WCI #336: Asset Protection In Real Estate Investing

This is the White Coat Investor Podcast where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high income professionals stop doing dumb things with their money since 2011.

This is White Coat Investor podcast number 336, asset protection and real estate investing. I estimate that 80% of doctors need, want and should use a financial advisor and or an investment manager. Some investment gurus, such as Dr. William Bernstein, think my estimate is way too low. At any rate, if you want to use an advisor temporarily or for your entire life, there's no reason to feel guilty about it. Just make sure you are getting good advice at a fair price. If you need help updating your financial plan or just getting one in place, check out our list of recommended financial advisors@whitecoatinvestor.com financial advisors. You can do this and the White Coat Investor can help. All right, welcome back to the podcast. Hope you're having a great fall, enjoying football season and the cooler, crisper weather. Maybe in a few parts of the country you're already experiencing some snow. I know it's starting to snow up at our ski resorts by this time of year, most years, but we're not done having fun yet. As you're listening to this, I've just finished doing a bunch of canyoneering trips to Southern Utah, so. Oh, I hope you're able to find a way to do something fun as well. Okay, let's do our quote of the day first. Abraham Lincoln today, everybody likes Abe. He said, you cannot escape the irresponsibility of tomorrow by evading it today. That goes for your finances as well. Okay, as you listen to this, the day this drops is October 12th. That is the final day. So I hope you listen to this. The day this podcast dropped. But today's the final day to register for WCI Con 24 at the early bird price. You can do that@wcievents.com it's going to be a great conference. I'm looking forward to meeting you there personally and to give you a chance to be inspired to accomplish your financial goals, to become more financially literate, to become less burned out and just to have a great time. We're in Orlando this year. It's going to be awesome to be on the east coast for the first time and I know a lot of people are combining this trip with, with a visit to some of the theme parks there. It's a great time of year to be down there. It's starting to cool off. Well, I guess it's starting to warm up by February when this thing runs, but it's still very nice down there and perfect time of year to be in Florida. So check that out. WCIEvents.com okay, another thing we're doing is we have a program where we try to give away a copy of the White Coat Investors Guide to Students to every first year medical and dental student in the country. That's starting again. October 17th is the first day you can apply to do this. And the way we pass these out is by the box, not by the individual book. It's just not cost effective for us to do that. So we send a box, actually it's usually like three or four boxes to a champion in each class and they distribute the books to their classmates. It costs you nothing but a tiny little application to be a champion. All you have to do is be a student in good standing in that class and agree to pass out the books. That's it. You get a little bit of extra swag for you and you get to be everybody else's hero. I mean, if you think about this, if on average, someone who becomes financially literate saves a couple million dollars over the course of their career and there's 200 people in your med school class and half of them actually read the book and become financially literate, that's a lot, a lot of value that you have provided to your classmates might be the most valuable thing that happened to them during their entire time in medical or dental school. So sign up for that. Whitecoatinvestor.com champion. We need one from every medical and dental school in the country. You have to be a first year, but you can start applying in just a few more days. So thank you for doing that. It is a great service to your classmates. All right, let's get into some of your questions that you guys have for us. We'll start with this one, which has to do with the subject matter of our podcast today about asset protection in real estate investing. Let's take a listen.

Hi Dr. Dali. My name is Serena Brown and I'm a family physician located in the D.C. area. I had a question for you about trying to rent out a property that I own. I'm transferring ownership of that property to my solely owned LLC for liability protection purposes. Prior to renting it out, I wanted to add an endorsement to my title insurance policy to add my LLC as a covered insured, but the title insurance company is stating that I need to purchase a new policy to have coverage. The property is located in Maryland and my Question. Ultimately, is anyone successfully been able to add an LLC to their title insurance policy without buying a new policy at a significant additional expense? I've been told different things by different lawyers who work at various title insurance companies. And so I'm at a loss of what to do. I'm just trying to make sure that I'm covering myself prior to renting out the space. Thanks for everything you do. I appreciate your time and thoughtfulness in trying to help me answer this question.

All right, great question, Serena. I like this question because you're trying to do the right thing. And in general, the right thing is to put rental properties in LLCs. Okay. That does a couple of things. One, you know, if the state law does so if state law provides this protection, it can provide both internal and external liability. So internal liability is something that happens at the rental property. You know, somebody slips and falls there, has a terrible injury, they say it's your fault, all, all they can take from you is your rental property. So that is a big benefit. That's internal liability. It can also provide external liability in that if you get sued for a gazillion dollars and for some crazy reason it's successful and not reduced on appeal and you have to declare bankruptcy. In some states, getting assets out of your LLC is very hard. That creditor is limited to a charging order, meaning that they can only take money from that llc. When you pull money out of the llc, when the LLC distributes money to you. But since you control that llc, you don't have to distribute any money. In fact, you can just send them the tax bill for their portion of the money that you never distributed to them. And what that does is it provides a heavy incentive for them to settle with you. And so that's a big benefit of having an llc. So the problem is LLC law is very state specific. Some states limit creditors to a charging order. That's more common on a multi member llc. And the reason for that is they're trying to protect your partners in this llc. Why should they be punished just because of something you did in your practice? You know, some real estate LLC with your partner's there, they shouldn't be punished. They're an innocent party. And so that's why that protection is extended. It is less commonly extended in a single member llc. So if I were in Maryland or I were in D.C. the first thing I would do in this sort of a situation is learn whether my state or my District of Columbia extends those protections. And if you will look at the white coat investors Guide to Asset Protection. You will quickly learn that Neither Maryland nor D.C. limits creditors to a charging order, whether it is a single member LLC or a multiple member llc. So your LLC really provides no external liability protection. And that's unfortunate, but that's the way your state laws are. So that makes this a little bit less valuable of a thing to do. Rather than just holding this thing in your own name and buying lots of property insurance and a big fat umbrella policy on top of it, you may opt to go down that route. Now, will the LLC help with internal liability? It still should, but that's going to provide less protection in a single member LLC than in a multi member llc. Hopefully still works, but that again comes down to case law and the specific situation, et cetera. Obviously you want to keep that as separate as you can from your personal finances. So you can argue that that it's a separate entity, but that would be the only reason to go through the trouble of putting your property in an LLC in that state. So now onto your question about title insurance. I don't know the answer to this question. I think that the answer you're getting is probably what you're going to get from every title insurance company, at least in your state. I don't think they're just trying to rip you off and get you to buy a new policy. The good news is you ought to be able to maybe negotiate a discount on the cost of that new policy since it's coming from you and you've already got a policy in place, title insurance in place. So I think they ought to give it to you a little cheaper than a normal one. But I guess that doesn't mean they will. Another problem people run into when they move properties from personally owned into an LLC is they always wonder about the mortgage, do they have to call the bank and change the mortgage? And my experience is that most people don't, they don't bother. And the reason why is if they have to get a new mortgage, especially these days, they're having to get it at a new, higher interest rate. But even so, typically a mortgage for a non owner operated, a non owner occupied property is at a higher rate than one in which you're living in it. So when you move out and you talk about, you know, changing the mortgage in any way, shape or form, they usually want a higher interest rate on that. So don't be surprised about that. You know, a lot of banks, they don't care if you go to them and say, hey, you know, this is now going to be A rental property, let me just leave this the way it is. And they're fine with that. But I think it's much more of a situation where people are not asking and not telling. And I don't know that that's necessarily some huge deal. What's the bank going to come to you and say, hey, you have to pay off your mortgage instantly. That's the risk? I don't hear that happening very often. And even so, that's no different than you having to go out and get a new mortgage right now when you move it into an llc. So I don't know if that should necessarily deter you from going down that route. Okay, let's take our next question. This one's about buying a house. Somewhat related, not necessarily Investment related.

Hi, Dr. Dali. Thank you for everything that you're doing for us. I have a question in relation to house buying. My current net worth is 800,000, of which 200,000 I'm saving up to buy a house. So essentially my assets will be 600,000.

I have a house on the market.

Currently, which I see listed at about 400,000. And I'm trying to put in an offer. So I would put 200,000 cash offer. So then I essentially have to pay 200,000 more to pay off the house. My question is as follows. So, one, how do I take the calculation for my network? So does it become 600 plus 400,000, of which 200 is already paid off, or does it become 600 minus 400,000? Or let's say 600 minus 200,000? 200,000 is already off.

I just do not understand.

How do I calculate the network with the house? If you could kindly explain this, that.

Would be really appreciated.

And once again, thank you for everything that you have done for us.

Okay, great question, Neil. I appreciate that this is a much easier question to answer than the last one. This is pretty straightforward. When calculating your net worth, you add up everything you own and you subtract everything you owe. So once you buy a house, you own the whole thing. If it's worth $400,000, that is a $400,000 asset. On the positive side, if you buy it with a mortgage, well, you've picked up an additional liability, and that goes on the liability side of your balance sheet. So if you've got a $400,000 asset and you've got a $200,000 liability, and that is everything you own in your entire life, well, you've got a net worth of $200,000, right? $400,000 minus $200,000. I hope that helps explain how to do net worth. Now, a lot of people also track a different number. You know, investable assets. Sometimes it's called your nest egg, your retirement money, whatever you want to call it, which is different from your net worth. And I think the most common way to do this is you leave your house out of this calculation. Right. You're just calculating your net assets, stuff that goes toward your nest egg, your number, the number, you know when you're financially independent. And most people do not include either the house or the mortgage toward that number. It's just a number of positives. You add up all your retirement accounts and your taxable account and your investment properties. If you have investment properties, you would include the mortgages for those in that calculation. But as far as your net worth, you count everything. All right, we've got one of our sponsors, Nathan Kleberg, with mlg, that I'm going to bring on. We're going to do an interview with him and talk a little bit more about real estate investing and what we're seeing out there in the real estate investing world. He's going to help me answer a couple of your questions as well. Nathan Kleberg, vice president of MLG Capital, now joins us on the podcast. Welcome to the podcast.

Thanks, Jim.

Excited to be here, I should say. Welcome back to the podcast. You've been here before?

That's right. It's good to be back.

How's life at MLG these days?

It's good. It is an interesting world we're in right now, so never, never a dull moment. But overall, it's been a good year so far and have a couple good acquisitions in the pipeline to round out a nice year overall.

Yeah, you know, I think it's great anytime in 2023 that a real estate firm can say, hey, it's a nice year. That's great to hear, because I am not hearing that from every estate firm out there. They're not all saying, it's a nice year, I assure you.

Yeah, I can imagine that that's the case. We are thankful to be invested in a moderately levered fund right now. And it's a strategy that wasn't so sexy a couple years ago, but now it's paying off.

Yeah, for sure. You know, Warren Buffett's famous for talking about you don't know who's swimming naked until the tide goes out. And a lot of people in real estate that were maybe a little over leveraged or maybe their operations weren't Very good. Or maybe all their debt or majority, their debt was variable and they're struggling now. They're having a hard time. I mean, rates have gone up 4% ish in the last 12 to 18 months. And that has a pretty serious effect on leverage. Real estate for sure.

Yeah, no doubt. And we have a couple floating rate deals in our portfolio. Thankfully we bought caps that are very much in the money at this point. But we're thankful that primarily fixed rate debt, that is saving grace in times like this.

Yeah, I've talked to people a lot in the past and not just about real estate investing, getting their own mortgages or refinancing student loans that if you get a variable rate, you've got to be able to afford the worst case scenario. You know, sometimes people can afford to run the interest rate risk themselves and, and they'll be paid to do that. And most of the time it works out fine. But clearly times like this where rates have rapidly gone up, you know, there's some real benefits to having fixed debt. All right, well, let's talk about what's going on at mlg. You guys are. First of all, for those who've never heard of it, how would you introduce mlg? How would you describe the firm?

Yeah, we're a real estate private. A private real estate investment manager. We've been around for 35 years. We offer a series of funds which we'll talk on our most recent offering, Fund 6. And then we also have some other tax deferred vehicles that we offer primarily via our legacy fund, which we'll hit on today too. But long track record, a lot of success over the years, which is why investors like to continue to work with us.

Yeah, 35 years is like forever in this space.

Yeah, it's longer than I've been alive.

So is there even anybody at the firm that's been there since it was founded?

Yeah, in fact, the M. Mike Mooney in MLG still comes into work every day. He's in more of a chairman emeritus role at this point. But Tim Wallen, our CEO, joined the firm in 1989. Founding year was 1987. So he's been here for 30 plus years. And rest of our principals joined in the early 90s, so the leadership is still very intact from last 30 years.

Well, I'm invested in Fund 4. These are closed funds that you come in, you raise money and then you close the fund. They're not evergreen funds. Right now you're raising money for Fund 6. What can you tell us about Fund 6?

Yeah. Fund 6 is a 400 to $450 million equity fund. With that we'll buy roughly 1.1 to $1.2 billion of real estate. Primarily what we invest in is multifamily. That's definitely the bread and butter of what we do. Typically 80 to 90% of the fund is multifamily. We mix in a couple different other asset classes. We like industrial a lot. It's hard to buy at scale, especially in the past few years with the competition in the industrial market. But we'll have a little bit of that in there and then look at retail and office very opportunistically. Has not been a significant part of our funds in the last three or four funds and will likely not be going forward. But the idea is you get diversified across different asset classes, across geographies and mitigates risk that way. Our investor base generally has made their money in life and don't feel the need to roll the dice anymore. So our first and foremost goal is to protect, protect their capital and if we can grow it in a responsible risk adjusted way, that's, that's a win for us and for our investors.

So how much the fund is raised?

So far we are sitting at around 180 million raised today. Just under 180. We've only been open for about 15 months in this fund so far. We have an either or end date, either when we hit 450 million or December 31st of 2024. So at most we still have about 15 months left on the fundraiser that's offering.

And, and how long is the expected?

Typically our funds have a life cycle, about 10 to 12 years. We expect to return all the original investor principal in roughly six to eight years. And then there's a profit share beyond that for the last four or five years or whatever it ends up being.

And no anticipated liquidity in between that time.

There will be occasional liquidity as we sell deals, but from an investor standpoint, it's kind of out of their control. It's whenever we're selling and when that makes most sense. So you go into it expecting six to eight years, that cash is pretty much locked up.

So if you were an investor, what range of returns would you expect from a fund like this over the next 10 to 12 years?

So we target annualized IRRs or annual rate of return of 11 to 15% our prior funds and over the course of our 35 year history we've actually pretty significantly outperformed that. But we rather under promise and over deliver and Also just trying to be real with where the market is at. Market's become a lot more competitive in recent years and so we try and manage expectations that way. But that's an 11 to 15% annualized rate of return. The way we get there is through a three tiered waterfall. I think it's worth hitting on just because we believe our return waterfall is very investor centric. The investor really gets the first two bites at the apple through an accruing compounding 8% preferred return. What that means is that's the first stage when we pay and our funds typically we start off paying a 4 or 5% distribution. The investor unpaid portion difference between the 4 and the 8 or 5 and 8 accrues and earns 8% interest until we make them whole on that. So our first obligation to investors is to get them current on the 8%. Once we've done that, we'll begin to sell some properties, return capital. But we don't get to share in any of the profits from sales or any of the investments until investors have the 8% annualized and all of their money back. So if the last asset in the fund doesn't perform as planned, that disproportionately impacts us relative to the investors to make sure we're incentivized to finish all the way through. And we only get to share once the investors have the 8% all their money back.

And what's the split above the 8% normally?

70, 30. That's our typical business deal. We have a special relationship with the white coat investor group. We once the group exceeded 5 million in this in Fund 6, we amended that to 75, 25 which we have hit that threshold. We're thankful for our relationship with the white code investor group. So actually when you factor that in, the total expected return is probably something more like 12 to 16 as opposed to 11 to 15.

Awesome. And you guys have something else going on that I've been noticing the last year or so, which I think is pretty cool. You know this is a little bit of a different fund, this legacy fund. Tell us what the legacy fund, who's it for and what to expect out of that.

Yeah, the legacy fund is born out of a realization that the current tax deferred solutions available to real estate investors in the market were inadequate in our mind. The most common one you see people Pursue is a 1031 exchange. Sell your property. You buy a like kind property and defer the taxes that way. But there are other options. You see Delaware statutory trusts or DSTs it's called an upreach where you're contributing your property to a reit. All of those for different reasons. We felt like we're falling short of creating the best solution for those investors. And so we concepted the Legacy Fund. It began in early 2021. And the simple idea is that investors can contribute their property to the fund. And a tax deferred contribution uses a different section of the IRS code. It's actually a 721 contribution, but they contribute their property to our fund in exchange for shares of the fund. The benefits of course, is first there, it's a tax deferred contribution, but also they become passive and then diversified. Because the fund today has almost 1.2 billion in assets and they become a partial owner in that fund through their shares. This product is perfect for those who are generally older, have owned their asset for a long time, typically a very low basis. Large built in gain, the ability to relieve themselves of the day to day management and get diversified and protect their money going forward is a pretty attractive option. And it's been evidenced by the market. Like I said, 1.2 billion in assets in just over two and a half years. Markets responded pretty well to what we're offering.

Yeah. So it's an exit plan for people who are direct investing and don't want to do that anymore.

That's right, Yep. And there's some tax and legal complexity with these types of deals. So the minimum equity check in order to do a contribution with us is 3 million. But for those who have that, that situation, it's a great alternative.

Yeah. So is anybody investing cash in this fund or is the only way to invest in a to rural property into it?

You could invest cash in this fund. It's primarily class A multifamily in the Sun Belt and as a result it targets a little bit lower returns and has a little bit less in the way of tax benefits that it can offer investors. But you could in theory invest cash. I would say in almost every case it makes more sense to invest in our finite funds and you get a little higher return and more tax benefits that way.

Okay. All right, well, let's see if we can get to a couple of listener questions here. First one, I think is a little bit about evaluating opportunities and particularly maybe what to do when things aren't going so well. Let's take a listen to that. Hi, Dr. Dali. I was wondering if you could give a brief history on real estate investment trusts, suggestions on what to look for before investing in a REIT. And subsequently, what options investors may have.

When REITs go bad.

I have about 10% of my investment set up for real estate, most of which is tied up in the peak.

Housing reit, which from my understanding you also have funds invested. At the beginning of August, they sent.

Out a pretty depressing update. And after some emails back and forth.

Due to rising interest rates, bad decision.

Making on their part, and needing to pay off a preferred equity holder, it looks like of the 175,000 I have invested, I at best may eventually only receive about 40 to 60% of my investment back. Any suggestions? Thanks for all that you do. All right, so this question from Kyle, let's take the general view of this. He's talking about real estate investment trust, but I think this can be broadened as well to just about any real estate investing opportunity. What advice would you give to Kyle about evaluating these and then what to do once, you know, if one of them's not going so well?

Yeah, well, the benefit of a REIT or, you know, a fund like MLG's is the opportunity for diversification. I think as a general investing principle, whether it's real estate or stocks or anything else, unless you're a very specific expert in the field in which you're investing, diversification is a good rule to live by. And REITs provide that, so do. So does a fund like ours. But I think what we're learning in the market right now is the next thing you should look at is a time tested manager. There are a bunch of real estate companies that sprung up in 2016 through 2022 that all made a bunch of money for a couple years, but had never been through a cycle. And many of those are the groups that are now having issues, you know, with their debt maturities and things like that. So I would say it's important to be with a manager with a good track record and then evaluate the risk profile of the deal as well. If you're an older investor looking to wind down your career, you're probably not looking for a bunch of development deals that have a higher risk profile when there are opportunities out there where you can invest in already existing, high quality real estate that has existing cash flow. So considering the risk return balance that you're looking for is important too.

Yeah, and there's more than just the risk of the real estate itself. Right. I mean, obviously a ground up development's going to be riskier than, you know, a class A core holding that's already fully rented out, but the deal itself has got risk in it you know how much leverage is being used, what kind of leverage is it? Is it short term variable rate debt that's going to have to be refinanced halfway through the deal? You know, there's a lot to walk through here. I mean, we put together an entire online course to help people evaluate, you know, real estate deals. But I absolutely agree with your first point, which I think is the most important aspect of investing, whether it's real estate or anything else. And that's diversification. Because diversification protects you against what you don't know, but it also protects you against what you can't know. And when a deal inevitably goes bad, it sure is great if it's not a huge piece of your portfolio, if it's a tiny piece, then it's a whole lot easier to stomach the fact that it's not going so well. But let's say you're in a private deal and things have kind of turned south. What advice do you have for somebody that's in an illiquid deal that's not going well?

Yeah, unfortunately as an LP investor, there's oftentimes not a lot of control or things you can do once you're already in a deal. I would say probably the biggest advice I would give people is use it as a, as a positive lesson to not make the same mistake again once you're in it. I think there's limited things you could do. There are some opportunities. If you end up realizing a loss, those losses could be useful to shelter some gain elsewhere in your portfolio. Definitely worth a conversation with your CPA on that front. But the biggest thing is don't make the same mistake again. But also don't be afraid of continuing to invest. There's always opportunity in the market. You just need to be with the right groups that can identify and still produce returns in a risk adjusted way.

Yeah, that's the thing with most of these passive deals where you are a limited partner is your due diligence has to be done all up front because then you're along for the ride. And it might be a year, it might be three years, it might be 12 years. You're along for the ride. Things go well, you're along for the ride, things go poorly, you're along for the ride. I've had a couple of deals that I would describe as not going well. One of which was a fraud problem, the operator was actually fraudulent. And the second of which was kind of an incompetence problem. In the first case, it's probably going to be a total loss for me. In the second case, it's going to be a significant loss of principal for me. So this stuff does happen. And this is a reason why expected returns have to be higher to make up for the fact that not all of these deals do well. This is one of the big reasons I think it's helpful to be in a fund rather than individual syndications. You get that additional diversification from multiple assets in the fund, but you still have one manager or one managing team. And so it's a good idea to also diversify between managers by using multiple funds. In my experience.

Yeah, I agree with that. And when you look at an individual deal versus a fund, you should always expect a higher rate of return in an individual deal. For those that have spent some time in the actual models playing with the projections, you learn quickly that the numbers are very, very sensitive to minor changes. And even if an individual deal pencils to greater than a 20% IRR, even if you miss on your rent growth by $50, which know, $50 a month doesn't sound like that big of a deal in theory, it can have a huge impact on your total return. That's why, like you just said, in a fund you can, you can kind of some outperform, some maybe don't perform exactly as planned, but you have a base of diversification that matters a lot.

Yeah, yeah, those pro formas really are pretty easy to make look good. You know, it doesn't take much tweaking to do it. And I've had some funds that have gone round trip or nearly round trip and 15 assets may be in the fund and at least one they just mailed in the keys. They said, we are not making any money on this property. We basically had a total loss in that fund and yet I still ended up with double digit returns on the fund despite the fact that one of their properties was a total loss. So diversification is important. These deals don't all do awesome and there's significant leverage involved and that's risky. All right, let's talk a little bit about taxes. Our next question comes in from Anil. Let's listen to his question about the taxation and where you can get some tax savings with some of these investments.

Hi Jim. I have a passive real estate syndication tax question. I will give you a brief example. If I invested 100,000 in five different syndications over a span of one year and I got paper losses of around 300,000 for those five syndications and in year two, one of the syndications got sold For a total profit of $100,000. Am I required to pay taxes on the gains that I got from that liquidated syndication, or will my passive losses cover the gains that I got from the passive syndication? The popular saying is that the more passive losses I accumulate, the less taxes I would pay. Also, if I keep accumulating passive losses over the next 10, 15 years, buying more or investing in more syndications and eventually die, would my heirs get a step up basis? Thank you for your help.

All right, lots of questions in there. Let's talk about taxation of real estate, syndications and funds, et cetera, in general, and then see if we can answer his question specifically.

Great. You want me to jump in?

Sure, why don't you jump in and give your thoughts on taxation and then we'll try to get to his questions.

Yeah. Well, in general, one of the biggest advantages of investing in private real estate, and this is more specific to a fund like mlgs, where it's an LLC structure as opposed to a reit, that's maybe one critical differential or differentiator. But in a fund like ours, when it's an llc, it's a pass through entity which allows for the pass through of the depreciation to investors. We use cost segregation studies, so we depreciate different component parts of the asset as opposed to the entire asset itself, which allow us to accelerate the depreciation. And then the current tax law allows for bonus depreciation on top of that as well. Which means if you depreciate an appliance or other 5 year property or 7 year property in the first year of your ownership, you can write off up to 80% of that in the first year. What it creates is like this investor mentioned, they invested $500,000, they got $300,000 of passive losses. If you have significant other passive income, this is passive ordinary losses, passive ordinary income. You can use those losses to offset and defer your passive ordinary income, which especially for highly taxed individuals, is a powerful, powerful tool because many times people are paying 50% ordinary income tax rates on that income. And to defer it both takes advantage of the time value of money. And when the asset is sold, you realize capital gains, which are a lower tax rate. So you have permanent savings created by the difference between cap gain rates and ordinary income rates. Now where it gets especially powerful is like this investor mentioned, if you have suspended losses that you're carrying forward and you have a passive loss activity that is sold and entirely disposed of, you trigger a large passive capital gain. The losses associated with that gain when the asset is disposed of are then freed up and released into your tax picture. But the beautiful part of it is they don't actually have to apply specifically to the gain that you realized in the sale. In fact, they can flow through to whatever income in your tax picture is taxed at the highest rates. So for a doctor, for example, if you have $100,000, let's say, of suspended passive losses, and you have a gain recognition event of 100,000 dol, triggering that much in passive capital gain income, those hundred thousand dollars of losses can even flow through and offset your W2 income. And what we see happen is investors have withheld the entire year expecting a large W2 income. And that's usually 45, 50% all in effective tax rate when you factor in federal and state. But then the losses offset that income and they end up just paying the capital gains tax. So we see people get a significant, significant refund on their taxes by capturing the difference in those two rates, which can be typically 15 to 20% depending on your tax picture.

Yeah, this is one of the most complicated aspects, I think, of private syndication LLC investing is just understanding all the moving parts because there's a lot of different categories of income. You've got your, you know, 1241 gains and you've got your ordinary income and losses, and you've got your long term capital gains, your short term capital gains and all that sort of stuff. And it can be pretty powerful when you can start using those losses not just to offset rental income that you might have from other investments, but also to apply it to other things when the property is sold. And if there are capital gains, you can often also use capital losses you've piled up from, you know, tax loss harvesting. You know, you pick up these gain, these losses as you go along and all of a sudden you're able to use them, you know, when you're selling your practice or when you're selling, you know, your house even you can get long term capital gains on your house. And so it's definitely a good idea to keep track of the tax picture, understand all the different categories of income and how they can apply to your particular tax situation. Most people, honestly, when you're getting into these sorts of investments, you're probably not doing your own taxes anymore. The K1s are ridiculous, right? I mean, my MLG, K1, I don't remember, but I'll bet it was 50 pages. It was probably 50 pages sounds about right. And if you got a dozen of these sorts of Funds or syndications. Right. Imagine plowing through all that on your own. This is a real cost of this sort of investing is you're going to be not doing your own taxes anymore, you're going to be hiring somebody else to do it. It's probably going to be a four figure fee you're paying every year to have your taxes prepared. And there's a good chance you're going to be filing in significantly more states than the one you live in. But you know, you've got to ask yourself, is that worth it for a little bit higher returns? Some pretty unique tax advantages. And obviously in my case I've decided that is worth it. But reasonable people can decide, hey, I just want it as simple as possible, even if it means I have lower returns or pay more in taxes. But that's a decision you gotta make on your own. Anything else we can add to the tax picture there?

Yeah, I always just tell people to talk to your CPA then. There's so much nuance that depends on what's specifically going on in your tax situation. It's hard to cover it in a blanket statement. So talk to your cpa. If you have other questions specific to how it works, at least with mlg, we're happy to answer that on our end, but it can be very powerful. I guess the last thing I'd say is don't invest in real estate just for the tax benefits. Do good deals first and then if you make money, which is the first goal, then you can do smart tax planning around it as a cherry on top.

Yeah, that's good advice for everybody. The first thing that often happens to a doc, they go through residency, they go through fellowship, they think they're paying taxes, right? They're not actually paying taxes. And then all of a sudden they've got a tax bill that's more than they made as a resident, maybe a six figure tax bill. And the first question they ask is, how can I pay less in taxes? Well, the best way to pay less in taxes is to make less money and lose money on your investments. You'll pay less in taxes, but that's really not the goal. Right? Your goal should be to make the most money after tax, not just to pay less in taxes. So be careful of that because there's a lot of scammers and swindlers out there that will take advantage of that desire to pay less in taxes to ensure you indeed do pay less in taxes, but end up having less money despite doing so. So thank you so much. Nathan Kleberg for coming on. He is the VP of mlg. He would love for you to come learn more about MLG. You can find out more@whitecoatinvestor.com MLG and learn more about their excellent funds and what they can do for you and your portfolio. Thank you so much for coming on.

Thanks, Jim. Thanks, everybody.

All right, let's take our next question off the speak pipe. This one's about a heritage trust. So let's hear the question.

Hey, Jim, My name is Dan from Texas. I was reaching out to you because my parents are working on estate planning with lawyers in the state of Ohio and they were discussing the idea of a heritage trust, which was a name I hadn't heard before. So I was initially a little bit skeptical, thinking maybe a name that I hadn't heard on your website or hear you talk about might be some sort of a marketing ploy. But looking into websites, there isn't a ton of information on it. But a couple individual lawyer websites for estate lawyers do seem to mention it as a type of trust where the trustee is the beneficiary and they manage all the assets, but there's a distribution trustee who manages all the distributions from that trust. So we're kind of in a situation with myself and two siblings and everyone's got a good head on their shoulders and no one's really struggling financially. And so my parents are kind of considering a three way sibling heritage trust. Just wanted to see if you thought that that was a good idea or if you had any other information on the topic. Thank you.

All right, great question. Wonderful to hear that you're in this fortunate position. Your parents and siblings and you. Good job to everybody involved. Right. People should be congratulated when they're successful to this degree. And so good job to everybody. Lawyers are funny and trusts are funny in that there's a lot of marketing involved there. Right. It's a competitive business, right? I mean, there's lots of attorneys in a given state and they want your trust business and there's only so many people that need trusts. You know, there's lots of people that don't have that much money and only a few people have enough money and concerns that they need a trust. So you want to capture that business. And the way you do that is through effective marketing. And a particularly effective way to market is to come up with a new name for a trust. And so I'm always seeing new names for trusts. And so this one was new to me. A heritage trust, well, I googled it as well. Just like you did, and read up on what people were calling a heritage trust. And it's just another irrevocable trust. Okay. Which are the ones that are used to ensure that your wishes are carried out after you're dead. Right. It provides asset protection to you when you put money in an irrevocable trust because you can't take the money back out. But mostly it's an estate planning tool. And I'm a big fan of estate planning, especially if you've got enough money that you have to start worrying about estate planning, estate tax issues, more so than just who's going to take care of your kids if you die young and who's going to get your stuff and you're putting together an I love you that goes to your spouse afterward. I love you, Will. Maybe you don't need a big fancy trust, but for those of us who have enough to worry about estate taxes, those of us who have complicated blended family kind of pictures or concerns with son in laws and daughter in laws, then you need a trust to deal with all that. So the definition I saw for a heritage trust was simply one, an irrevocable trust where you're trying to hose your in laws if they get divorced. Right. That you want your money to go to your grandkids, not that no good son in law in the event that he leaves your daughter. That's a heritage trust. Well, that's an easy provision to put into any sort of irrevocable trust. Whether you call it a heritage trust or dynasty trust or whatever you want to call this sort of a thing. It's just putting your wishes into the irrevocable trust that you're leaving behind to your kids. Now, trusts are governed by state law, so they're state specific. You need to see an estate planning attorney in your state. But as a general rule, the beneficiary and the trustee that controls distributions, not the investments. But distributions often has to be a different person. For example, our irrevocable trust, its particular flavor is called an idgt, Intentionally defective grantor trust. And a specific type of that is a slat, a spousal Life Access trust or whatever it stands for. I think that's what it is. Anyway, the point is, this trust is an irrevocable trust. The beneficiary is my spouse, the investment trustees are my spouse and I. But there is a distribution trustee that is not a beneficiary, happens to be a relative of ours whose job it is to determine the distributions. And then there's a Trust protector you can put in place in case your trustee sucks, and you can change the trustee. But the bottom line is the distribution trustee could not be Katie or me. It had to be somebody separate. And it sounds like that's probably the case in your state with this particular type of trust. But the bottom line, you go in, you talk to the attorney about what you want to happen, they tell you what's possible under the law, and you try to get as close as you can to what you want with what's possible. We all want this super flexible thing that costs nothing and is super easy to maintain. And that's not always the case, but you do the best you can, so hopefully that's helpful to you. I wouldn't say Heritage Trust. Oh, you need to run. This is something terrible. Someone's going to scam you. It's just another name for the provisions in an irrevocable trust. All right, next question off the speak pipe. This one's going to be about the home office deduction.

Hi, Jim, this is James in Texas. I had three questions about home office deductions. My first question, does a home office need to be one continuous space or can it be multiple spaces? For example, if I have a desk in a bedroom that is used only for business, and if I have a large closet that I use only for supplies, but they're in separate areas, can that be part of the same old office? Second question, can the home office be used for multiple businesses? For example, if I have a property rental business and I have an S Corp for patient care. And third, can I take the home office deduction and additionally rent out my house to my business for board meetings and the Christmas party? Thank you very much. I appreciate what you do. Have a nice day.

Great questions. First one, I don't think there's any problem with splitting the space. The rules for the home office deduction, you have to be in business for yourself. Number one, you can't be an employee, but you have to be in business. You have to actually be running a business out of this space. But the rules are exclusive use and regular use. If you're using that space for anything else, that's not exclusive. If you use it once a year, that's not regular. The IRS has not necessarily defined regular, but in an audit, those questions would come up. The easy way to take this is just the standardized way is $5 a square foot up to 300 square feet. That's $1,500 a year. And you don't have to keep track of all the expenses of your house and divide it by the percentage of your house that is being used for this business and then subtract add that to the basis when you sell the house later. The simplified deduction is the way to go for most people just for ease of use. But for those of you living in expensive houses, especially if you have a pretty big home office, that's probably not the biggest deduction. You could probably get a bigger deduction by keeping track of all that and only you can decide if it's worth it or not. Does it have to only be used for one business?

No.

But I'll bet when most people report this, if they've got multiple business, they probably put it on one business. Now, does that break the exclusive use thing? I don't think it does. If you're using this thing for business right now, if your kids are doing homework at that desk, that's maybe not exclusive use. If you're doing a bunch of other stuff at the desk, your volunteer work or something, maybe that's not exclusive use. But let's be honest, nobody is coming to your house and watching you 247, 365 to see what that desk is being used for. So there's a little bit of a spirit of the law here that we're talking about. Remember, for corporations, the way to do this sort of a thing is to rent the space from your corporation. You know, and so that doesn't necessarily help you tax wise. It changes it, you know, maybe from one kind of income to another, but doesn't necessarily help you. If you're just taking a deduction on one side and then it becomes income on the other side, it might not be super helpful to you. The exception, of course is if it's being rented for 14 days or less a year. What you talk about in your last question, okay, and you can take the home office deduction and rent the house out to your business. You can do both of those in the same year. That's not a problem. We do that here at WCI because the space I'm claiming for my home office is not the entire space that we use for our meetings. So I think that's completely legit. Okay, let's take another question. This one comes in and it's related to a blog post and an event that happened a couple of years ago in the great state of Washington. They had basically some legislation passed that forced everybody to either buy long term care insurance or pay a tax. And if you didn't have much money, the tax wasn't very high, but if you had a lot of money, it turned out it was cheaper to just buy long term care insurance than it was to pay the tax. And not to mention then you had long term care insurance. Whether you needed long term care insurance or not, you had to do one or the other. So now this doc from California writes in I've been following you since med school. I've continued to do so as a practicing physician in the Bay Area. Your advice has saved my family and others lots of money. Thank you so much. Blah blah blah. I recently heard that California State may be closely following Washington State to consider mandating a statewide long term care tax in California and that it may be implemented as early as in 2024 without any warning for preparation. I was previously quite scared to learn about the disaster with the implementation of Washington State long term care tax that many Washington State residents were scrambling to obtain private long term care insurance. Assuming a physician family makes 600,000 to $700,000 annually and a minimum of 0.58% California state tax rate to fund the LTC program, the LTC state tax can mean an additional $3,600 to $4,200 in state tax a year. I'm wondering if my family should consider buying private care insurance that costs less than $2,000 a year for the entire family with a combined benefit of about $144,000 by the end of this year. So my family can opt out of the state mandated LTC tax in the future. There can be options to just pay for 10 years for the private LTC benefit with the three times higher premium than lifelong payments and we don't need to contribute afterwards. However, it is hard to gauge the minimum total payout. I heard the current minimum for LTC insurance in California state is 3,000 per month for 12 months times 2 years per person equals $72,000 per person. Maybe needed to opt out of the tax as details have not been disclosed. Transferability to other states and termination flexibility are other issues that I'm not sure about. I was originally planning to save enough so my retirement pools will cover long term care costs, but it seems like the climate of California and other 10 states is pushing taxpayers to make less than ideal financial decisions. It also seems unfair to current California residents who may leave the state in the future for various reasons. Any insights and suggestions on this issue will be highly appreciated and valuable. Thanks in advance for reading. Give us an advice. Okay then he says. Please talk about this in a blog post or podcast. Well, we'll do it on the podcast. It's a hard situation. It was a hard situation for all these in Washington because things changed. What happened once this legislation started getting finalized is all the long term care insurers left the market in Washington so you couldn't buy became a problem. People had to pay the tax because they couldn't buy long term care insurance. So knowing that can happen, the safest thing to do, although it may end up causing you to spend money you wouldn't otherwise spend, the safest thing to do is to run out there and buy insurance now while you still can. So I guess that's what you probably ought to do now. You could cancel it next year. If it has any sort of cash value in it, you could roll it over into another type of insurance or you know, cash out of the cash that you, you have in it. But without knowing the details, what you buy might not meet the requirements. So there's some risk there, there's a lot of legislative risk that what you do won't actually work. So it's a bit of a gamble. I don't know what to tell you. Without a functioning crystal ball, without sitting there in the committee meetings with the legislators, I don't know how likely this is to pass at all. Number one. Number two, what it will look like. Number three, what the long term care insurance market will do in response to it. I'm Also, you mentioned 10 other states. I couldn't even tell you what those 10 states are that are thinking about doing this sort of thing. I agree with you. It was a disaster in Washington. I thought it was a terrible rollout the way they did this law. And if this starts becoming more commonplace, I think more people are going to struggle with exactly what you're struggling with right now. Obviously $2,000 beats $4,000, especially since you're actually going to get something for your $2,000. But it's not guaranteed that you'll have to pay $4,000. And once it is guaranteed, you might not be able to spend the $2,000. So you're really in a catch 22. I feel bad for you. Yet another reason maybe California should have fewer doctors than it has. High taxes, high cost of living. You know, it sounds like you're making good money, but lots of docs aren't being paid all that well in California and now this. You know, Nevada, Arizona, Oklahoma, Texas, they'd love to have you. But if you're dead set on staying in California, there are patients that need you there and you'll have to decide what to do about this issue. I hope that advice is helpful to you. Take a look at the column I did about Washington. That's whitecoatinvestor.com Washington Long Term Care Insurance Law. Read the comments section. It talks about docs and how they made their decisions and you know, how things changed over time. So it's really interesting, you know, as a kind of a case study of what happened in Washington. But there's no guarantee that your experience in California will be the same. I estimate that 80% of doctors need, want and should use a financial advisor and or an investment manager. Some investment gurus, such as Dr. William Bernstein, think my estimate is way too low. At any rate, if you want to use an advisor temporarily or for your entire life, there's no reason to feel guilty about it. Just make sure you're getting good advice at a fair price. If you need help updating your financial plan or just getting one in place, check out our list of recommended financial advisors@whitecoatinvestor.com financial advisors. You can do this and the White coat investor can help. Don't forget about WCICON24. Today's last day for early bird registration. So if you're just hearing this, go home tonight and register wcievents.com yes, you'll still be able to register afterward if it doesn't fill up, but it's going to cost you $300 more. So we're selling it for the same price we did the last two years. We haven't raised the price right. You're paying more for everything else in your life, but not WC Icon. We're keeping the price the same now. I guess if we start selling out in two days like we did at least once in the past, we may have to raise the price at some point, but for now we think it's a fair price. We think we're putting together a great experience and we think it's well worth the money. So please wcievents.com love to see you there in person. Don't forget to sign up for the Champions program if you are a first year medical or dental student whitecoatinvestor.com champion, you can get all the information about that. It's not a huge commitment and you'll be a hero to your class. Thanks for those of you leaving us five star reviews. They really do make a difference and help us to spread the word about this podcast. All right, keep your head up, shoulders back. You've got this. We'll see you next time on the podcast.

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