Rental Profits Without the Pain – Tax Strategies

by | Jul 5, 2018

Okay. So everybody has their tax strategies. Some of these again, they may not be very pertinent right now. Although, for some of you who already own properties, they will certainly be pertinent. The very first one is one of the ones that is not the most glamorous one of all, but it has to do with passive loss limitations. What I mean by that is, there will be years, not all years, but some years where you are actually going to show a paper loss.

You are going to wonder why you would show a  loss when I have an income producing property. One of the realities, one of the biggest benefits of running real estate is, you get to take the deduction called depreciation. Uncle Sam lets you depreciate, or take a deduction based on the depreciation of your property, which is about three and a half percent of your purchase price over 27 or 29 years.

Any case, what happens here is up to a certain degree; you can claim losses up to $25,000 as long as your adjusted gross income is not over $150,000. Let me repeat that. If your adjusted gross income is below $150,000 you can claim up to $25,000 in losses on your tax return, which means you reduce your income by $25,000. That may be totally because of the depreciation. There were a lot of years where I was able to structure my tax return where I basically showed a net of zero.

You want to try to do that. I will show you some other strategies on how to do that. Legally, ethically, every way. Some of you know me better than others. I don’t take chances. I don’t take risks unless it is a very educated, informed risk when it comes to investing. When it comes to taxes, I am actually very conservative. I have taken advantage of this tax deal here in the early years. When you are first building your portfolio, you may shell out more money than you will later years.

You may buy properties. You are putting more money into to improve the quality of the property so you improve the quality of your tenants. You improve the quality of your rents. With that strategy then, what happens then if you earn over $150,000 you may not be allowed to take any of that. Another really positive benefit here is let’s say you had more than $25,000 in passive losses. You can actually defer the amount over $25,000 to some subsequent years.

Let’s say you do a lot of renovations this year, and I am going to explain this in a minute here, but instead of you capitalizing them, you expense them. You exceed $25,000, let’s say it’s $37,000. You can roll over $12,000 of losses into your next year’s return. You can do that for a number of years. That is a huge benefit. If you can imagine now, the tax savings of that. Say you are in a 15% bracket that means, what would that be? Three thousand? About $3750, you will realize in your pocket, actual money in your pocket by taking this tax advantage here. Everybody okay so far?

Okay. Let’s see here. Terry, up on the top of your screen Terry if you click on, it looks like a blue, it has six pods on it. It is just a blue symbol. It has six little circles grouped together. Click on that. That should show you the screen. If you can let me know when you have done that I would appreciate it. By the way, just in case you are going to get the replay.

You should be able to do that. Now, the next one says Auto-proofing techniques to worry free and cost IRS intervention. Here is the number one technique. This doesn’t have to do with real estate, although you will find yourself just like me over the years, building additional businesses based on your real estate investments. One of the things you can do is, with your businesses you can determine, what is your calendar year? What is your actual fiscal year?

More importantly, on your personal return you can file an extension to file your tax return late. If owe taxes you have to pay them when they are due. If you owe taxes, and you calculated that, you have to pay them by April 15th. You can determine to delay the filing of your return all the way until October 15th. I’ve done it a number of years. The reason that’s important is, the bigger you get, the more properties you have.

If you build other business like Carl for example. You are doing a lot of remodeling and capital improvements for other people. Build your real estate up. Take your business and incorporate it. Make it a single number, LLC. A lot of your income, you can have pass through to you onto your personal return. Especially all of your rental income is going to pass to you through your LLC to your persons. Not only is the passive income, passive income means, according to the IRS, you don’t actually work for it.

We all know we work for it. It comes through to you in a form where you don’t have to pay other taxes on it, like Social Security. You just pay a basic income tax on it. Same thing with your LLC. You take as many deductions as you possibly can with your business. You pass the remainder onto you, onto your personal tax return. The more you do that, the more complex your return will be.

I remember back in 2007, it was the first year my tax return exceeded 100 pages. Now my tax return is over 200 pages. It takes a lot of time for my tax return to get created and filed. I extend it for very good reason. It just takes all that time to compile it and compare. Here is the benefit, the longer you wait to file your return, the less chance you have at getting audited. It is mathematical certainty. The IRS has a first in, first out philosophy on auditing. Those who file early have the highest chance of getting audited. Those who file later have a lesser chance of getting audited. That’s why that strategy is in there. You eventually will need it.

Understanding the tax savings accelerates your wealth. This is just simple math, but I want to cover it anyway. This is part of the benefit of taking advantage of tax strategies. What you are doing, you are taking advantage of structures, where you can control a little bit about how your pay and when you pay.

As a result, you benefit more from the dollars you keep in your pocket at the moment to invest further. Any savings you get on using tax strategies can be used to invest further. The example here, is one of them is essentially if you took a dollar and doubled it tax free for 20 days, it is going to be worth over a million dollars. I would love to do that every day, but it is not realistic. However, the theory still applies.

Whatever tax dollars you save, you can roll into making a savings account where you accumulate money for another down payment on a property. That’s the third paragraph there. Let’s say you took $2,000 annually on your tax bill, good tax plan. You should be higher. Let’s say you get a tax free on your return of 10% for 20 years. That’s $114,000.

That’s a lot of money to be used to buy additional properties. So, the bottom line is, what the suggestion is, this is my suggestion too, don’t just spend the money that you save. Use it, accumulate it and buy more properties to give yourself more tax benefits, more income.

Let’s go ahead and look at the depreciation deductions. One of your most valued words, deductions. There were years I owned so many properties; my depreciation was well over $100,000, close to 120. That’s good money. That’s a lot of money. That’s money I can live off of pretty easily. If you do them right, I am going to move this screen forward a little bit. We are going to go to table of contents here at the end. We are going to look at some of this now.

Let’s see. Substantially increased depreciate inductions versus componentizing. What that means is, in your property you don’t just have brick and mortar. You also have a lot of other things in there. You have refrigerators. You have cabinetry. You have stoves. You have air conditioners. You have things that are not permanently attached to the building. They are not part of the permanent structure of the building. A permanent structure on the building is going to be 27.5 years on the appreciation.

There are commercial properties with 39 years. I will go into a couple of those. Typically it is going to be 27.5 years. There are other things you can have that would be depreciated in three years, five years, and seven years. Matter of fact I own a big truck for my apartment complex in Whitehall. That depreciates over a seven year period. There are certain appliances that are three years. Cabinetry is five or ten years. The bottom line, where it becomes important, instead of just taking the 27.5 year depreciation, which is going to be about three and a half percent per year on the cost basis of your property, you want to split out of that total purchase price, how much of it was the building, and how much of it was these other items like appliances.

That is typically called chattel. The reason this is important is later on when we get to section seven or eight, we are going to talk about negotiating and making offers when you are negotiating. You want to be able to put in your offers if you are buying $100,000 building, you are paying 90 for the building and $10,000 for appliances and chattel and other items that you can depreciate more quickly, more rapidly.

If you can imagine what is going to happen on your tax return, you may be taking a $3,000 deduction on your depreciation on the building, but you may be taking a larger deduction because of appliances, carpeting and cabinetry. If you have a vehicle that you use for business, that too. You want to accelerate the appreciation on those items because you are allowed to. That is called componentizing. There is actually businesses that are built around helping other businesses determine how to do this, and make the most of their tax strategies.

There is some other stuff in here about land we are not going to get into too much. I just want to explain the basic concept of componentizing. If I could get a quick chat from you guys, a quick message, let’s see here. Getting loans, one second here. These paper losses effect getting loans on new properties? No. The reason is, you are going to go to banks who know how to work with people and invest real estate and they are going to do due diligence on your tax returns and you personally and your properties.

They are going to figure out what your true cost basis is, what your true cash flow was, and they will understand, they do understand that tax strategies is part of your overall game plan. That’s a very good question by the way. Let’s see here. Let’s go ahead, if there are no more questions, let me just check one more time. Okay. Generating prepared deductions: Employ strategies to reclassify or have improvements in the fully deductible repairs. This is a biggie.

It used to be called tax rule 172. I used this lot in a lot of years. When we bought the big building down in White Hall, 78 unit complex, 30 garages, just a caveat here guys, I don’t expect you guys to buy a 78 unit building today. What I expect you to buy is two, three of four properties in the case of some of you guys, Jason and DJ have a 20 unit property, a 10 unit property because that’s where you are.

The bottom line is here, when I bought that building, I bought it with the knowledge that I was going to put about $200,000 in it right out of the gate, replacing all the boards. These are big, huge commercial grade boards. I also repainted the parking lot. It was on a two acre lot. You can imagine this lot was big and long. There was a lot of black top. We also put steel reinforcing beams on the front wall of all these garages. I think we put in 36 of them.

All together I spent a lot of money. Now, conventional wisdom and most tax strategists say and tax preparers say, you have to capitalize all those big improvements you just made. You just spent $200,000 and those were long term, capital improvements, and I agree. They are capital improvements. The tax code allows me, and some accountants will argue this, but my accountant is in agreement with it. You can expense some of that in the year that you spent the money.

What I did is, I didn’t expense it all. I capitalized some of that money. I capitalized half of it. I took a huge expense that year of $100,000. That basically put me in position for several more years because of tax strategy number one. Where is that? The passive loss, the void of rolling those over, I rolled over those losses for the next three years. I knew with those capital improvements, I was going to be generating more income in rents.

That was part of my strategy. When I bought the property I got a really good deal, but I structured it so I made those capital improvements in the first year. I expense some of those improvements in the year that I spent the money. I get the full tax deduction in one year. The remainder, I left in there to capitalize the 27.5 year life span of the property. The excess over the $25,000 I rolled over into the next three years.

I am setting myself up for four years. Bottom line is, you want to recategorize what your costs were. Talk to your tax accountant. See if you can move them over into the tax column. Hope you guys got the gist of that. By the way, the rest of that verbage ties back into componentizing. You really want to look at what it is you are improving. Some of those components, some of those items that I improved for example, capital improvements were privied items.

I didn’t have a choice. They were 27.5 years. I did go through and remodel several apartments. I had exposed the floors. I replaced the cabinetry. You better believe I actually took those and componentized those. I took those off of a three to five year period. Everything else I expensed.

You need to keep all your documentation. Everything. As always. Always keep your documentation. Here’s one, I know this guy on the call right now. This came up the other day. He was looking at buying a building and living in one of the units. Anyone can buy a multi-unit property and live in one of the units. The big benefit is, there is two benefits, and comes in the way of tax deductions and financing.

If you are buying a multi-unit building and you are living there, you actually still qualify for NHE financing. This means you can put down the minimum, three and a half percent, finance the rest, at the low four and a half interest rate for 30 years. That is awesome. In the meantime, the other three units, they are not just paying your mortgage, you are probably still cash loading on that property. Down the road, you have to hold that property, you have to live in it for a certain period of time.

If you live in it, and you sell it later, as long as you have lived in it for two consecutive years and the most recent years, you can actually defer all the capital gains on that property. As long as you live there in two consecutive years, you can defer the taxes on that property. We have two people who are doing that right now. Awesome strategy. You get to take advantage of tax rules, and you get to take advantage of financing rules, in your favor. That is a huge double win.

That is probably more than the $2,000 for the cost of the course. Strategies number two and number five. Strategies number seven. I want to see if there are any other questions. I want to take a quick breath here. Any questions so far? I know I am going through these a little bit fast, but we have three more to go and there is more I want to cover here.

Plus I want to open it up for some Q & A. Don’t hesitates. If you have questions please use the chat box. Okay. If you don’t mind I am going to get a drink of water real quick then. Here’s one. Can these strategies be combined?

Absolutely. I don’t know why you couldn’t use all of these strategies. Maybe not now, but in years coming. All at the same time, absolutely. Let’s see here. New strategies leveraging your money in today’s market: Here you go. Buying properties that are already up and running on day one. This is the part I really love because we are in an environment where the money is still pretty cheap. You can lock into a 10 year fixed rate loan right now at five and a half percent, but you can also get the standard four and a half percent loans on a commercial with a five year repricing.

You can use other money for down payments. For example, borrowing from a 401k. The first time I did that I was really nervous. I have to admit I had a lot of money in that account. This was backing when everybody was making money in the stock market and feeling good. We weren’t worried about the future too much. I borrowed against myself.

I called up human resources and found out what the rules are for borrowing against my own 401k. Here’s the typical rule, typically in any 401k, you can borrow up to 50% of the value of your 401k. It is your money. They let you borrow it. You do have to agree to a payment plan. I think mine was five years. The reality is, the money that I paid back, I was paying back to myself and not to somebody else. That was benefit number one. Benefit number two is, the cost of borrowing the money was almost insignificant. I think I paid a $50 processing fee. You can never go anywhere else, get a loan for 10’s of thousands of dollars and only pay $50 to get that loan.

There was no due diligence. There was no process. It was my money. I actually paid it back a lot faster. I think I paid it back in the first year. I started doing it over and over again. It was such an easy process. For those of you who are still skeptical, let me remind you here of something. Psychologically speaking, when people use no money down strategies, and they are pushing paper around, they are wholesaling, they are controlling property via the contracts without actually owning the properties, when times get tough, the reason they can walk away.

They don’t get hurt. Somebody else gets hurt. That’s why I don’t like it. Number one it is too easy to walk away from. You don’t fight for your property. Your hard earned investment, when you have your own money in the place, and you have 100% ownership, you have all seven rights of ownership, I promise you, you are going to put everything you have into that property and make sure it stays up and running and afloat and generating cash flow.

That’s one of the big reasons why I am not in favor of all those other strategies. I actually have used them, but I don’t like them. They are not in favor right now. Right now, why would you give somebody eight or ten percent when you can get a four and a half percent loan. Even if you had to go to a family member, a brother, uncle or cousin or any partner to borrow money for a down payment. I would rather see you do that, and give them a six percent return, six percent interest rate on the loan that they give. Make them an equity partner. I have seen a lot of good partnerships out there. There are a couple of them on the phone tonight.

I have been in partnerships. I generally don’t like them personally, but I have had one that was very good. That’s why I teach it because it is a great strategy. Back to the 401k. You can do that over and over again. It is reusable money. The money you are paying yourself back is you. You are generating your own income on your own money. In multiple ways I just love that strategy.

Whole life policy: You can also borrow money against your whole life policy. I know there’s at least person on the phone tonight that has done that. Awesome strategy. If you do that you have to first call your whole life, it only works with whole life by the way. You can’t do it with term life because it has no value. Term life has no cash value.

I don’t know about universal. I never had a universal policy. I don’t have the answer to those questions, but we can certainly find out. Whole life policies, great way to earn money for a down payment. Use the banks money for the remainder. Let’s see here. Commercial line of credit. If you already own properties, here’s where I will make a little bit of a deviation. If you already own properties and you have equity in a number of properties, and I have done this a number of times. You can go to a regular bank, go to their commercial loan division,and ask them if you can take out a commercial line of credit based on the equity in all of your existing rental properties.

The first time I did this I pulled out $100,000. It was with Bell Federal Savings. Now they are a part of Northwest Savings. They used to not work with investors. I knew the guy. He was one of the Hines families. He was the CEO of the company. They knew me. They knew my investment portfolio and said, “Sure we will do it.” I bought a course and bought several other properties using that money as down payments.

I leveraged, even though I borrowed money and I got the money from the bank, it was really based on my own equity and my own property. I really felt like I was borrowing from myself. I was paying back my equity. The additional risk there is if I got hit by the proverbial bus, they will take the properties. They will have to pay off the first because they are in a second position, but they will do that.

Any case, let’s see here. Loans on new properties whole life, receive money in one week. Terry did that and he got his money for a whole life policy in one week. Okay. Back to the commercial loans. If you do that strategy, don’t get a fixed rate loan. It may be tempting because of the interest rate, but the reality is if you get it in the form of a line of credit, you get to recycle that money over and over and over again. You can use it, pay it back and use it and pay it back and use it and pay it back. If you don’t use it for a period of time, most of you know me. If you haven’t used it for more than a year, they may make you go through more of a screening process to use it again. They may just want to check your financials for examples. I think someone is going through that right now that is on the call. Matter of fact, they are going through that right now.

It doesn’t take that long. They just want to review everything, make sure you didn’t do anything crazy in the last year. I like that strategy. You can also use home equity loans if you haven’t already done that, it’s an easy one. You are borrowing against yourself because you are borrowing against your equity. You might run into some resistance there from your spouse because they are going to see risk. The reality is, you have full, complete ownership, and that is one of the key things that I want to stress here.

Don’t buy a building where you don’t get all seven rights of ownership. If you do that you have really big risk. You want all seven rights of ownership. There are very few situations where I would recommend buying a building where you did not get all seven rights of ownership. I know the concept of a land contract came up recently. It came up again this week down here in Virginia. In this situation, I did recommend it. It was between two family members, and it was the perfect solution for their situation.

In other situations, check it out thoroughly. Get other people’s advice and see what you think. Here’s the last strategy for putting money down on a property. Using cash. Again, everybody in the world is teaching it, don’t use your own money. You know what? They are planning to not lose. I am playing to win. That’s an important distinction. When you are playing to win, psychologically is in a state of mind where you are going to win. There is no plan b. There is no other option.

You will do whatever it takes to win. Guess what? That’s the way life is. Stuff is going to happen, every day. Flat tire, child needs braces, parents get ill, you get sick. It is going to happen. Nobody is exempt from life trials and tragedies. You have to fight through those things. You have to persevere in spite of those things. When you don’t have any skid in the game, it’s too easy to walk away from those things. When you walk away, just because you get hurt doesn’t mean somebody else doesn’t get hurt.

What goes around comes around. By the way, the reason we suffer so much in high interest rates and charges and fees is because of people walking away from things. I am not saying there might not be a situation where that has to happen. You are faced with imminent danger. You have no choice. I get it. I have never been there. I have been close, but I have never actually, I just fought my way through it. That’s because I had all seven rights of ownership, and I had my own skin in the game.

Okay. Enough preaching for the moment. Strategy number eight. Avoid inept CPAs. That seems kind of comical, but my tax accountant is actually pretty conservative. I like it that way, but here’s the difference. I don’t take a lot of deductions because I work out of my house, and because I use my car. I don’t use those entire little penny pinching deductions. When I look at the benefit, when I look at the end, the means don’t justify the end.

I am spending dollars to save pennies. Where I draw the line is, when it comes to my real estate investing in businesses, I don’t want him to be overly conservative. I want him to be aggressive and use the tax strategies that are available because they are designed; the tax code is actually designed for you to use it. Granted, it is very complicated. It is ridiculously complicated. It is a shame that the average person can’t understand the tax code, but that’s okay. You just have to be able to understand the concept.

You don’t have to be experts at it. None of these things here, I would be expecting you to fully embrace and comprehend and be able to prepare a tax return. Some of you maybe, like Casey probably could. The reality is, a lot of this is a better use of our time and money and energy to pay a professional to do our tax returns. If you have a tax accountant, what you might want to do is in your first year out; this is going to be a little bit expensive. I used two guys across the street from each other.

I gave them both the same information. I had them both prepare a tax return. They both came back with different returns and different figures. The guy that I consider a little bit of a gun slinger, he was more aggressive, but more importantly he actually missed a few things. I went with the guy that was a little bit more conservative, took his time, took a week longer, but didn’t miss a beat. He didn’t miss anything.

Here’s a test here. The joke is, ask your tax accountant, “What is 2+2?” If he says four, you don’t want to hire him. If he says, it depends, what you want it be, that may be your guy. You want to interview, and maybe you ask him to give you an example of other returns he has done and others he has worked for. Any case, interview him. Ask him questions. Ask him to tell you about recent tax changes. What the best that you can expect? What are the most of all these tax strategies that you can use in your situation?

If you only have one property, I know you aren’t going to have much out there for him to work with. You start somewhere. You start there. Any case, I just made sure I used a guy who actually owned properties himself. That’s the final analysis I want to tell you with this one, number eight. The guy that I settled with for my returns has been doing it for 16 years, actually owned properties. I am thinking, “That’s the guy I am going to use.” He was elderly. He was a little bit conservative, but he was thorough, and he knew what I was doing.

By the way, that same approach, I have used in other areas. Like contracting, banking, one of my favorite bankers. Some of the contractors have been investors. The reason is, they know what you are doing and know what your expectations are and what your objectives are. Okay. In honor of tax rent income. Is ordinary income, rent income is not subject to social security taxes? I mentioned that in the very beginning. The bottom line is, it is passive income.

You should only pay regular tax, income tax on that. Not social security or any other tax. If your CPA misses that, and believe me, it has happened. I have had people come to me. They went to H&R block. If I get in trouble here, I apologize. It’s true. They came back. They put in there, you have to pay extra taxes for social security, and the client did it. Next year they found out through other investors, that no they didn’t have to do that.

They switched tax accountant. I just like private, individual people. I don’t like the business in a box firms. Okay. Here’s another one of my favorites. When purchasing your next rental property, alter who pays for various expenses on the HUD-1. This alone right here could probably give you your money back on the course, just on this one approach right here. If you are buying a $200,000 property, the average real estate commission is six percent. On that property, the commission is going to be $12,000.

Now, conventional wisdom says that the seller pays that. It comes out of the seller’s proceeds. It goes on the HUD-1 settlement sheet on the right hand side for the seller. I get it, 99,999 times out of 100,000 times that is what you are going to see. The one time you won’t see it is on one of mine. Here is what I teach people to do. Once you go through the class, you will know to use it. If you are negotiating, and you are getting close on your price, but you are having a hard time getting over that hurdle, one of the strategies you can use is say, “Look I will give you your net.” In other words, if we were to agree to $200,000, you would pay $12,000 commission. That means you would get a net of $188,000. I will agree to give you $188,000 if you let me pay the real estate commission.

For you the buyer, here’s why you want to do that. When the seller goes to do his tax return, he is going to pay taxes on his net proceeds. Say he gets the full $188,000. He is going to pay taxes. He is not going to be able to claim anything after that. It is going to be a net affect. The strategy doesn’t affect his tax return at all. It can very much effect your tax return. Let’s say you pay 188 and you pay the $12,000 in commissions, you get to claim that 12,000 in commissions as an expense to you, the buyer. If you are in a 15% bracket that is $2,000 right there in your pocket you just saved by using that one strategy.

That is an awesome strategy. Almost no one ever uses it. I don’t use it all the time, but from a negotiating, and I am getting close, I will pull that magic card out of my back pocket and use it. Hopefully some light bulbs are going off right now on this one. By the way, you can also do it with transfer taxes. Typically you split the transfer taxes.  We have always done it that way because that is what everyone has always done.

It doesn’t have to be that way. You can say, “You know what? We are very close here. I will tell you what I will do. I will pay the transfer tax. Me the buyer. I will pay the complete transfer tax, and then you get to take that off.” You have to roll that in your cost basis of your property, but it does help you. Any case, that’s tax strategy number ten. That is one anyone can use at any time. As you get bigger and buy bigger properties I highly encourage you to use that because it will save you money on taxes. By the way, if you can imagine the transfer tax on $188,000 is less than a transfer tax on $200,000.

You actually save more money on your transfer tax itself by the buyer paying the commission and lowering the price of the property. Any questions on what we just went over?

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