Strategic Tax Planning for Real Estate Investors with Thomas Castelli

Welcome to another episode of the Smart Real Estate Coach Podcast, your source for actionable real-life examples and advice to help you move to the next level of investing. Each week we help you make a quantum leap in your business, your finances, and/or your life. We want to help you take back control, help you thrive during chaos, and lead you through the current crisis to a better tomorrow. For more resources, check out smartrealestatecoach.com. And be sure to give us a rating and review on your favorite platform.

Good morning and welcome, Wicked Smart listeners. It's Chris Prefontaine, your host again with another awesome— I must say I'm biased— with another awesome episode. I met these 2 individuals last week when I was on their show and I said, guys, why have we not booked you on our show? Because just like I look for constantly and we were introduced to these awesome, this awesome group. We look for people that are in the trenches and specializing in something, right? And these guys are no different. Thomas Castelli and Ryan Carreira, they're tax specialists and they're investors specializing in assisting real estate investors minimizing tax liabilities. Okay, well, that's a pretty cool thing. They've actually collaborated directly with a bunch of investors throughout their career to optimize tax savings. So again, in the trenches, okay? It's not in theory. Additionally, they have experience in real estate investing in general themselves. They're part of our sponsorship team. For an 82-unit apartment community. They invest in different syndications and as a limited partner in different funds. They have some cool recognition, guys, inside of our lovely industry, and they've been named Emerging Leader by the NYSSCPA and featured on 40 Under 40 list by CPA Practice Advisor. They actually, the podcast that I was on, this is a writer-downer, is called Tax Smart. I love the name. Maybe we should buy them. Tax Smart REI Podcast. So get over there and subscribe to that Tax Smart REI Podcast. It is recognized as one of the leading tax podcasts for real estate investors. And last but not least, they're authors, are co-authors of Short-Term Rental Tax Strategies. Okay, Thomas, with that as a backdrop, welcome to the show, buddy.

Thank you for having me. It's a pleasure to be here today.

Yeah. So I mentioned a couple seconds ago in the intro, your, your show and make sure that everybody subscribes to that. 'Cause I get to hang out with you guys and that's how we met. So I'm glad you're here. We'll, we'll dive in here. Um, let's start with sort of the, well, actually I'll go back 2 levels. Start with sort of behind the green curtain, how you got here, meaning you and your partner Ryan, what you're doing now. How'd you land here?

Right. And then we'll dive into some of the broader issues. Yeah. Yeah, absolutely. So, uh, way back in like 2014 now, it's over 10 years ago, I had, uh, been in college and I was going to school for accounting. And I was also exploring real estate investing. So right before I jumped into college, right before I jumped into my first full-time job in accounting, I went to a syndication weekend where I learned everything about real estate syndication, really kind of fell in love with that model and started investing as a limited partner. And then basically it became a crossroads in my career. I was like, how can I match accounting and real estate together? So that's when I decided to go into tax for real estate. I met Brandon Hall, who's the the founding partner at Hall CPA, and he gave me a shot at the job. And long story short, worked my way all the way up to a partner. So here I am today. Hall CPA, we work with real estate investors across the US. Every different asset class investment strategy you've seen, we've seen and worked with it. So that's just a little about us and how we got to where we are today. Ryan's the co-host of the podcast and he's one of the advisors at Yeah, I love it.

As I said earlier, because you guys are in the trenches like us, right? That's what I say about our, about our community. And it's a little different, wouldn't you say, with CPAs that, that aren't engulfed in real estate or haven't touched it ever?

Because there's plenty out there, right?

I'm assuming.

Yeah.

You're trying to take on clients.

Yeah, absolutely. So, um, many CPAs out there are like what we'd call generalists. Uh, so they know, uh, a lot about a very broad area of expertise, but they don't really go deep into anything. And what I've found with a lot of CPAs who are generalists is they know like the surface level understanding of real estate. So, you know, for example, they'll tell you, you can't take more than $25,000 of losses, you know, against your active income, which is generally true, but there are ways around it, like the real estate professional status or using short-term rentals. And they just don't know. They just tell you you can't. They're not even aware this stuff exists. So it's just, there are issues. You're, you know, if you're working, if you're in real estate, you need to be working with somebody who understands real estate, A, and B, has a deep understanding of, you know, that area could help you to the fullest extent possible.

Well, let's meld that together with sort of the broad tax system and then real estate. And let's talk about some of those things that can be done, right? And then I know it's a broad question even, but that indirectly screaming to them about your last answer, meaning be careful because you can also lose money or miss out on certain things, right? If you're not careful with the right CPA. So can you talk about the tax system in general and how it can be better for them?

Yeah, absolutely. So in general, if you have earned income, which is income from a job or a business, you're going to be taxed ordinary income rates up to 37% at the federal level. And then there's state taxes if you live in a state that has income tax. And then there's FICA taxes, which is 7.65% on your wages. And if you're self-employed, you get to pay both sides of the FICA tax, the self-employment tax, which is 15.3%. So if you're a high-income earner, you're in the top tax bracket, it's not uncommon. And we see this all the time in like states like California, New York, and other states that like, you know, even in Boston, for example, that are, that where people are paying 40, 50% of their income in taxes. And it's a very inefficient way to earn income and very hard to shelter that income from tax. But with real estate, the first benefit of investing in real estate is being able to use depreciation to offset your rental income, because rental income's also taxed at 37— oh, at ordinary income rates up to 37%. But you can shelter that from tax using depreciation. So what that does is It does 2 things for you. First of all, you're getting tax-free cash flow. Second thing it does is it reduces your effective tax rate. So your effective tax rate is the amount of tax you're paying divided by the amount of income that you're generating. So as you are able to generate more rental income from your rental portfolio and you're not paying taxes on it, your taxes are staying the same and your rental, your income's going up. So your effective tax rate is actually So it, that in and of itself is a powerful strategy that comes with real estate a lot of people overlook. But then, and there are people who leave money on the table with general CPAs. For example, we just ran a bunch of case studies from people we were working with, and this one couple, they were generating, I think it was over $50,000 in rental income, taxable rental income, and their CPA never told them about a cost segregation study.

That's going to be my next question for you.

Cost, yeah. Yeah. They never told them about it, which accelerates the depreciation. They were able to cover, uh, they were able to basically pay no tax on their rental income. So that's just, that's the first key pillar of, of investing in real estate.

Yeah. We didn't touch it. We, because we're in the insurance business, we didn't touch it until we started hanging onto properties longer. And then that's, that was going to be my next question. So do you guys handle that or does that have to be a third party?

So, uh, that's something actually we're looking at bringing in-house. Uh, but right now it's handled through a third party. But there's nothing preventing a CPA from doing cost segregation studies.

Got it. Well, that's good to know. So when do you think you guys might have that?

We're looking at doing it. I don't want to, I don't know who competitors are listening to this show, but this year at some point.

Yeah.

Yeah.

No, that's great. So if I'm a listener, let me ask you a few questions about, for the listener's sake, if I'm a listener and I never did business with you at all, I can obviously, we're going to give them some places to go at the end here, but I can also maybe contact you ASAP about some cost segs or any menu of services, right?

Yeah, right. So the way we typically work with our clients is we're an advisory-first firm. So we absolutely do tax returns, but that's not the only thing we do. And the reason for that is your tax returns are basically a report card of the things that happened the prior year. And in order to influence that report card, you need to take certain actions During the year. Once the year closes, there are some things you can do, but you're limited. So what we like to do is we like to take a look at our client situation, including their portfolio, their goals for the future, their financial situation, and say, okay, great, here's a roadmap, here's a blueprint from where you are today to where you want to go and how you can navigate that in a tax-efficient manner. So what strategies can you employ? What things can you do to make sure that you're, you're, you're taking advantage of the tax code and not, and not paying more taxes than you have to. So that's our, our goal is to proactively advise our clients on what they can do to reduce their taxes so that when it does come time to file taxes, which is an important part, and don't get me wrong, but you're coming out, you're coming out with better outcomes. Yeah. Love it.

And what states, um, I sort of remember from when we chatted last week or week before, but what states do these guys know? Are you represented? Can you represent them?

Yeah, we're in all 50 states. Obviously we can't represent all 50 states. We're in 49 states. I think North Dakota right now is the only one we're not in, and that just happens to be kind of the way the cookie crumbled right now. But there's nothing preventing us from doing that.

So what are some, I'm thinking through just practical, if someone's never, you know, even looked into getting a better situation for their taxes, what are some repeat things you've seen, mistakes like new investors come to you and you go, oh man, like, Are there some repeat things like that you're seeing that can easily be fixed?

Yeah, I think the first thing is taking depreciation, right? You have to take depreciation, so make sure you're taking it. We constantly see on people's tax returns depreciation just not being reported or other expenses not being reported, like insurance or property taxes. And these are expenses that most property owners are going to have. So how do you—

Oh, you're saying a regular CPA misses that?

Yes.

Yes.

That's crazy.

Yeah.

Yeah. It's, it's kind of insane. And, you know, to give the CPA some credit, it comes down to bookkeeping, right? Because if the client's not giving good books and records, then the CPA can't report it. But it's something that if, if I'm a CPA and I'm looking at my client's tax return, it's Schedule E, and you're looking at a rental property, why isn't property insurance there?

Yeah. You're going to ask.

Yeah. Why isn't insurance there? Something must be missing. So just the fact that we see that and other issues, like other mistakes, like for example, I'm trying to think of one of the other mistakes I just saw very recently.

You're seeing these on returns. It's not like this is theory.

Yeah, no, this is very real. Like for example, the real estate professional status, right? There was a client that we were working with, they're a full-time real estate agent. They fully managed their own rental portfolio and their spouse had a very high-income W-2 jobs, and they very clearly qualified as a real estate professional. What the real estate professional status allows you to do is take your rental losses, which are usually on paper thanks to depreciation, and use it to offset your active income. So your W-2 income or business income, which could lead to substantial tax savings. And this particular client that came on board with us had years that they could have been using this and their CPA never told them about it. So that's just one example of something like that was very blatantly open to them. Their CPA had no clue how to do. We had another client who, I forgot if they self-filed their return or if their CPA did this, but they opted out of bonus depreciation. So bonus depreciation is the ability to like rapidly accelerate depreciation in the first year. Right now it's 40%. So that means 40% of what's eligible would be reported, would be deducted in the first year. If it comes back to 100%, which is widely expected, it's going to be even more powerful. But you can opt out of that. Sometimes there might be strategic reasons to opt out. Most of the time it doesn't make sense to, but this specific client opted out of bonus depreciation, which shot themselves in the foot for substantial tax savings. And we're looking at it, why would this happen, right? So it was just all these little things that we see, and there's, I could go on and on on it, but like, There's some, like, just the simple stuff to the more, okay, here's another one, right? Here's another one. So we had a client, and this wasn't real estate related, but it's business related, that they were right, that their CPA had been writing off, had created a shell corporation to write off their personal expenses amounting to hundreds of thousands of dollars of basically deductions that they weren't eligible to take. And we had to go back and correct it, which unfortunately led to some back taxes, but that never had to happen. So it just, the bottom line is like, you have to work with somebody who knows your space, knows what business you're in, knows, and who can navigate it appropriately for you.

So if I'm listening to you and I go, oh shit, this is definitely like already errors in my tax return. If someone's listening to this, can they go back like that one you said didn't take the bonus? Can they go back and amend their return? Or is it?

Yeah. So you can't, say you didn't take your bonus depreciation, right? Or you didn't do a cost segregation study. If it's one year behind, okay, so if it's just one year ago and you haven't filed your next tax return yet, you can go back and amend the return and fix it. And that's fine from a cost segregation perspective. If you opted out of bonus depreciation, you might be in trouble. But if it's beyond that first year, so say 2023, right? You didn't do a cost seg and now it's 2025. You would need to file a Form 3115, which is just a tax form to bring the depreciation that you should have taken in 2020 or 2023 in this case, up to 2025. So there are ways to correct it. Some things, not all things to be corrected, but with depreciation you can usually correct it.

Sounds like a pain in the butt too. So might as well get it right the first time.

It's more expensive, so you don't want to do it. You want to go that, you don't want to go down If you don't have to.

Can you, I just realized I did what I always do with my vernacular. Can you define for the listener, just in case, cost segregation please? Because I know even in our community, people will go, can you explain that? I don't even know what it is. So explain that. And then I have a question on that.

Yeah, absolutely. So when you buy a rental property, if it's a residential property like a house, it's going to be depreciated over 27.5 years. If it's commercial property, it'll be 39 years. And they call that straight-line depreciation. However, the entire, within your building, there's different components and they have different depreciable lives, 5, 7, and 15 years, which is shorter than 27.5 or 39, which means that you're going to already be increasing your depreciation expense in those initial years. So what a cost segregation study does is it, an engineer typically comes down or surveys your property. They use software too these days. to break down the different components within your property. So it's going to give you a report and saying, okay, outta your property, this amount is going to be 27.5 years. This amount will be 15-year property. This amount is 5 and 7-year property. And then that allows you, the 5, 7, and 15-year properties all eligible for bonus depreciation. So that's why people get cost segregation studies done is to identify this property with lower, with lower-class lives that can be accelerated. That's what a cost segregation study is in a nutshell.

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So we've wrapped the support mechanism around this. We've allowed you to get into a Slack community where the other associates who previously were protected in Slack. And now you get to jump in there and experience that for 12 weeks. You also get to come to the In the Trenches boot camp, which is private. It's a chance to hang out with the family team and one of the coaches for 2 and a quarter days in our conference room, roll up our sleeves, get calls done, get deals done. If you come with leads, you leave with deals. Absolutely incredible. I could go on and on. Go to the website right now. Check out more information about the apprentice and I'm going to give you the In the Trenches boot camp site because you don't have to become an apprentice. It just happens to be free with apprentice and associate. So 2 links I'm going to give you, super important. smartrealestatecoach.com/ittb-pod. That's going to give you some information about the boot camp. If you want to buy a ticket to the boot camp, it's more expensive, but you can just come check us out. About 1 or 2 people every time we run it do just that. Or become an apprentice and it's for free. smartrealestatecoach.com/apprentice-pod.

Perfect.

And is it true that, just for further clarification for them, take, give me an item, like pick any item in there that the logic is it wouldn't last 27.5 years, right? Yeah.

Carpeting, appliances, land improvements, things like pools, decks, and sheds. Those are often carved out there. Certain types of fixtures, furniture, if there's furniture that exists, there's a lot of different things that could be carved out. Usually somewhere between 20 to 30% of the property's cost basis, which is more or less purchase price, can be reallocated into this 5, 7, and 15-year property.

Yeah, it's huge. The number's big. We started when we started doing 'em, so that's why I wanted you to dig deeper. Thank you for that. Is there a, when someone comes to you and says, I'm going to stay in this cost seg for a second. And they say, yeah, I'm going to do this property. Do you, do you, would you like to check with them? Hey, how long are you going to keep it? Like if they're going to sell in 2 years, is it not worth it? Is it 10 years? You know what I mean?

Yeah. Yeah. What justifies it? So what justifies it is the time value of money. So let me start here. So in order to take depreciation in general, you need to have the property for at least 1 year. Right? If you buy it and sell it in the same year, you're not claiming bonus, you're not claiming any depreciation. But it's about the time value of money. A dollar saved today is worth more than a dollar tomorrow. So if you can accelerate depreciation and just for the sake of this example, save $10,000, well, now you can take that $10,000, reinvest it, earn a return on your money when that money would've otherwise went to the IRS. So that's the first reason why you'd want to do this. Why you'd want to accelerate it. The second reason why you'd want to accelerate it is there's ways to mitigate this on the back end, right? If you do a 1031 exchange, you're deferring the depreciation recapture when you sell the property. And depreciation recapture's the tax you have to pay on the depreciation you took. So you can defer it with a 1031 exchange. You can use the losses from new properties you acquire to mitigate the exposure to it. So those are the 2 reasons why you'd want to do it and how to kind of navigate that. But in terms of years, it depends, right? If you're going to hold it for 2 years and you're going to do a 1031 exchange, then yeah, go for it. Usually it makes sense. There might be strategic reasons not to other outside of that, but for the most part, go for it. Yeah, for me, I always look at whenever I remember people ask that question, is it 2 years? There's no right or wrong answer.

Okay.

It depends on your goals, not only with that specific property, but are you committed to real estate? If you're committed to real estate for the long term, You're going to have usually not that many issues mitigating that tax on the back end. If you're just doing it, I just want to get this tax benefit this year, I'm going to get rid of this property as soon as I can. Maybe that doesn't make sense, or maybe it does. Maybe the juice is worth the squeeze on that particular hassle for whatever that situation is. You know, maybe that the tax savings would be so substantial that it's worth it, and there's goals around that that makes it make sense. So I I don't like, I don't like, I don't, there's no right or wrong answer to 10 years.

No, I like that. So it's really, it's like, it's their situation cuz you don't know every situation, so how the heck can you answer it until you get with 'em? Right?

Right, right. Yeah. It just depends.

Okay. Got it. Um, so I don't forget, uh, Thomas, can you give these guys any, anything you want to give 'em for ways to get you, social media, et cetera?

Yeah, absolutely. Uh, like, like I think you mentioned earlier. There is the Tax Smart REI podcast. That's, that we talk about taxes nonstop there. And like really, you know, you could dive into a lot of powerful tax strategies just by listening to that. Me, myself, I mean, I'm on most social media platforms. You could find me probably LinkedIn or Facebook would be best. But also if you are looking to look for a new CPA, we do, we are taking on clients. We get, you can book a discovery call. It's going to be smart real estate coach.com/hallcpa, and you can book a call with us there. And we'd love to learn more about your situation, how we can help.

Love it. All right. So, so that, so I don't blank out after doing a million podcasts today. What else do you want to share with these guys that I didn't hit you on, or a nugget or two, but what's burning on your mind that we can share?

Yeah. I mean, I would say this, you know, a lot of people who I speak to look at real estate, look at the losses and say, how can I use these losses to offset my W-2 or active business income? And if you're able to use the real estate professional status or you're investing in short-term rentals, then that's a very powerful strategy. But I really encourage people to take the longer view, right? And I'll give the minute or 2 snapshot of this right now, right? First, with real estate, you're able to, like I mentioned before, generate tax-free cash flow. Then you're able to, from there, if you hold the property for a long period of time, you can take cash-out refinances as you pay down your principal. As you, as the property increases in value and those cash-out refinances or those lines of credit, those proceeds are tax-free, right? So you can take that money so you don't have to sell your property to tap into the equity, and then you can take that money and reinvest it to continue growing your portfolio. From there, if you do need to sell your property, you can use a 1031 exchange or buy new properties and use losses from cost segregation studies and depreciation to offset the gains and appreciation recapture, mitigating or eliminating your taxes there. And then if you hold your properties until you pass away, you can reset your cost basis to zero. So your heirs will receive the properties at the fair market value when you pass away. And if they were to sell it the next day, hypothetically, they're paying zero taxes and you've eliminated everything. So really what I just encourage people when you're looking at real estate, Look at the long term.

Look at the—

there's no other asset class that I'm aware of that has the tax benefits that real estate has. So don't get caught up on the W-2 losses. That's great and that's powerful if you could do that, but look at the long-term tax benefits.

Yeah. So I want to give that link again, smarterealestatecoach.com/hallcpa. So that will get them to a discovery call.

Yeah. And on discovery call, we'll have a conversation about their portfolio, what their goals are. And, you know, if there's a way that we're able to help them, you know, reduce taxes and optimize their situation, then we'd love to work with them.

Yeah. And guys, Wicked Smart listeners, we're going to do some more stuff with these guys on a lot of different fronts. So you are going to see them and you are, you'd be doing yourself a disservice not to just get into the right bucket. Let me give you a quick story, Thomas. So one of our, and I may have said this on your show, one of our sort of our superstar students now. He's a coach. When he was moving full-time from this government job after 30 years to work with us full-time, he fought me on this, the CPA. He's like, ah, no, I do my own tax. I said, look, you're going to make a mess. So he screams about this now that it was the best thing he ever did. So I just can't emphasize enough for the Wicked Smart listener, get over to smartrealestatecoach.com/hallcpa, get a call. It's You have nothing to lose. And then, get in the right hands so you can go ahead and worry about— not worry about, focus on everything else that you're good at. Yeah.

No, I appreciate that. And, the way I always look at it is if you need heart surgery, are you going to perform heart surgery on yourself? Or, if you have an advanced car issue and you're not a mechanic, are you going to do your car work yourself? No, you're going to go hire a mechanic, you're going to go to a cardiologist, right? Uh, this is, it's very similar in the CPA space, right? You get to a point where your, your time is more valuable working on your business. You may not have the expertise and it's complicated and you can make mistakes and, and that could cost you a lot of money. It's time to delegate that. And we see mistakes all the time. And I'm not just saying that because, you know, I'm a CPA. I'm saying that because we see it and I'm like sometimes just facepalming like this could have been prevented, like if, if with the right advice. So it's just like.

Yeah. Yep. Time to take action, guys. Thomas, I really appreciate it, buddy. I know we're gonna do some other things together, uh, both our companies, so I love it. And I think it's gonna be super productive for the Wicked Smart community. And, uh, appreciate you being on. I look forward to doing another couple swaps together.

Likewise. Thanks, buddy.

Okay. Wicked Smart listeners, that wraps up another Wicked Smart Masterclass with Mr. Thomas and Mr. Ryan. Uh, I hope you guys enjoyed that. Um, you definitely wanna reach out to these guys. Go to smartrealestatecoach.com/hallocpa. H-A-L-L-O. smartrealestatecoach.com/hallocpa. Guys, I am going to scream from the rooftops here. We're sitting in May. I'm going to scream from the rooftops about our ITTB, which we refer to as our In the Trenches Bootcamp. It is the most effective thing we've done. And if you're on the sidelines waiting for opportunity to knock, It's time to go ahead and open the door because this In the Trenches bootcamp is private. We bring in 10 or 15 people and it can be for you for free if you're in the community. Now I say it's for free, but I want you to go check out what it's all about. Go to smartrealestatecoach.com/apprenticepodcast. We'll see you at the next bootcamp. See you on next week's episode and the next Wicked Smart Masterclass. Hey guys, are you simply sick of juggling a dozen different software tools for your real estate business? I know I was, and I know I'm not a tech person. So it was frustrating. A subscription for this, you get a subscription for that, and they don't even work together out of the box. That's very frustrating, especially in the real estate world where your best time spent is going to be out in the field or on the phone with sellers. And now you're stuck hiring a tech guru just to make all that sync up. So let's ditch the chaos and let REI BlackBook handle everything. Automate your lead follow-up, track every deal, analyze things quickly for you, make offers all in one platform. In fact, with the Wicked Smart platform, we now have access. If you're in the Wicked Smart community to all the other associates' properties, can you imagine that? So you're brand new in the business perhaps, and your seller looks on your website and sees 20, 30, 40 properties, instant credibility. So you're going to get everything on REI Black Book from our custom workflows for lead generation all the way to closing. It has it covered. Try today for just a buck. $1, guys. Visit smartrealestatecoach.com/reibb-dd. smartrealestatecoach.com/reibb-dd. All right. Thanks for tuning in to the Smart Real Estate Coach Podcast. If you got value from today's episode, guys, be sure to subscribe so you never miss a future episode. It literally takes one nugget to access some of the things we're doing. And when you're talking the amount of the size rather of the paydays, it's an opportunity cost that you can't let go. So don't miss an episode. And for goodness sake, share it with someone who needs to hear it. If you're ready to find your best path for getting started on your real estate investing journey in general, head over to smartrealestatecoach.com/getstarted. We're going to help you take the guesswork out of your next steps. See you in the next episode.