Tax Savings Tips for Real Estate Investors

About the Video

In this episode of Wealthy & Wise, join NCH’s Executive Corporate Analysts Adam Kintigh and David Vanlandingham as they unravel the complexities of real estate investing and its tax implications.

Prefer to read? A full transcript is provided below.

Adam: 

Welcome to another edition of Wealthy and Wise. I’m your host, Adam Kitnigh. I have with us today an amazing expert when it comes to taxes and real estate investing. My good friend and colleague, David Vanlandingham. And, David, so nice to have you here today.

David:

Oh, it’s great being here. Love it.

Adam:

Flew all the way up from Florida to grace us with your presence.

David:

It’s a pleasure. It really is.

Adam:

Excellent. So when we start talking about buying and investing in real estate, it is probably the greatest unknown, how exactly is this going to impact our taxes? And one of the biggest problems we see all the time is people not accounting for things properly. Not taking time to do some tax planning with their accountants and people that even will do their own taxes using TurboTax or all these software is out there that really just kill their tax savings.

And I want to start by talking about when someone is buying real estate. What in your view is the greatest tax benefit they’re going to get?

David:

So when buying real estate, it’s kind of generic. We have to look at two different segments of that. Actively buying or passively buying because the taxation on those are totally different. So the first thing we have to do is educate our clients as to the activity that they’re doing. Is it considered active income? Are they working on a daily basis? Are these like wholesales? Are they rehabs or are they long-term investments? Or now we have Airbnb that’s kind of a hybrid right? In between. 

So all of these have different tax considerations. One of the things that we see often unfortunately, is people on Instagram or Tic Tac, TikTok, and some of these other, social media platforms where they’re telling you, oh, yeah, you want to, you know, set up a real estate business, take a cruise, pay for your cruise.

It’s just not true. They’re gaining clicks, and that’s really what they’re doing. So in our consultations, we dig down to exactly what are they doing? You know, are they buying for a long-term hold? Are they going to be short-term? 

And the big difference is on expenses on, you know, a long-term hold. If you’re based here in Nevada and you fly to Florida to go buy a rental property, is that trip tax deductible? The answer is no. And people get confused about that. The cost of the trip would be added to the cost basis of the property. If they purchase it, if they don’t purchase it. Yeah, it’s kind of like a vacation.

Adam:

There you go. So we talked about active income impact passive income. And I think the biggest point that our audience members have to know is that when we’re flipping houses, that income is subject to state, federal, and Social Security and Medicare, a 15.3% versus if it’s a long term rental, you’re buying it with the intent of holding it for more than a year an a day, and you’re renting it out.

Now, it is passive income, and there is no Social Security and Medicare. And again, on all these great YouTube videos and TikTok videos, people say, well, set up an LLC and have a tax as a corporation, to write all these things off, can you share the biggest danger of having a long-term buy and hold property inside of an S corporation?

David:

Yeah, there are really two things that come to mind. I mean, depending upon how you’re investing with your your real estate. A lot of people like to leverage their properties. So if you buy a rental property with an S-Corp or an LLC taxed as an S-Corp, the big problem there is now if you pull it out to leverage it, it becomes a taxable event.

We know there’s going to be a transfer tax for sure. But it would also constitute a potential sales tax as well. And then of course they have to put it back in which would be another transfer of tax. So that’s a very dangerous thing. And the other thing that people really just don’t know is that when you put it in that LLC taxed an S-Corp or an S-Corp in general, the big problem is you lose your step up in cost basis.

And we’re talking about most of our real estate investors are wanting to build generational wealth. And that’s a generational wealth killer. Because what happens is the step up and cost basis. Let’s say you buy a property for 200,000. That’s called the basis. If you make improvements to the properties over the years, that is a basis that now gets adjusted to that total price.

We buy a property for 200,000, over the years we put 50,000. That adjusted basis is now 250,000. The day that you die, it’s worth 500,000. Let’s just say it’s appraised at 500,000 the day you die. Here’s the problem. If that property is in an LLC taxed and  S-Corp or an S-Corp, they don’t get to step up in cost basis they being your beneficiaries.

So now they would have to pay the game of that 250 a basis all the way up to what it was at the time of death, where if that was done in a disregarded LLC, the step up in cost basis happens. And that’s how you build generational wealth. Your beneficiaries sell that property for $500,000. They don’t pay a penny in taxes.

Adam:

That’s a super good point. Now, you briefly touched on the new one now is the Airbnb properties. And can you kind of give us a rundown of what we need to be prepared for if we’re buying an Airbnb? I know there’s a difference between you managing the property versus someone else managing the property. How does that really work?

David:

And how the property’s held right. So we just talked about putting that property into it an S Corp. You know, depending upon what you’re doing, if you’re managing. If you’re managing, that’s active income. If your stays are less than seven days on average, that would be seen as active income too. So really on an Airbnb structure, you would just about have to have two separate LLCs.

And I’ll make an argument for just one. So you’re doing, midterm 30 days out, a lot of, travel nurses and, you know, executives that travel and stay in a place for 30 days or more, then that’s passive income. So what we want to do is hold the property in the passive LLC, because now we don’t have to worry about the loss of step-up in basis.

Now the operational side would actually go into an LLC taxed as an S corporation because that may be deemed as active income. Now if you’ve got somebody else doing everything and you’re doing nothing in your stays or seven days and up on average, then that would be considered passive. But a lot of people out there are doing active income thinking that it’s passive.

Adam:

Now, the other part that I think is important for the audience to know is that when we are starting to buy these properties, you’ll hear so many gurus out there that say, well, every property needs to be in its own LLC. So if there is a problem with one property, it cannot affect the others. And it sure sounds nice, but it turns into an absolute nightmare to manage. Can you imagine you build out your portfolio, you’ve got ten rentals, ten LLCs, and ten checking accounts. What a nightmare. What’s a better way to do it?

David:

So it’s in simplifying taxes and everything. It depends on how many properties you have. So we don’t want to have an LLC for every property obviously. That’s crazy. So some people say, well, I’ll just put two properties in the same LLC. That’s disastrous. One gets sued, and the other is now dragged into it. So we basically set everything up under a disregarded LLC.

And then each individual property is held in a land trust because what people are always saying, look, if that’s the answer, putting one property per LLC, what about the due on sale? What’s what’s there to stop that. Right.

Adam:

Let’s stop for one second. Due on sale, what do you mean by that?

David:

Well, due on sales when the mortgage company has decided that you’ve effectively bypassed your loan agreement. So what they’re going to see is an unauthorized change of title. It’s gone from Adam Kintigh. Right, they took your credit, they looked at you and as far as your education, they’ve done everything. DNA and everything on Adam Kintigh. And now all of a sudden they see X, Y, LLZ on title.

And this can happen because mortgage companies do sell their paper and it will come up during that. It could come up in an internal audit as well. So what they’re saying is you’re violating the loan agreement. Whatever you owe us, you owe us in full, today. Not a great letter to get in the mail.

Adam:

No, it’s not. So instead, you recommend putting the property into a land trust? 

David: 

Correct. Put it into a land trust based on the Garn Saint Germain Act of 1982. We can take an encumbered property, a property at the mortgage, and place it into a qualified inter vivos trust, which a land trust is, as long as it’s four units and down. So residential, not commercial. And we preempt the due on sale.

Adam:

So fourplex, triplex, duplex, single-family homes, townhome condo. Put the property into a land trust. They cannot invoke the due on-sale clause. You’re not violating the mortgage. The land trust we have owned by an LLC. So I get the protection that we do there. And for tax purposes, it’s all disregarded. So would there be any additional tax filings with this structure?

David:

No additional. With the disregarded everything’s going to follow the schedule E as it normally would. And then we’ve got the estate planning, right? The death time beneficial interest of those trusts goes to the revocable living trust. So they bypass probate, and get the step up in basis that we talked about. And it’s just a very smart move from a tax perspective.

Adam:

Good. Now, problems that we see all the time with people going to get mortgages. And they’ve been doing their own taxes. This just happened in one of our clients last week where he had written off all of these things. And when he bought the property and some furnishings that he did for the property, etc., by the time he got done, he had lost a lot of money.

And then he goes to buy his next property. And of course, you have to show him your tax returns. And it was showing that this guy had lost so much money that he didn’t qualify for the mortgage. Oh, thank goodness we can do an amendment and go back and change these things. But he thought he was being really slick, getting his tax liability to almost nothing.

And come to find out, the mortgage company, when they looked at everything on paper they found that A it was done wrong. So thank goodness it was when the past three years we were able to do an amendment and fix it. But if he’d let that ride, he’s killed himself for future loans. Done a terrible job with the accounting side of it.

So I try to remind people that when you’re buying a property, we need to keep organized the purchase of the property, all your closing documents, you had one. We need to keep a list of repairs, maintenance and capital improvements. If you do have a property manager, generally they do that for you. If you’re managing it yourself. There are all kinds of software you could use to do it, but keeping these things per property is so important and making sure that you’re working with a good CPA that understands the difference between long-term rentals, short-term activity, etc..

Share with us. I know you have, you work with people day in and day out on getting these things set up and structured properly, but share some of the biggest mistakes that you have seen that we can hopefully as our audience, you can not make these mistakes, by doing it the right way. 

David:

Yeah I mean, exactly what you said. A lot of people, you know, when we first consult with people, we want to know what their business model is going to be. Are you in this for cash flow? Are you in this for appreciation? We want to understand that, and those people that exactly what you said they try to do to meet their cash flow.

I mean, they’re getting depreciation right over 27.5 years. So they’re they’re getting that to offset some of the income. But yeah, when they wipe everything out, just imagine you being, you know, the next banker looking at that paper and going, why would I loan you money? You’re losing money on this property. You actually want to make money on the properties.

The appreciation and buyers are great, as well, simply because what they’re doing is, is they’re buying a property for a couple hundred thousand. They’re getting somebody in there to pay down their mortgage, which is fantastic. And then on top of that, now they can pull money out, and refinance at a higher rate.

Adam:

And because the structure is set up properly, refinancing a home is not going to be a taxable event. A lot of times the banks are going to give you a better mortgage rate. If you’re doing a 30-year fixed rate mortgage, using your name and your credit. So with that in mind, you are normally going to buy the property. We then did it into the land trust. And now if you in the future property appreciates you want to refinance. So some banks will just leave it there in the trust. They’ll fund the loan. No problem. Some banks say, hey, I need you to move this back to your name. We’ll fund the loan. You can put it back in the trust.

We are slaves to the lender, so whatever they want to see, we’ll do. But doing it this way really will avoid the potential tax issues that might pop up. 

For those of you that are in Florida. This is also a great structure because of the darn transfer tax, right?

David:

Yeah. The transfer tax in Florida is like $0.75 per $100 of value. And so you avoid that by having that land trust. And Florida is one of the few states that actually recognizes and has statutes on the books on land trusts. So what we do basically is take that land trust. We pull the property on the land trust, with no transfer tax. We connect it to the LLC and it’s like you said if we ever need to pull it back out, we pull it back out, refinance it, and put it back in. We don’t have to deal with any of that transfer tax. Unlike states like Pennsylvania.

Adam:

So land trust can be used in all 50 states?

David:

No, they actually can’t. Oregon does not recognize them and we don’t do them in Oregon. We really don’t like to do them in Pennsylvania because again, there’s no benefit. You still have to pay the transfer tax.

Adam:

It’s 2 to 4%.

David:

That’s 2 to 2 to 4%. Right. So these are all tax-saving methods. And I’m not saying don’t invest in Pennsylvania but just understand look up county by county because it’s going to be 1% for the state of Pennsylvania. And then the counties can range from two up to 4.5%. So it can be expensive to take those properties in and out and leverage them.

Adam:

Well, when it comes to the tax savings side of things, keeping things organized is so very important. And we have an entire team of professionals here at NCH. David, and I’m part of his team, we work together and our goal is really to understand what you’re doing, and how you’re doing it, and we really try not to be short-sighted because these are long term plays where it’s you and your family.

We need things done right. We don’t want to have problems. So keep yourself organized. Whether you’re using NCH or you’re doing these things on your own. Keep yourself organized. Organize things on a per-property basis. And David, you and I, we would love to have a consultation. We’ve got a team of experts here to support you. Absolutely no cost involved.

You give us a call, you can use the link below to schedule your free consultation. We can talk about LLCs and trusts and taxes. In-house we have a full legal department. We have an excellent CPA firm. We have a business credit team and a business plan team. We do the estate planning like the trust in wills. We do self-directed IRAs and self-directed 401 K’s. So all the support services, we have experts to help you with those things. 

So be sure to hit the like and subscribe button. Share this with your friends. And please do schedule that consultation and let’s talk about what you’re doing, how you’re doing it, and making sure that you’re avoiding costly mistakes doing things the right way. Thank you so much for joining us today, and we’ll look forward to seeing you again.

DISCLAIMER: The above material has been prepared for informational purposes only, containing opinions of the provider, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.