Ep 80 – How to Make the Tax Code Work FOR You with Brandon Hall, CPA

Everyone discusses the tax benefits that come about from owning real estate, but what are they really? Are they overblown? Understated? Or are there avenues out there that you haven’t even considered yet?

Adam Schroeder and Zach Lemaster talk with Brandon Hall, a real estate CPA, about what to make sure your CPA is doing with your taxes, strategies you can implement to make sure you’re getting every available benefit, and how to offset active income WITHOUT being a real estate professional.

Learn more about Brandon HERE

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Transcript:

Hey, rent to retires is it’s Adam Schroeder here with Zach Lemaster. And today we are joined by Brandon Hall. He is the founder of Hall CPA. And yes, we’re going to talk about the topic that everybody loves to talk about so much, and Zack actually does love talking about and that is taxes. So Brandon, welcome to the show. Thank you guys for having me on. I really appreciate it. Absolutely. So let’s start a little bit, I want to ask the question that I want to ask every single time I talk to a CPA and that is, how do I know if you’re in a good? So how can I tell if my CPA is any good? What are some things that people need to be looking for? And asking when they’re vetting their accountant to see if they need to hire them or fire them? I love that question. So the the first the answer to your question is you will you cannot verify that you cannot possibly verify that

the way that you can reduce your risk of having somebody that doesn’t know what they’re doing is to explore their website, explore their social media profiles, explore the type of content that they’re putting out. And if it’s very generalized content, if it’s content

related to a niche that’s not real estate, then maybe they’re not strong in real estate. And

maybe they don’t actually work with a lot of people like you. So the way that I approach it, because I approached the same, the same issue with with my own vendors, right? Like if I’m if I’m hiring an attorney, how do you know that the attorney is going to be any good? The reality is you don’t? So what you do is you try to figure out well, how large of a firm are you if you are a larger firm? Who do you hire? What are their credentials? And do you work with other people like me? And that that last question, in my opinion, is the most important question to try to figure out and I really think the only way that you can figure it out is to do some internet sleuthing. But the reality is, is that a lot of CPAs make mistakes. I mean, our firm makes mistakes. So you have the ultimate responsibility to your own tax position. So our firm with our clients, we actually train essentially, our clients on how to review a tax return how to analyze their own tax position so that if we do make a mistake, they can call us out on it, because I don’t want to have people just you know, getting a 300 page tax return back and just saying it looks great five minutes later, which happens probably three or four times a year. I know you didn’t look at it, if you just replied that it looks great. Let’s send it in five minutes. Well, it’s a huge education piece to Brandon’s just making sure that people actually understand it. I mean, I would think that most people, myself included rely on their CPA to guide and yes, while I think it’s good to understand it, I don’t know if I’m going to review my entire, you know, 300 Page tax, Application and Submission. But I think it’s it is important to fundamentally understand what you’re doing help to gain a strategy on how you’re going to be moving forward and make decisions that you do. A lot of the investing that we do is determined by the tax advantages and tax strategy. You know, especially from the 2017 Tax Act, which gave us a lot of huge benefits, which we’re kind of at the end of right now, we’re only have a few years left on certain things. But I always tell people having a CPA is your core group, right? When you’re when you’re being a successful real estate investor, you’re building a business, and you need to surround yourself with your your advisory team and your professionals that are that understand your goals and can help guide you. And that goes from every firm. Everything from CPAs attorneys, I mean, property managers, contractors, 1031, guys, everything is going to insurance agents, you need that core group of people that are going to assist you in really accomplishing your goals. But I think the biggest way to find good people in the industry is you know, coming through networks like this where we’re featuring you on on our podcast, because you we know that you’re in the space and doing some really cool things for people that you are a real estate investor yourself and you kind of you’re in the game, you know what, you know, you know, this industry, and so that’s vitally important, but let’s go ahead and dive into the actual tax side of things. I mean, there’s there’s a lot of changes always happening politically and with different legislation. Can we just do kind of a quick overview with the Biden administration, there’s some new proposed bills going through I mean, what what are we looking at in the future of what is changing in the tax world that we need to be aware of? Yeah, so there were a lot of original originally, believers back early 2021. There were

A lot of proposed changes, or a lot of talked about changes that were going to impact the real estate industry, but eventually got stripped out where they weren’t going to be impacting the real estate industry at all. So, Ian Manchin, Senator Manchin killed the bill by not not voting on the Democratic side. So we have no bill, there is talks of a potential new bill coming up, but I have yet to see anything substantial there. I will say that the Budget Office released their annual budget and one of the line items on the budget was related to depreciation recapture, being taxed at ordinary rates. So anytime that you buy a rental home, you start depreciating, you have to depreciate it’s not an option, you are forced to depreciate your homes, your rental

homes. So you take this annual depreciation expense, it’s a freebie expense, we call it a phantom expense. Because if I if I have a $1,000 depreciation expense on my schedule E, which is where you file your rentals, I’m not physically coming out of pocket to pay that $1,000 expense. It’s just a think of it as like a credit that is granted to me from the government as a thank you for owning rental real estate and investing in rental real estate. So I invest in this rental real estate, I get this $1,000 depreciation expense. But when I sell the property later, most of the time I have to pay recapture taxes on that $1,000. That is that 15% now or what is that? Yeah, so it follows capital gain rates all the way up to a 25% maximum. But the Budget Office wants to see it wants to see the recapture rates on all depreciation go up all the way to 37%, the ordinary rates so but again, note, no proposals that I’m aware of Today, no proposal is on deck. So we have to kind of see what happens, what we’re, we’re keeping our eye on. And so depreciation recapture, I think a lot of people are unaware like, that’s a thing, you know, you get this great depreciation

during the course of owning the property, and you can even do creative things like accelerated depreciation with cost segregation studies, which we do. But regardless, that’s now which is a benefit. Because you you get to have more investing capital now that you can go in and reinvest and earn an income on versus turning it over to Uncle Sam right away. But that there is depreciation recapture. So that’s something you need to be planning for, however, the way to continually defer that would be through a 1031, correct? Yes, yes, definitely. And a really quick way to just explain this, or help people visualize this. Let’s say that you buy $100,000 rental home, and you depreciate it $10,000, your adjusted cost basis is $90,000. So if you sell this 100k, home for $101,000, most people would think I bought it for 100. I sold it for 101. So I have a $1,000 gain. But what’s really going on is you take your sales price minus your adjusted cost basis, which was $90,000. Thanks to that depreciation write down. So I’ve got 101k sales price, minus $90,000 of cost basis, my total gain is $11,000. In this example, $10,000 of that gain is coming from depreciation. And that’s depreciation recapture. So that’s kind of how you think about it. In a simple, simple sense. So depreciation recapture. Sorry, I’m is I mean, that’s that’s recaptured at a long term capital gains rate. Right now, as it stands. Okay. Yes. I want to skip back to the beginning, when you’re talking about the 300 page report. Just real quick, when you look at your report, what are some of the big, like, on your schedule, especially? What are some of the big things you need to look at the big line items to make sure that you’re taking full advantage of the tax benefits that are there and that nothing was was missed? Like, are there certain lines that are way more important than others? I would assume? Yeah, well, kind of I mean, on Schedule E. So Schedule E, IRS. Schedule E is a profit and loss statement, essentially, for each one of your rentals. So you’re giving the IRS your profit and loss statement in a very organized way. So you just want to make sure that Schedule E is complete, meaning that we have property taxes listed, we have insurance listed, we have depreciation listed. amortization of loan points is listed, management fees, commissions, that type of thing. So we just want to look at Schedule E. And you want to ask, Does this make sense based on how I operated my property this year? And is this complete? The most important form that very few people look at but every single person that owns rental real estate should look at once a year, it’s the most important form for you. It’s form 8582. So in every tax return, if you’re a landlord, you should have a form 8582 With the exception of if you’re a real estate professional, you

might not have won. So form 8582 is the is the aggregation of all of your passive activities. A passive activity is any rental any rental property, unless you’re a real estate professional and any trade or business that you do not materially participate in, meaning that if I went and invest in my local hair salon, all I did was give them capital, I didn’t participate in management, that’s a passive activity for me. So form 8582 aggregates all of your passive activities together. And it nets out all the passive income and passive losses. I hear from people all the time to say Oh, my tax advisor says that my rental from my rental loss from rental a can’t offset the income from rental B, or my syndication loss that I’m an LPN can’t offset the gain on sale from rental a and it’s all hogwash because it all gets netted out on form 8582. And if you look at this form, you’ll see very quickly that it all gets netted out on form 88582. And if you ever dealing with a tax advisor that tells you no, it doesn’t work like that, ask them to prepare a pro forma form 8582 for you, and they will quickly realize that they are incorrect, but form a five a two nets, all your passive activities, together all passive income, all passive losses, and then it tracks your suspended passive losses per activity that you have per passive activity that you have. So every single rental activity is assigned and a suspended passive loss every single year, which we can get into. But the point is, is that if you aren’t tracking that your CPA may mess it up, especially in years that you switch CPA firms, because sometimes new firms, especially if they are very small firms or local firms, or maybe firms that don’t work with a ton of real estate investors, they don’t have procedures in place for their tax compliance process to actually review the prior turn and make sure that they carry forward any suspended loss. That goes for Schedule D, your capital gains and losses on stock sales. But it also goes for form 8582, I have, we’ve helped clients recover hundreds of 1000s of dollars in Miss suspended passive losses, because they switched firms three times and one of the firm’s forgot to carry forward the loss. So you need to be looking at that every single year. So that you know what you’re carrying forward. Not only to protect yourself whenever you’re switching CPAs are protect yourself from CPA errors, which we do make, but also to remind yourself of how much loss you’re caring for because I’m caring for 200k of suspended passive losses, thanks to a cost six study because I invested in some syndication, and I have a rental over here that I want to sell for $220,000 gain. If I’m not aware that I’m carrying forward this 200k Suspended passive loss, and I forget to ask about it, I might set up a 1031 exchange for my 220k gain. But in reality, I could probably just sell the rental and completely eat up that 200k Suspended passive loss, right? That’s, you know, we just want to be more aware of what we have going on in our tax position. So many people, when they start investing in real estate, we see it all the time as they they’re used to filing their own taxes, especially if they have a W two job, it can be rather simple. But we always encourage people to hire a tax consultant to actually hire legitimate CPA that is in the real estate space. My opinion is that by hiring the right professionals, you know, don’t look at the cost even even someone that may be a little bit more expensive, they end up saving you significantly more than the cost. So it’s it’s a necessary cost. But what would you say to someone that’s used to filing their own taxes, they’re starting to get into the rental property world, they’ve been filing their own taxes on their own rentals? What would you say to those individuals? I mean, I would say I don’t file my own taxes anymore. So it’s, it’s just, at some point, the cost benefit, the cost outweighs the benefit, right? Like, I could file my own taxes, but it’s not beneficial for me anymore, for my time to be sunk into filing my own tax returns. So everybody has their own cost, benefit breakeven point, right. And you have to find yours, maybe you are very analytical, maybe you enjoy this type of stuff, cool. You can certainly read about everything, you can certainly listen to our content and read our content, you could probably get pretty close, you could probably get 90% of the way there. But at some point, your portfolio is going to scale to a point where it’s just not worth your time. And that’s something so funny that I see it it’s it’s a alright, we can file a tax return for $2,000. And if it takes you, you know, 100 hours to do it, is that hourly rate really beneficial for you. Shouldn’t

you instead be hanging out with your family, hanging out with your kids, golfing, you know, whatever it is that that you find fun and that’s kind of where I was at from that cost benefit analysis. I focused into it. I’m an expert at it. But is it actually worth my time?

or should I just be in this reviewer role that is much less of a lift for me timewise and still make sure that I get all that all the expertise in there. Yeah, that time is probably better spent trying to grow your portfolio and, you know, focus on money making activities.

You talked about passive losses, playing for let’s just talk about, in general, a real estate investment. And I know, kind of the the concept we want to get back to is kind of what we’re seeing today. So we’ll talk about things that are changing right now, as far as costs, eggs and, you know, opportunity zones. And there’s some time specific timelines that we’re we need to be aware of with those and how those work but with, with just a rental property income, just so everyone’s work, because I think there’s a lot of confusion about this. Let’s say you have $100,000 Rent rental property, but the gross rent is $10,000. Annually, your your net would say $4,000, after you know mortgage management, everything like that.

Are you being taxed on we’ve before write offs, you’re technically being taxed on the gross income, the $10,000 income, right? And then you have all the write offs to write that down, you’re not being taxed on net income, is that accurate? No. So you are only ever taxed on your net taxable income, whether that’s an income or a loss. So I think I think what ends up happening is you have $10,000 of rental income, you have $4,000, or $6,000 of expenses. So you have a $4,000 net operating income.

If that doesn’t include depreciation, then you throw depreciation in there as well. And depreciation on $800,000 is going to be like 20,020 $4,000 a year, so, so let’s call it $24,000 A year $4,000 of net operating income minus $24,000 With depreciation equals A $20,000 taxable loss. So in this situation, I earned $4,000 of actual cash. So that hit my pocket $4,000 of net operating income, because I had 10k of rents, 6k of actual expenses, 4k of actual cash, but I’m telling the IRS, I lost 20 grand, thanks to depreciation. So I actually don’t pay tax on actually if, if I can claim that 20k loss, it gets my other income, I’m even getting a tax benefit as a result. Of course, that’s being an active real estate professional in that case, not just you know, owning a few rentals passively in that scenario. What about debt service, though? Your net operating income does not include debt service, right? Correct. Yeah, yeah. Okay, so So the principal piece of of your debt service is not deductible. Of course, mortgage interest and things like this depreciation is really the key here, because that’s going to wipe out with that $100,000 property, you know, take it out 27 and a half years, roughly $3,000 a year, that’s going to wipe out the majority of your your actual net operating income in most cases. So

with I’ve heard rumors about if people and this goes back to filing their own taxes with depreciation, if you don’t take depreciation appropriately. Does the IRS still count counted on a REIT? I mean, you’re you’re technically not taking it, but I heard something along the lines of, you’re still potentially taxed on it. You know anything about that? Yeah. Yeah. So if you look at form 4797, which is where you report sales in the year that you sell a rental property or passive activity or any activity, form 4797, there’s a little line on there that says, you have to report the depreciation allowed or allow a bull. So even if you took no depreciation, you would technically have to report the depreciation that you could have taken in that whenever you sell. And so you’ll be assessed recapture tax

on depreciation that you never actually benefited from. And that’s why I said at the beginning depreciation is requirements, not an option. Now, the reality is, is that you can certainly report $0 there on that on that line item on form 4797. And, and just hope for the best, you’re technically incorrect if you do that. But under audit, the IRS would correct that for you. And they would make you pay recapture taxes on that depreciation. And then they would be assessing all sorts of penalties for not doing it correctly. So you actually get penalized for not taking the depreciation appropriately. This is why it’s not a good idea to file your own taxes.

You got to have someone in there that knows depreciation, you got to be taking it. Yeah. So I’m assuming a lot of this stuff. And we talked a little bit before we started, a lot of this stuff is covered in your tech smart boot camp. That’s kind of what this that’s focused on. It is yes. Can you talk a little bit about what that is? Yeah, so we do a four week boot camp. It’s about two to three hours of pre recorded videos every single week. You come in with a cohorts. We launched it about once a quarter are actually launching our next one here next week or when we’re first week of June, 2 week of June, based on whenever we’re

gets released. But for weeks pre recorded videos, and then we do a live q&a with the cohort. Every Thursday, you also get a access to an insider community during the bootcamp to kind of bounce ideas off of each other, as well as our team. The whole purpose of this is to basically help you get educated on on tax strategies that are available to you. And also kind of the things we were talking about form 8582, what is that? How do you actually review it? What are the line items mean, we show you how to step through that, so that you can have better conversations with your own CPA. So the bootcamp is really for people that, you know, might look at our firm and say, Oh, you guys are too expensive, or for whatever reason, I don’t want to work with you. I’m gonna keep my current CPA because I love the guy, he’s my best friend, we’ve heard all that type of stuff. And the bootcamp allows you to still basically access our knowledge in a really condensed format. And then and then be able to have more sophisticated conversations with your own tax accountant. We love the education piece. Can we talk a little

bit about passive versus active losses, I mean, for someone that say they have a W two job, doctor, attorney, engineer, whatever the case is, they have some rental properties, you know, those passive losses that you talked about, can be offsetting the income on the property, so like depreciation, and then that if you report a loss that is passed forward to future now and possibly applied to capital gains, I guess, but there’s, you know, let’s talk about how you position yourself to be an active investor. Really, what that means is, as far as taking additional losses towards active income, that’s a huge thing I think a lot of people strive to work for. And I’ve heard things about three different classifications like if you’re a passive investor, you have your active investor, potentially, where there might be a threshold of passive losses, and then your real estate professional can we go through that just make it as simple as possible for people? Yeah, so the way that I like to describe it, is when you are investing in real estate, you have two buckets of income, you have your passive bucket of income, and you have your non passive bucket of income in your non passive bucket or things like your W two job, it’s your business income, where you are working on the business, you’re working in it on a on an ongoing basis. So my CPA firm income is in the non passive bucket for me. Also, in the non passive bucket, those might not make sense logically, but this is these are the rules, interest income, dividend income, capital gain, from sale of stock, Bitcoin, all of that is in the non passive bucket, in my passive bucket is every rental property that I own unless I qualify as a real estate professional, and any trade or business where I do not materially participate. So again, if I put $100,000 into the local hair salon for expansion purposes, but I’m not on the management team, I’m not making decisions, I’m simply a capital partner. That is a passive activity that I’m not materially participated in, or sorry, that’s a trade or business that I’m not materially participating in. So it’s in the passive bucket. The issue is that the things in the passive bucket if they create losses, I can’t jump them out to the non passive bucket, unless I qualify for one of the exceptions that you were mentioning. So then we start talking about the exceptions, because the reality is, is that when I buy a piece of rental property, I can cost segregate it, I can accelerate the depreciation, I can claim these large tax losses in the first few years of ownership. And it would be great if I could actually utilize those tax losses against my CPA firm income, which is in that non passive bucket. But the problem is that by default, those tax losses from that rental real estate that I just cost segue, by default, it’s stuck in the passive bucket. So I have to try to figure out how to get it out of the passive bucket into the non passive bucket, so that I can offset my CPA from income. There’s a few exceptions to the rules that allow you to do this, the first is earn less than $150,000. This is modified adjusted gross income. So if you have, you know, 100k For one, w two and 100k from another w two, you’re out, you phased out. If you earn less than 150k, you can qualify for a portion of or the entire amount of a $25,000 loss allowance from the losses from my passive bucket. So it’s not like a full blown I can take all my losses. If I generate 30k of passive losses, then I can potentially take up to 25,000 of that simply by earning less than 100 And is that adjusted gross income at 150. Okay, so anyone 150 or under 100? Just gross income. If you own rental properties, you could potentially have a $25,000 deduction, of taking passive losses against whatever your career field is. You do not need to be a real estate professional in this case.

that can be huge. That’s a half downpayment on another house. Oh, yeah, yeah, you do have to own at least 10% of the activity. So typically doesn’t work for people investing in syndicates, you also have to be actively involved in management. And all that means is that you can, you can have a property manager that’s actually running the day to day, but they kick up management decisions to you, you’re actively involved in management. So those are the two caveats for that. The second exception to jump things out of the passive bucket and into the

non passive bucket. The second exception is to sell a rental property at a gain. And when you do that, you can use the losses from the passive bucket. So that’s, that’s it, they call it a disposition. So if you dispose of an activity, that’s another exception to these passive activity loss rules. And then the third exception is to qualify as a real estate professional. For the second bucket, you have to hold the property for a period of time, can you flip it? That’d be you do not you do not have to hold it for a period of time, it just needs to be a passive activity. So if you are flipping property, that will actually be a non passive activity that will be a trader business that you are materially participated in. Well, isn’t that determined by length of hold, though? I mean, isn’t that one year threshold considered like we’re would go into or the intended use of it? Or how to, yeah, you’re hitting on the factors, there’s multiple factors that the tax court looks at to determine if somebody is a real estate dealer, hold period and intent are two of the factors. But not the only factors, they kind of look at the entire situation to sort of figure out, are you really doing this for profit? Or are you doing this as investment purposes. And that’s why one of the things I talk with people about is as they grow their portfolio, sometimes you look at the higher priced properties that don’t cash flow as well. And you have to say, well, think about it this way, your enter nicer neighborhoods, so you might get better appreciation, but also, that one, your higher ones that don’t cashflow as well, that depreciation is going to offset your lower cost, higher cash flow properties, and really kind of they work together to give you kind of a net zero income from real estate, when in actuality, you know, you’re making a good chunk of money at it. So what are some reasonable kind of effective tax rates that you’ve seen real estate kind of your average real estate investor be able to get down to? I mean, we tell people, if you’re not at 15%, you need to be working with somebody that’s helping you actively get to that point. We have clients that are at five to 10%. But these are clients that are full time in real estate, they have a large portfolio, and like you just described, properties are offsetting each other for a tax from a tax perspective, but their cash flow healthy, the entire portfolio is increasing in value. And they pay very, very low tax rates effect about 00. Yeah, I mean, yeah, if you if you can achieve zero, that’s phenomenal. I think that we dream client, and we have one client that doesn’t have about 700, it’s a little harder to achieve than I think most people realize. But yes, always a good goal. You buy enough properties, I always tell people, if you are a real estate professional, and you’re buying enough properties, you know, and you’re active in the business, that’s not out of the question, right? It’s just a math equation, and you buy enough, I mean, the reality is okay with this is get off my soapbox here in a sec. But if you have a million dollar property, and you do accelerated depreciation on it, and say your study comes back at, you know, 30% of the improvement, or whatever, so we’ll call it a $300,000. reduction, and you made $300,000 active income, you just completely wiped out your taxes, right? I mean, it’s yeah, pretty well in so I’ll add a little bit of flavor to this. So you’re totally right, what we like to look at is what is your actual total tax liability. So a lot of people forget that on my w two, I’m paying Social Security and Medicare taxes, and we actually like to factor those in to the entire conversation. So if you truly want to get to a 0% tax rate, you need to not have a W two job, you cannot be running a business. You cannot be you know, investing in dividend stocks, you can’t be lending anybody money, you know, to get that interest income, you can’t sell any stock, you can’t sell any bitcoin. You just got to be in real estate full time and investment real estate full time. And you can it is possible to build a large portfolio to cashflow a very healthy amount every single year and pay $0 on that cash flow. And so that’s the key is can you can I pay $0 on my portfolio? And over time, can I work to make this portfolio my primary income stream and then ideally my only income stream? Now of course, this is not wealth advice. This is simply tax advice. But if you want to get to 0%, that’s what you have to do. What about short term rentals versus long term rentals? Are those go in the same bucket? Are they in different buckets? How do those how does that play into each

other? Yeah, good question. So back to the three exceptions to the rule of all rentals are passive unless you jump it out of the passive bucket by qualifying for one of these exceptions. So we talked about

The 150k rule, we’ve talked about the disposition rule. And the last rule is that real estate professional status rule. And to qualify as a real estate professional, you get to spend 750 hours in a real property, Trader business and more time in real property trades or businesses than you do anywhere else. And typically, that more time in real estate than anywhere else automatically kicks out anybody with a full time job, and most people with part time jobs. So the problem is, is you got you got all these people that are earning lots of money at their day jobs, or they’re earning lots of money running their businesses, and they start investing in real estate and they go, man, all my CPA just said that I can’t use any of the losses, so I don’t get any of the tax benefits. And that’s a big bummer. And what’s really going on is the not understanding real estate professional status rules, or they’re not a real estate professional. So all their losses are stuck in that passive bucket, and you’re still getting the tax benefits. By the way, it’s kind of like a thing that irks me, you always get the tax benefits, you’re earning cash flow you’re on, you just can’t claim the additional tax benefits. But that’s a that’s a sidebar anyway. So back to short term rentals, that is a fourth exception. That’s not like a It’s not like an explicit exception. So that’s why I didn’t name it earlier. But the fourth exception to these rules is to own short term rentals, because a short term rental and this is from the Treasury regulations that come with section 469. And the Treasury regulations interpret the Internal Revenue Code. So they’re authoritative, which means that we can rely on them. The Treasury regulations say that if a rental if the rentals average period of customer use is seven days or less throughout the year, then that is not a rental activity under Section 469. Now, the passive activity rules again, say all rental activities are passive unless you qualify as a real estate professional. And also any trade or business that you don’t materially participate in, is passive. So what I like to encourage people to understand is that words are extremely important. So if we have a short term rental, and it’s not a rental activity, but section 469 says all rental activities are passive, unless we qualify as a real estate professional, I don’t have to worry about that. Because I don’t have a rental activity. Short term rentals are not rental activities. So I don’t have to worry about qualifying as a real estate professional, which means I don’t have to worry about spending more time in real estate than I do anywhere else, which means I can be working a full time web job, I can be working full time on my CPA firm, and I can go and buy a property that I’m going to Airbnb or VRBO. And as long as I do a few things, as long as I’m materially participate, which we can go over, I will have a non passive rental activity or rental property, I’m not gonna use the word rental activity. So that means you’re taking you’re in that scenario, it’s an active business, really. And so those those losses you can count against active income without being a real estate professional, no income limit type of thing. Exactly. Okay. And are you also taxed on that income at active rates?

of income? Yes, but even if you had rental, like actual rental activities, like long term rental properties, the same would hold true for them. If you had net income after depreciation, you would still be taxed on that net income at ordinary rates. So this is huge, because if someone’s saying there’s no way I can become a real estate professional to offset the whole idea here,

and I love that you made the point, Brandon, that’s so huge about you, everyone gets the benefits of owning real estate, is just when you’re taking it right with Accelerate accelerated depreciation costs, like that’s just accelerating the same benefit you would get over time anyways, in year one, to take a larger taxable deduction on your active income. So a way around that is short term rentals, doing that and taking those active losses against your other businesses, because it’s considered active income. Do people do? I mean, so you can in theory, do a cost sex study on on those to accelerate the depreciation against active income? Oh, yeah. Same rules apply. What about one other caveat? Here’s what about someone that’s a professional w two position and they have a spouse that decides to become a real estate professional. How does that incorporate against the their active income in their W two position?

so let me let me actually take this two different ways. So first, let’s talk about the short term rental piece because one thing that I see confused often in this with these talking points is people think, well, if I have a short term rental, I don’t have to worry about real estate professional status, but I also get to include it in my real estate professional service hours. And the Tax Court has ruled historically that short term rentals because you don’t have to be a real estate professional. You also can’t count the hours towards real estate professional status will only make that that a very visible distinction. Yeah, so you don’t need real estate professional status, therefore, you can’t count it towards the real estate professional status hours.

And also, I do want to just just caveat the whole short term rental conversation. If you’re if this is the first time that you’re hearing about this, please do not just jump into investing in short term rentals. One, you need to really understand how short term rentals operate. But two, you have to really understand how this tax strategy actually works, you have to understand how to successfully make the jump from the passive bucket to the non passive bucket, you have to you have to materially participate in the activity. And it can be difficult to materially participate in the activity, if you don’t structure it the right way from the get go. If you have if you outsource all your property management, and if you outsource all of your vendors, it’s gonna be extremely difficult for you to prove that you are materially participating in the activity. So it’s still going to be passive, even though you don’t have to worry about real estate professional status. Just want to make that clear. But back to your question, so. So yeah, so if I’m a full time physician, and I’m earning a million dollars a year, in my spouse’s stay at home, my if my spouse is interested in real estate, so funny whenever we do this type of tax planning, the physicians and the people, not just physicians, but anybody that’s the high income earner, they’re like, Okay, my spouse is going to do this and you talk to the spouse and like, yeah, I don’t know if I really want to do it. Step one, watch HGTV with your spouse. Step two, is to is to encourage them to be a real estate professional.

But, yeah, if your spouse qualifies as a real estate professional, then when you file a joint tax return your tax return the way I like to think about this as your tax return as a real estate, professional status, tax return. And you can use the rental losses from your spouse’s real estate professional status activities, to offset your W two income. And we have many clients that do it that way. Now, one of the things that a CPA told me and I don’t know how good they are at real estate as, for example, I could technically with my hours qualify as a real estate professional, but they said, Well, all of your loans are in your wife’s name. So it’d be very difficult to have you qualify, saying you were materially participating in those properties. Now, in your case, with the physician making a million dollars and his wife staying at home, the properties probably aren’t in her name, right now, is that an issue? Or is it just, you know, you’re married, so it’s kind of joint and everything’s fine? Yep, not an issue at all. Don’t know where that. That advice was stemming from. And I’ve done very extensive research on the topic. And I’ve helped people through audits, I can tell you that that has never come up. Ownership doesn’t really matter. What really matters is the facts and circumstances around your participation in the activities. You do have to own the property, but you have constructive ownership when you get married. So whatever my spouse owns, I own whatever I own, she owns, right? So we own it, regardless of who’s on title, who’s on mortgage, it doesn’t matter. If you’re interested in learning how the IRS would audit you, I highly recommend this for anybody that is going to qualify as real estate professional or for anybody that’s going to use that short term rental strategy, Google, IRS, passive activity audit technique guide. Or you can just Google IRS passive activity, a T G for audit technique guide. It’s a, I believe it’s like 50 to 70 pages. It’s a pretty extensive guide. But it’s basically step by step what questions the IRS auditor is going to ask you how they’re going to step through the audit, what citations they’re going to use to potentially catch you. It’s all published all very easily accessible, and it’s free to access sounds like a thrilling read. Yeah. Sounds like you need to know the activity guide actually reads. It’s actually not that bad. You know, the code is thrilling read, but I don’t know brand new coming from a CPA, but you know, sounds like you need to be allowed them for personal tax advice.

And, yeah, so that’s, that’s a good point. You know, if, regardless of you know, who’s on the mortgage, or you know, potential tighter title of it, I mean, you obviously have constructive ownership. And as my wife reminds me, what’s hers is hers. And what’s mine is hers. And so, you know, that’s how it goes. But you get nothing.

Less kind of circle is better.

That’s true. And that’s where the worth it all. But let’s go back to kind of the, you know, what’s going on right now in this is mid 2022. With the tax code. So we have it sounds like in summary in there’s there’s no immediate pending tax changes that we need to be real aware of. There was something I heard of watching another podcast about a self directed IRA checkbook, Ira control being changed in legislation. You know anything about that, or? Yeah, there was a tax

court case that came out that basically said if you are going to self direct your IRA and have checkbook control, you cannot take possession of any of the assets. I believe that the issue was that the person

and was investing in gold. And the gold was literally being stored at the person’s house.

So that was a problem. And and I believe that that was the main problem, I actually am not the expert on SDRs. At our firm, one of my partners is very, very well versed in it. And that was his download on the. So it really doesn’t change anything, though. I mean, you can still invest through your IRA, I think you set up an LLC to do that anyways. So it’s arm’s length. But okay, so no changes there is as far as tax planning that’s already or tax legislation that’s already in place that just basically has time periods associated with the 2022 is the last year you can take full bonus depreciation on a cost segue. And that steps down, I believe, 20% per year, the following year is Is that accurate? Or can you clarify? All right, and is that down to 20? And then down to zero over the next five years? Or? Yes, so it’ll be it’s 100% this year, then it’s 80% and 2023, then 60, then 40 than 20, then zero? What about my expectation is that the sunsetting will be kicked down the road? And I hope so what about people that have properties that they own that they want to go back? And maybe this is the year I mean, because in theory, you could do accelerated depreciation. If you qualify say this is your first year qualifying as a real estate professional. You can do cost eggs on properties you didn’t just buy this year, right? I mean, how does that work with previous previously owned properties? Yeah, so it’s all about the year of acquisition. So if you buy a property this year, but you decide to do the cost study next year, it’s still going to be 100% bonus depreciation, because that you’re the year of acquisition that you’re applying these changes to would be 2022.

So I don’t know if that answers your question, what about people that bought property in 2020 2021? And they didn’t do a cost sex study at that point? Can they still do it now on those Yeah, so you may be able to say maybe you really need somebody to look at your situation before you before you pull the trigger on this, you may be able to file a Form 3115. And in the year that you filed the form 3115, you you effectively claim all the depreciation that you should have claimed, had you done it the right way the first time, including bonus depreciation. So get with it’s a very, very complex form. And it’s you need kind of an analysis prior to that, because if you filed form 315 In the past, that has to be looked at, and that can impact this filing. So in theory, you could have access to some of that those additional tax benefits still this year. I know that you’re and I don’t know how, what your knowledge base is on opportunity zones, I believe that we still have time with that I believe 2047 is the year that you have to sell. And you got to hold those for 10 years. I don’t know if we need to go deep into that. But anything else on that aspect? Besides those timelines? Yeah, there used to be a five 10% And then a 5% step up and basis, but I don’t believe that you can qualify for either now because the timelines passed. So now it’s just if I invest in an opportunity fund, I get to defer my capital gain. But I have to hold for 10 years too.

In order to be able to defer or eliminate the additional appreciation on my investment, we don’t see many people invest in opportunity funds. The people that we do see invest in opportunity funds are typically reallocating their portfolio, away from equities and into real estate. That’s where we’ve seen people utilize it. Yeah, it’s been challenging with opportunity zones of like, people are interested in it, but like, you know, there’s these rules as far as like, if you buy $100,000 property, you have to put an equal $100,000 of improvement to it’s like that’s unrealistic on any sort of rehab. So it’s like, That doesn’t even make sense. The only way I’ve made opportunity zones ever really work is with brand new construction where, you know, that’s that’s a potential option. But Adam, what were you gonna say? I was just gonna say, Brandon, thanks for for coming on the show. Really appreciate you spending your time I know you have to run off to help people actually not pay taxes. Legally, legally, I should say. So you can check him out at the real estate cpa.com. Brandon, is there anything you want to leave our listeners with that? I know just, you know, well, yes. I don’t know why I just said no. But yes.

Educate yourself on the fundamentals, get get some help read some books, take a course. It’s really important that you know what to look at and your tax and you don’t have to look at all 300 pages, but you should look at the top 10 That really materially impact your filings and and just reduce your risk of anything going wrong. So get educated, it will help you build a portfolio in the future where you can get down to that 0% effective tax rate. Fantastic. Well, once again, people you can find him at the real estate cpa.com And you can find us at rent to retirement.com. You can see all of our properties scheduled

Call to talk with us. It really appreciate you leaving a review on your podcast platform. And again, rent to retirement.com. Any questions send them to podcast at rent to retirement.com and we’ll see you on the next episode.

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