxes when you flip
building.
Speaker 2 – 29:27
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Right. And maybe you got a good deal on the new building. Maybe it’s a more valuable, maybe long term, you know,
something along those lines.
Speaker 1 – 29:34
And the reason you want to do this, if you didn’t want to pay taxes that year or if you’re expecting to keep it till
death.
Speaker 2 – 29:39
Correct.
Speaker 1 – 29:39
And assuming that step up in basis rule still exists.
Speaker 2 – 29:42
Yeah.
Speaker 1 – 29:42
Which depending on, you know, not to get into politics, but they affect tax opinions. And so the step up in basis you
should be aware of it has been discussed that should be taken away now. It has not yet. And we don’t see it
happening in the next, you know, under this new bill.
Speaker 2 – 29:57
Right.
Speaker 1 – 29:58
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It’s not there, but it could be in the next 20 or 30 years if there’s legislative changes. So this strategy is not a fail
proof. But it. What is fail proof is if you don’t want to pay taxes here and you want to keep your real estate thing
going, you can do this 1031. So how tight of the window are we talking about?
Speaker 2 – 30:14
Yeah, so let’s say you sell the property. You have 45 days to find the new one and officially inform them. So let me
back up for a second. So the money has to be held by an intermediary when you do sell the property. Okay. So you
basically have to hire an attorney to hold the funds for you and then you have to inform them in writing within 45
days of what your new property is going to be. You then have 180 days to close on that new property. One thing I
want people to know that 180 is not tacked on to the end of the 45. They’re running concurrently.
Speaker 1 – 30:49
So if you. Seven and a half months, that’s six months.
Speaker 2 – 30:52
Correct. So if you take 44 days to find that new property, you only have. What would the math be? 134 and a half
months. You have 136 days then to close on it.
Speaker 1 – 31:01
Gotcha.
Speaker 2 – 31:02
Okay.
Speaker 1 – 31:02
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That’s a tight window because I mean, yeah, there’s inspections, there’s all kinds of stuff you have to do, go
through. You have the loi, and then you have to agree on your sales agreement. And then now you’re negotiating
again because there’s all the stuff you found wrong. Maybe, you know, maybe you did sign a sales agreement.
You’re taking it as is. But the reality is like that’s it’s a tight window. That’s not. It is, it’s not stressful. If you’re
working with a pro and be like, okay, that’s what I want. You kind of already have like a verbal agreement, but if you
like have no idea what you want, it’s be very hard.
Speaker 2 – 31:30
Oh, for sure. It can get tight on you before you know it.
Speaker 1 – 31:33
Yeah.
Speaker 2 – 31:33
So you almost want to go into it knowing what your game plan is. And obviously I know things fall through, things
happen, but go into it with kind of some sort of mindset that way. This 180 days isn’t a, you’re up against it, you
know, because you don’t want to be up against it.
Speaker 1 – 31:47
181 days and now you’re suddenly you’re.
Speaker 2 – 31:49
Paying 4.9, 4.9 million gain.
Speaker 1 – 31:52
3.8 federal. Yeah. Pennsylvania 3.7% state.
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Speaker 2 – 31:55
Correct.
Speaker 1 – 31:55
So now you’re giving up. What’s the matter?
Speaker 2 – 31:57
A lot of money.
Speaker 1 – 31:57
I mean 4.0 over a million bucks.
Speaker 2 – 31:59
I mean that’s.
Speaker 1 – 32:00
Yeah, It’d be close three bucks.
Speaker 2 – 32:02
Yeah. Some net investment income.
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Speaker 1 – 32:03
27. Oh yeah, yeah. You’re talking almost one and a half million bucks taxes. Yeah, that’s. That’d be a unfortunate
surprise.
Speaker 2 – 32:10
Yeah, exactly. And one thing also I’ve seen to keep. Just to keep in the back of your guys mind, if you have a
mortgage outstanding on that property, you know, hopefully it’s paid off on the one you’re selling. Paying that off
counts as boot. Right. That counts as basically cash you’re keeping unless the new property has a mortgage
against it as well.
Speaker 1 – 32:30
So it can’t all carry forward in that example.
Speaker 2 – 32:32
Correct.
Speaker 1 – 32:32
That’s why you’re a cpa. I’m not boot and all that.
Speaker 2 – 32:36
Yeah, I know it’s.
Speaker 1 – 32:36
I just short window in public accounting. Yeah, yeah, I learned about all that.
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Speaker 2 – 32:40
Yeah, I dealt with that a couple years ago. Is that they had a mortgage outstanding on this property. They didn’t
really talk to us beforehand. They went through it with. They went through with this 1031. Turns out it was kind of
ineligible.
Speaker 1 – 32:52
Got it.
Speaker 2 – 32:53
Not ineligible but they had the mason they thought was.
Speaker 1 – 32:56
There wasn’t this big of the.
Speaker 2 – 32:58
When you pay off that mortgage, you don’t have a new one on the new property. That’s basically cash you received
taken out of the sale.
Speaker 1 – 33:04
They thought they were getting a 16 ounce fillet and got 8 ounce. So that’s. That’s unfortunate. But okay. And just
in real estate in general, I know this is. There’s a lot more details and you can go into than just on the podcast
though. We wanted to talk high level because I think a lot of people think oh there’s so much tax savings. My friend
said this. There’s a lot of details in your eligibility for how much it makes sense depends on your situation. Active
versus passive real estate, professional or not. So we would encourage you if you have questions of something
you’re interested or considering, come see us or go see another professional that is knowledgeable about these
topics.
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Speaker 2 – 33:41
Yeah.
Speaker 1 – 33:42
Anything else that you would add to just real estate in general, words of caution or good stories, etc.
Speaker 2 – 33:48
Really I don’t have too much in terms of good stories unfortunately. But I can’t emphasize enough record keeping
especially if you’re going to do this real estate election. It is super heavily scrutinized by the IRS right now. So if you
do it if you decide to do it and again, talk to your cpa, talk to us. We’ll see if it’s something that’s that you’re eligible
for. Make sure you have good records. There’s definitely a chance it’s going to get questioned and I’m sure we’ll
talk about on the next video.
Speaker 1 – 34:13
Thanks for joining us, everybody. Look forward to catching you next week.