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Wealthy & Wise: Tax Benefits for Real Estate Investors

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April 28, 2023
Author: NCH

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About the Video: Wealthy & Wise: Tax Benefits for Real Estate Investors

Real estate investors can often take advantage of various tax benefits that can help reduce their overall tax burden. One such benefit is depreciation, which allows investors to deduct the cost of the property over a set period of time. Additionally, real estate investors can often deduct expenses such as mortgage interest, property taxes, and repairs from their taxable income. In some cases, real estate investors may also be eligible for a 1031 exchange, which allows them to defer paying taxes on the sale of a property if they reinvest the proceeds into a similar property. By understanding and utilizing these tax benefits, real estate investors can potentially increase their profits and achieve their investment goals more efficiently.

Prefer to read? A full transcript is provided below.

Cort:

Hello and welcome to another edition of Wealthy and Wise. I’m your host, Cort Christie. And today we’re going to be talking about the tax benefits that go along with real estate investing. Very important. One of the biggest reasons why you want to become a real estate investor is there are massive tax advantages and to break this down for us and simplify it, we have an expert on the real estate investing side with taxes. We have Adam Kintigh. Adam, welcome to the program today.

Adam:

Thank you for having me.

Cort:

Absolutely. Adam has tons of experience in the real estate investing world, has been working with investors that are clients of NCH for 15 years now, very long time and has a stage presence if you ever get to see him on stage he’s absolutely amazing and he’s got so much knowledge to share and we’re going to just get a small piece of it today on this program. So, Adam, Let’s jump right in. Tell us about, you know, high level stuff and we can get down to some of the weeds. But, you know, why should someone consider real estate investing from a tax perspective?

Adam:

Yeah. So real estate investing is one of the only investments you can make that you do nothing. You buy the property as a long-term rental. Your intent is to hold it for more than a year and a day. You buy the property, hold it, you do nothing, and automatically you get these depreciation losses. Where for residential real estate, the government says anything that’s four units or less, fourplex, triplex, duplex, single family home, townhome, condo, it’s depreciated over 27 and a half years. So, the depreciation creates losses, passive losses that offset your passive income. The rent you’re collecting and you get to write off the mortgage interest and your repairs and maintenance. All these things go into this equation where even though you’re putting money in your pocket, you’re not paying very much money in taxes on that money.

Cort:

That’s incredible. So just for buying it, all of a sudden you get a tax benefit.

Adam:

Exactly.

Cort:

It’s kind of like having a kid. You know, the minute you have a child, you get to, you know, take advantage of them as a dependent to you and you get to lower your taxes. Similarly, that’s what you get for depreciation on real estate.

Adam:

Exactly. So commercial real estate is depreciated over a longer period of time, but residential is a great focus for anyone getting started in real estate. Building out the rental portfolio with multiple passive residential real estate properties is such a tremendous benefit. And over the course of time your tenants are paying down the mortgage. Your property values through inflation generally go up. When I say generally there could be some dips in the market but generally go up. So over time you really start to build a lot of wealth by owning these properties and having your renters pay off the mortgage. So, a renter won’t buy themselves a house, but they’ll buy you a house.

Cort:

Interesting. Well, so we do have a former president that I’d never wanted to share their tax returns because we all know they were heavily involved in real estate and probably paid no taxes at all, even though they had massive real estate holdings.

Adam:

Yeah. So, these big guys like our former president, they have these commercial buildings that they start breaking up. They do cost segregation studies or they have engineers come in and they say, well, the elevator is only going to last for ten years. So, we think the cost of that elevator is $1,000,000 and we get to depreciate that over ten years instead of 39 years. So, commercial real estate gets to appreciate over a longer period of time. So, you start taking these massive cost segregation studies accelerating depreciation, creating all these passive losses. Now, keep in mind that if you’re doing the cost segregation, the accelerated depreciation, you hear a lot of people talk about this with residential for real estate. However, with residential real estate, most CPAs are not going to coach you to do a depreciation, accelerated depreciation on residential property. Normally it’s for big properties, commercial properties.

Cort:

And you hear about it for office buildings and warehouses and, you know, much bigger projects than just a condo or a single-family home. Well, let’s talk about some of the other benefits besides depreciation. What other tax advantages are there?

Adam:

Yeah, so if you are, I talked to a lady today that she is building a house in Florida. It’s a new build and working with one of our partners, affiliates. And she went down to check on the property and sale is coming along and that airfare, hotel, meals, the Uber to and from her hotel to and from the location she gets to write all those things off as a real estate investor. So, travel expenses, keep the receipts like that airfare, hotel meals, keep all your receipts, give that to your CPA, because those are things we’re going to get to write off over the course of time.

Cort:

That’s fantastic. So, you can invest in real estate and wherever you invest in that real estate, you’re saying, if I’m going to go do some research in Florida or the Caribbean or a foreign country because I want to buy real estate there and have it for Airbnb, VRBO investment purposes could be just to rent it out to somebody, you’re saying I can write off that travel to and from the time that I’m staying here, the meals, everything else is included in that?

Adam:

Absolutely. I had a lady just a few months ago that did an Airbnb in Mexico, and so she bought this Airbnb property. She flew down there. She was there for two months for furnishing the place, getting it ready for rental. Now, is two months an appropriate time for what she did? Maybe not. So, keep all those receipts. The CPAs might come back and say, listen, out of the eight weeks you were there, we can justify six of those weeks as time we can write off as a business trip for those properties.

Cort:

And I know in a lot of countries and I’ve done this in foreign countries with a rental that I have, getting anything done quickly isn’t a thing. And you know, Let’s just say you wanted to replace some flooring or you wanted to upgrade some cabinetry or countertops and even buying furniture, it’s not easy. You know, nothing moves as quick as it does in the United States of America. So, you know, whether it was justified or not, I will tell you, it’s much more difficult. Now, I’m sure she enjoyed her time down there as well. Got to see some of the sights, probably. And if you think about it, if you’re going to have one property in the right kind of vacation area, if that’s the case, you might be looking at adding more to that portfolio as well. So, it makes a lot of sense.

Adam:

Now, one of the other benefits we get is doing these Airbnb properties. If you’re managing your own property and you’re taking care of managing yourself, we qualify for a short-term rental loophole where there’s going to be a point where we run into passive loss limitations and you make more than $100,000 a year as your modified adjusted gross income for every $2 above 100 grand, you lose a dollar in passive losses. So, by the time you made $150,000, the most you can write off in passive losses is $25,000. Unless you or your spouse qualify as a real estate professional. And as a real estate professional, now we’re able to sidestep those passive loss limitations. Well, for a lot of people that have Airbnb’s that they manage themselves, the IRS has actually reduced those rules to where we don’t have to spend 750 hours in rental property. We can spend 100 hours on rental property with material participation because we’re doing everything we get to sidestep that. They call it a short-term rental loophole where we can offset a lot of our active income with our passive losses. And it’s just a great a great avenue to take for people that are involved with Airbnb’s and the VRBO’s.

Cort:

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Interesting. So, it’s down to 100 hours.

Adam:

I believe that the number is 100 hours of material participation. And the hours spent in real estate, you have to spend more hours than other people. So oftentimes people can even get a CPA to look at it and say, well, your cleaning crew, do they spend more hours than you? And if so, I might have to think of ways of changing out that cleaning crew to qualify for that short term rental loophole.

Cort:

Interesting. You know, I know that for those short-term rental people, I mean, they’re on multiple platforms. I’m doing it myself. You’re responding to questions all the time. You know, people are wanting to know, you know, does it have this, or does it have that or is it near this or how far is the grocery store? Do I need to rent a car? All those things constantly, you’re getting, you know, peppered with questions. And so, there’s time involved. And then if you go visit and check on and all that, there’s even more time involved in your investments. So, I could see that. So, that’s a great little loophole. I did not know that. That’s fantastic.

Adam:

And one of the most important pieces is to track everything. So, use an Outlook calendar or a Google calendar or something so you’re tracking those hours. Because in the event of an audit, that’s what the IRS is going to look at is, were you keeping a record? Do you have an hours log of some kind showing what you were doing in those hours that you were supposedly spending in real estate. So, it’s a really good common practice. Get a calendar or something and you can track those hours just to have the proof.

Cort:

Interesting. So how about, you know, if somebody is operating in a job out there, a career, they have a lot of taxes they have to pay. They have to pay federal income taxes, state income taxes, unemployment, Social Security, you know, all the payroll withholding taxes that are included. Are there tax advantages to rental income when it comes to paying all those taxes?

Adam:

That is a great point. So, rental income is not subject to Social Security and Medicare, state and federal tax only. And one of the best benefits about having rental properties is that we don’t have to pay the Social Security and Medicare. So, a lot of times when we’re setting up real estate investors, we have an LLC that is disregarded for tax purposes, it doesn’t file a separate tax return. It’s passive income. Passive income automatically gets offset by passive losses. We don’t have to do a separate tax return and we get these tax benefits. We want to keep that separate from if we are doing short term activity, an active business and needs to be a totally separate company. It’s taxed differently. So, I always let people know we should have one LLC for passive income, one LLC for active income. And it’s so important that we keep the passive income and active income separate, not only from a tax standpoint, but also from a liability standpoint as well.

Cort:

Interesting. And, you know, I think that the significant amount of savings that you gain by becoming, you know, an investor with multiple properties that you have for the benefit of the rental income and the depreciation that you get on that property is, you know, let’s just compare that to a job making $100,000 a year versus a portfolio properties that generate $100,000 a year in income for you. You eliminate, what, $16,000 roughly of taxes that you’d have to pay as normal payroll taxes. That’s a huge dollar amount. Anybody making $100,000 a year that can save themselves $16,000 that goes into your pocket. That’s a massive amount of money.

Adam:

That’s huge. And not to mention the benefit of being able to build generational wealth. So having your estate plan set up properly, you’ve got these rental properties, a portfolio you’ve built, and you have your cost basis, what you bought the property for. If you sell it, we could do a 1031 exchange and defer taxes, or we can pay capital gains. I bought it for 100, I sold it for 200. I’m going to pay taxes long term capital gain of 15 or 20% on the sale of the property, which is a huge benefit. However, if you keep that property and you pass, you’re able to give that to your children with a step up in basis. They inherit the property with a $200,000 basis, in this example They could sell the property tomorrow and pay no tax. What an incredible benefit.

Cort:

That’s huge. And then they, if they decide to hold it and let’s say it was fully depreciated, you get to start the depreciation clock all over again.

Adam:

Well, one of the best things about having that rental property for generational wealth is that cash flow that’s coming in for your family, for generation after generation, and giving them the ability to sell the property, to keep the property, just a lot of great options that they have when they have that portfolio.

Cort:

And I know when it comes to like legacy planning, generational planning is, you know, you can also take that lower priced asset today, put it in a trust for the benefit of your heirs. And I’m talking about an irrevocable trust which actually gets it out of your taxable estate. Even though you can be the property manager, you can derive income from it. It’s out of your estate into your legacy, your kids or whoever is going to get your stuff someday. And you can cut the IRS out from the estate taxes. If you’ve done this in the right preparation early enough, you know, let’s say you hang onto your properties and over the next 30 years, they, you know, quadruple in value, which is not unusual. And we’ve seen that, especially with inflation today, all of a sudden you’re passing something for very little money today versus what it’s going to be 30 years from now. And your kids get it all.

Adam:

The great loophole that allows for that general, generational wealth to be built.

Cort:

Fantastic. All right. So we’ve learned many different things that are ways to benefit you and your taxable income by having real estate, whether it’s depreciation, whether it’s eliminating payroll taxes, whether it’s being able to travel and identify property and writing all of that off. Or, you know, even as we talked about legacy planning, eliminating estate taxes, if you get ahead of it and really helping your kids ultimately set up their nest egg for the future as you build your wealth. Any parting thoughts for everybody here today, Adam?

Adam:

Yeah, my parting thoughts are it’s the first step of getting these things in place. Protect what you have. Reach out to us here at NCH, set up a good solid estate plan, a good asset protection strategy. Real estate, you can make a lot of money, but you can also lose a lot of money. As innocent as you may be, if you own that property, anything bad happens, you’re responsible. So, make sure you have a wise plan in place to protect those assets.

Cort:

Yeah. Thank you very much. I appreciate that. And keep that in mind, with any asset, there’s liability. And that’s one of the reasons we always recommend to all of our clients. Do not hold real estate in your name. Say it again, do not hold real estate in your name. Hold it in a separate entity, just in case there’s any liability that comes from it. If somebody gets hurt on your property, property burns down, somebody gets, you know, killed on your property, whatever it is, it can end up being your liability and you do not want it to. So, insulate yourself from risk, whether it’s in business or whether it’s with investments as well, very important. So, thank you for bringing that up. And if you want to speak to an expert like Adam, who is fantastic, Adam will lay it all out for you, really simplify it for you. Simply follow the link at the bottom of this YouTube video here today and register for a consultation with one of the experts at NCH, free to you. It’s an opportunity to kind of lay out your scenario and have somebody that’s an expert like Adam break it down for you and simplify it and show you how you can save money in taxes and how you can protect yourself from the liability of being a real estate investor as well. So, thank you, Adam.

Adam:

Thank you.

Cort:

All right. Thank you each and every one of you for tuning in to another episode of Wealthy and Wise. I’m your host, Cort Christie.

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.

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