Ep 056 - The Smart Homeowner’s Guide to Tax Deductions

Welcome to Be a Smarter Homeowner Podcast, where you'll discover strategies to save money, save time, and be better organized in managing your largest financial asset and biggest expense, your home. Your hosts, John Bodrozic and Beth Dodson, who are co-founders of HomeZada, have been supporting homeowners for over 20 years. They are here to share with you their tips and suggestions, as well as interviews with industry experts, with the goal of helping you become a smarter homeowner. Now, here's your hosts, John and Beth.

Let me ask you this. Are you ever paying on your taxes and don't even know it? Because for most homeowners, your home is your biggest financial asset, but also one of the most misunderstood when it comes to taxes, deductions, and total long-term financial strategy. So today we're breaking that down. Today we're joined by Craig Sheets, founder of Crestville Accounting, a CPA firm focused on helping individuals and businesses not just stay compliant, but actually save money and make smarter financial decisions. With nearly 25 years of senior-level accounting experience across both public and private sectors, Craig has worked across everything from individual tax planning to complex business and estate scenarios. And what we love about Craig's approach is that it's not just about filing taxes, it's about helping people keep more of what they earn and make better financial decisions. year-round. Craig, thank you so much for being here and welcome to the show. I am so excited you are here.

Yeah, thank you so much for having me on the show. I'm so excited to talk to you and talk to your listeners and kind of get some, some ideas out there and maybe break some myths about things and demystify things because people hear stuff around and have conversations and you got to make sure you have, you know, talk to the right people.

Yes. And so that's— let's just start it off. What's one of the biggest myths or misconceptions that homeowners have when it comes to taxes in their homes?

Well, you know, it's interesting because there's a lot of different ways people— when it comes to real estate, you know, if I have a new client that comes to me and they say, I have some real estate, there's so many questions to ask. You know, how do you own the real estate? Who owns the real estate? Do you rent the real estate? Do you plan to rent the real estate? When people own the homes in their individual name, They have some deductions that they can take for that home, and a lot of times they forget. In this year, starting this year, and I think it was January 13th, it was the day that the president got inaugurated. They made the changes. So it's like January 1st to January 12th, the rules didn't apply. And I think it was the day he got inaugurated. He was a little funny or cheeky, as they'd say, to say, all right, we're going to make these rules start for the OBBBA, the O triple B A. Um, on January 13th, I think it was. But the rules now, um, one of the big ones that people forget about because they've been so like ingrained with this cap on, on taxes, that you can actually now deduct up to $40,000 of taxes for the— well, there's multiple things. It's not just your home.

Yes.

It's your state income tax if you live in a state in which you actually pay tax in. And then there's taxes, and people think, okay, yeah, real estate taxes. Well, no. It doesn't stop there. There is a special clause within the IRS for, for those that itemize. You can actually take sales tax on specific items on renovations of your home when you are able to itemize your taxes. And that's a big if. Some people don't have enough to itemize, some do. Um, that Schedule A is a really big place you can take deductions on. It's a really good, good spot to take deductions on.

Um, that's huge.

And sales tax. So what happens is, let's say you're in Florida, right? You're in the state of Florida, which is where I'm from.

Yeah.

Where we're at. Yep. There's no state income tax. You think, okay, well, there's no space for me there for anything else besides real estate taxes to take deductions because I don't have any, uh, income tax taken out of my payroll. Well, let's just say you do live in Florida, or let's say you live in a state like Texas where you don't have state income tax.

Yeah.

The big thing is, if you have a major renovation you've done to your home, there are specified items within that that are, you can take sales tax from those renovations and certain expenses from your actual home as deductions on your Schedule A in addition, so plus, in addition to your real estate taxes.

This is huge. Huge.

People forget about that. So let's, I've had, you know, you have clients come to me saying, oh, you know, I don't have anything else in my house. I don't pay income tax. I got real estate taxes. I'm like, well, did you do any renovations to your home? Oh yeah, I had a $40,000 renovation in my home. I'm like, hang on a second, we got a tax deduction opportunity here. Let's break it down. So what I make my clients do, or what you, you know, you should work with your, your CPA or me if you need one, you want to talk with them to say, right, give me a breakdown of what you did to the home and then let the CPA work on it to find out specifically line by line What is sales deduct— sales tax deductible? Take the sales tax in the county you live in and then multiply it times your state, say, your area's sales tax, and you take that as a deduction on your Schedule A in addition to your real estate taxes.

Dude, this is like, this is like big because if I recall correctly, some of this renovation type activities, especially on, for instance, like rental units that you may have, it was like a deferred process for a really long time. And so you're saying that some of these renovations, and I forgive the phrase, is it capital assets? Yes.

And I'll go into that. That's a really good point.

Yes, please.

So what you're talking about now, so I always refer— this is good. I'm going to break this down into 2 categories for the listeners. So the first one for this specific topic, let's just talk about sales tax just for a minute. There's 2 different topics. The first is if you're an individual homeowner, you don't rent it out, you just own your own home. and you have a renovation on your home, you can take sales tax on a portion or different parts of the renovation of your home, which is great. You know, you did— before you were capped at $10,000 by the government. Now it's $40,000. Again, there's some rules on your MAGI, your modified adjusted gross income. It's under a certain threshold. Talk to your CPA about that. But assuming there's no threshold issues with you, take the sales tax on your home for the renovations. That's if you own a house. Now—

Your primary home.

Your primary home. Now let's leap over into rental property. Let's bridge that gap. Let's get this topic into rental property. So this is a home you use that you're making money off of, not just renting it for a day or 2 days. You're talking about usually long-term rental of the property.

Yep.

And you have deductions against that. And what you were just mentioning was there's 2 components to the house itself. There's the capital fixed asset of the home, and within that, you take that over the lifetime of the usually residential property, Typically, it's 27.5 years, and you bleed that out. So, if you bought a $275,000 home, you're going to get that deduction in incremental amounts over that time period. It doesn't matter what it is. It's 27.5 years. Then you can also take deductions quicker than that, like the sales tax. So, let's say you did a renovation to the house. Let's say you did a new kitchen, right? Yeah.

Did a new kitchen.

You got cabinets. You got Appliances. Appliances, all those things.

Counters.

Those items then also become fixed assets, but they're depreciated at a different level. If it's, if it's part of the home, it sticks to the home, it sticks to the 27.5 years. But of that, you can, you can extract out of that cost and squeeze out of that to be quicker, and you can take the sales tax of those items, remove it from the depreciation, move it into a quicker bucket, and then you can take that sales deduction faster than you could on the 27.5-year portion of the fixed asset.

Which is fantastic because if people are, let's say they're older and they're buying a property and they maybe— I'm not saying that's going to happen, but let's just say somebody passes away, then they never even get to receive all those deductions because then it has to get sold and then it gets passed on to family members or what have you versus them being able to take more of the deduction in their lifetime.

In their lifetime.

Oh my gosh, it's huge.

So doing that, and then there's another component. So again, we're going to stick to the topic of rental real estate. There's also something called cost segregation. Have you heard of cost segregation before? Are you familiar with cost segregation?

No.

Okay, so it's a fancy term for taking your house. So imagine your house is like a, um, oh, Like components of inventory, right?

Yeah.

You're going to have a house. Part of your house is going to be cabinets. Part of your house is made up of a roof. Part of your house is made up of walls. Some of it's going to be— I'm just thinking of all goes in a house. I don't know why I'm like, but you know, it's different pieces. A cost segregation company will come in and say, right, you own a house, but there are different categories from the IRS that allow you to depreciate the home in different manners based on what it is. So, cabinetry might be a 10-year depreciation cycle. A roof might be 20-year depreciation cycle. Maybe your actual foundation is 27.5 years. Maybe your flooring is going to be 15-year cycle. So, what the cost segregation company does, they're a licensed company that works within the IRS's regulations and they say, I'm going to break your house into different components.

Sure.

and you're going to have 5-year, 10-year, 15, and 27.5-year assets. Go to your accountant with that cost seg study, change that $275,000 house and say, right, $20,000 of it is going to be 10-year, $32,000 is going to be 15. Now you're speeding up the depreciation cycle because you broke the house into different components.

And by the way, so I know I didn't know this, and how many other people have not understood this and know this? And all the more reason why you need to be with an experienced accountant, by the way, because this is complicated.

Right. It is. It is. And it's different. It's not so much just you can take a house and go, right, I'm going to depreciate it and it's this number of times. Well, there's things you can do. Look at the sales tax of your renovations. Look at the cost segregation of your house. When you have rental property too, and I'm going to dive into rental property deductions. Is that okay to change topics now?

Absolutely. Let's do it.

Okay. Let's stick again on the second. We got 2 camps we're talking about, homeownership individually, and then we're going to talk about homeownership as a rental, you know, actual.

Okay.

So, we're going to stay in the rental side of things. There's a couple of things people may forget about when you're renting out your home. If you are a regular homeowner and you have no experience in real estate, you're not a real estate professional, but you are actively managing your home, The IRS gives you up to $25,000 loss on that home. Again, it's based on MAGI, modified adjusted gross income, under a certain threshold. If your total income is under a certain threshold, if you're— I won't even go what they are, but just—

Yeah, yeah.

There's certain thresholds. You know the IRS, they don't make it too easy for you, do they? No. So, if you're— just assume, we're going to assume all my scenarios, everybody's within the regulations of income. You can take a $25,000 loss on that rental property as long as you're actively managing that rental property. So, that's all your deductions, your depreciation, all your expenses minus your, you know, your rent is your income minus expenses. You can take up to a $25,000 loss. Now, some people choose to use a management company so they don't actively manage their home. They're passively managing their home. And when you passively manage your home and use a management company, you can't take that $25,000 loss. So everyone says, oh, use a management company, it's great, you don't have to do anything. Great, you click that box off and you're no longer a non-passive owner. Non-passive means active, which is—

Yeah, yeah, yeah.

Oh, it's contradictory to me. But anyways, non-passive means you're actively managing it. Take that box away, you're passively managing it, you lose that, that $25,000 deduction. And now you have lost a major benefit 'cause you're using a management company 'cause you're not actively managing your rental property.

Yeah, so for people who are listening, this is, we're not telling you not to use a management company, but we're telling you to evaluate the situation that's going to best work for you.

Very good point. Very good point. Very good point. You're right.

Oh my gosh, this is wild.

But then here's the thing though. Is that $25,000 deduction worth it to you if you don't have a manager company and you're going to lose renters Exactly, Beth, exactly what you said. Sometimes that deduction, which might equate to what, $2,500 or $3,500 in your pocket, sure is extra deduction or extra tax refund. But is that worth it if you don't know how to manage your own home? You got to talk to your professional advisors and talk with your own situation. Now, there's a third scenario. This is getting extreme. This is extreme.

I love it.

You really want to be extreme now? You can go out and get your professional real estate license. Become a realtor, become a professional. The expense losses are then unlimited. So active professional realtor managed real estate has an unlimited loss on that. Well, again, talk to your accountant. It depends on your tax situation, all that. But then you're not limited to $25,000 because you're actively managing your own property and you're considered a real estate professional. Is it worth getting your real estate license? If you got 7 rental properties, And you want to manage your property, your own properties, and you have a big loss, it might be worth you getting your real estate license just so you can say you're an active professional real estate advisor managing your own property. This is like—

this conversation just started off with a big bang. So this is huge. Yeah, no, but this is good. This is huge because we're looking here at renovations. We're also looking at here of existing primary homes that you live in. For those people who own rental properties, which there's a lot of people that are either experimenting with this, do this maybe with a vacation home or a second home or what have you, or people are determining whether or not to do this, get into the real estate space of rental properties. These are huge decisions that people need to consider because Time is valuable. So if someone's working a full-time job and they don't have the time to manage all these properties, obviously they may have to hire a third party to do that. But if they— if there's one person in the family that has availability and they want to become a real estate agent, that becomes a whole other opportunity.

Huge.

When managing these properties. I mean, this is huge.

Yeah, no one thinks about that. And we talked about cost segregation as well. That's another good thing to do. You can take those deductions faster. Now, if you're going to just kind of toy around with renting your property, let's say you just want to rent it for a small, small, small period of time. You don't want to be into this active rental real estate. There's a rule based on the Masters, believe it of all things, golf, called the Augusta Rules.

Yeah.

And it allows you to rent out the house for a certain period of time, but you don't have to prescribe to all the different regulations that the more complex long-term rentals come into. So, talk to your CPA about something called the Augusta Rules, which came from the Masters because people would rent their homes out for 2 weeks at a time and they got straddled with all this rental real estate depreciation recapture complexity thing.

Yeah.

And the IRS finally said, right, we're going to make up a new rule called the Augusta Rule. Talk to your CPA about short— that's very, very, very, very short-term rentals. That way, you don't get caught up in all these these rules and problems when it comes to, you know, depreciation recapture. We can get into that later. But there's a lot of things you can do to manage your property. If you stay in it, I'm going to stay on the rental property. I can give you some ideas about extra deductions you can take if that helps.

Oh yeah, let's do it.

Okay. So when you rent a home and you're actively managing it, there are things you can deduct that you normally otherwise couldn't deduct If you are passively managing it. So let's go through a couple of those. So let's say you drive to your rental property. Let's say your rental property is on the beach or your rental property's a flight away from where you are.

Yep.

You may have to fly to see your rental property and to number one, check on it to see if it's okay. You may have to drive to your rental property. Those flights to where your rental property are, are then deductible on taxes because you're checking on an actively managed property. Let's say you live in New York and your property is in Miami.

Yes.

You're flying to Miami to check on your rental property, aren't you?

Yes.

Of course you are.

Oh my gosh, that's brilliant.

Or if you're in Hawaii, you know, you're flying to Hawaii to check on your rental property, right? So those are things you can look at to take as a deduction because you're actively managing your property, right? That's one of the things you're doing. And now that some of these deductions— driving to your rental property, Flying to your rental property, these things then become deductible for you. As well as, let's say you use cell phone. Maybe you have to talk to the renters, or you have to talk to your management company, or you have to talk to the, I don't know, repair people. That cell phone, part of your cell phone usage now becomes deductible as well because you're using your cell phone to manage an asset.

Yeah.

Therefore, part of your cell phone usage.

Conduct business.

Right. Also, internet. You know, you have your internet at your house. Maybe you're actively managing Your management company or you're checking in, you can see the rent being paid. You need some of your— a fraction of your internet as well to take a deduction for the rental property as well. So you need internet services. There's another deduction you can take for rental properties.

Yes.

If you get really, really aggressive with rental properties, you have 7 or 8, you then can start taking fractional portions of your home as a deduction. So in other words, let's say you have an office space You know, like, I'm kind of here in a big office space, like 20 by 15 over here. And let's say that you manage 7 rental properties. You got a lot of rental properties. That's what you do. You got your license. You decided to go all in. Now you can take a fractional portion of your home as your deduction because you're, again, you're actively managing real estate and that's your business. So now you can take a fractional portion of your home's utilities or mortgage or real estate taxes or insurance as a deduction against your rental property.

So this is— so what I hear happening is if you are managing your rental properties, because we're stuck on the rental properties for right now, if you're managing all of these properties and you're taking an active approach, then basically you are acting as a business.

Yes.

And so as a business, Yeah. This is the cost of doing business. Therefore, it becomes a deduction in some capacity. Speak to your, your own personal accountant, the CPA, please.

Yep.

In your region, in your county, in your state.

Something.

And, and understand that, that this aspect of running a business has tax deduction implications.

Right. And you want to make sure you talk to, again, your specific advisor. Each person could be different. It could be passive, it could be non-passive. You could own it in a partnership. All the rules change depending on how you own it. Don't just take that as gospel. But I'm just saying there's some opportunities out there if you plan for it that you can take deductions you may maybe otherwise think you couldn't.

Yeah, we're all about planning, planning and preparation.

Yes.

The more visibility and more information we all have, in managing our homes and our properties, the better we can make decisions. And you offered up several new decisions that I think, or options that I think other people can consider that they may not have ever known.

Right. Well, that's good. That's what I'm trying to do is educate people. And, and when I work with my clients, the first thing I do is I talk to them and sit them down and understand more about how they use the rental property, understand how they're Plan on future use. Do they want to use it as short-term? Are they going to retire soon? They want this a little long-term. Because if you're going to own this for a short period of time, 2, 3 years, is that cost segregation worth it or not? Or if you're going to own it for a long period of time, is the cost segregation worth it? Do you want to suck up all the expenses now and then sell it later, or do you want to draw it out longer? It's different for everybody. You know, there's no certain one rule.

Yeah.

But understanding, like you were saying, all the options gives you a chance then to be able to make a better informed decision. Yes.

And so, absolutely. And so I have another question as it relates to properties, and it keeps coming up, and I'm a little unclear about what it is. So I want to make sure that our audience is clear. Okay. And it's like, what's the difference between a home repair and a capital improvement from a tax perspective?

I love this question. I love this question. So it's not as easy as this, but I try to equate it as if it's something that's stuck to the house, Or sticks to the house, that is a renovation versus a repair. But it is, it is a little bit more confusing than that. Let me tell you, there's 3 different categories for property.

Okay.

Okay. There are appliances, and a lot of people get appliances confused with, with the home itself. Appliances can be taken out and put back in— refrigerators, ovens, washers, dryers. Those are depreciated in their own way. 5, usually 5-year, 7-year, depending what it is. And those are totally different kind of asset, which is appliances. They got their own little bucket. Now, there's repairs and then there's renovations.

Okay.

So, a repair is something like, um, maybe a small hole in the wall that needs to be repaired because somebody knocked it through, or they, or they put like some paintings on the wall and they put nails in the wall. And they have to go hire somebody to paint the wall. So paint would be a repair. Any kind of paint in a home would be a repair. So if you get someone to do a brand new kitchen, which the kitchen itself is going to have 3 parts to it, you're going to have appliances.

Yep.

Which would be a 5-year asset. You're going to have renovations, and I'll get to renovations, what they are in a minute.

Okay.

And then you're going to have repairs, which is the paint. So the final part, which is the paint of the actual prop of their kitchen, that painting of it, That literally is going to be a repair, and you can deduct that immediately. There's no long-term deductions on repairs. Renovations— and I saved the renovations till last, and I know that was your main question.

Yeah.

Because it's not confusing, but it— you got it. It's very specific. So renovations are major improvements to a property, and sometimes there's even a threshold associated with it as well. So I usually use a threshold of $2,500. So if there is a wall, right, a wall can be a repair if it's a small, like, a hole in it.

Yes.

Or there's a little nail in it, that's a repair. But if you're gonna rip down an entire wall in order to expose to make your kitchen bigger, Yes. 'cause you're gonna make an open floor plan kitchen, that's— that tearing that wall down is gonna cost you more than $2,500 by the time you get the people in there. That's a renovation.

Mm-hmm. Yeah.

So you got that same wall, you got damage because someone punched it or, or put a hole in it.

Right.

That same wall is a repair if it's under $2,500. But that same wall you tear down to make your kitchen an open floor plan is a renovation. So I didn't ignore the question, but renovation and repair, that's a great, great, great question because one is going to be depreciated over 27.5 years and one's deductible right away. Repairs are immediately deductible. Renovations are long-term.

Okay. And then, so I have a quick question because you brought specifically up appliances repairs and renovations. So equipment like HVAC equipment, hot water heaters, water heaters, whatever, where do they fit in this category?

Yeah, that's a really good question. Now when you buy a house, everything that's inside the house is— everything in there is going to be 27.5 years. That's okay. Bought a home, think of it when you buy the house, there's no separation of everything, right? It's just a home, 27.5 years. As you repair each appliance, then that appliance now gets its own brand new life as a brand new living, breathing entity, and you follow the rules of the IRS. So water heater is going to be considered now— it's a brand new asset. Now you follow the rules of the IRS, and I think it's 10 years for water heaters.

Okay.

Don't quote me on that, but it's a different life cycle. Air conditioning units are a little bit different because there's 2 components to an air conditioning unit. There's an air handler Yes. Which I— it's not the dumb end, but it's not the— it's at the end that just the air goes through and all the coils are in there. That would be considered part of the home because it's a structure. But the compressor, which is the smart end I call, which has the fan and it's electric and it— you always hear it outside blowing away. And, you know, if you've got a quiet one, even better. That's great. That's going to be considered a fixed asset, and that's depreciated over like a, again, a 10-year useful life. So even within an air conditioning unit, you know, if you want to say and kind of squeak by the rule, the whole thing's the air conditioning unit.

Yeah.

When you buy it, maybe it's 10-year, but you're supposed to handle the air handler a little different than the compressor. But even that can be confusing, right? When you buy appliances, what is and what isn't deductible right away. So an air handler, I would consider more as part of the home structure, where a compressor has the fan and has moving parts. Moving parts. You know, that's a good question. If it's moving parts, it's an appliance, or if it has electricity, it's an appliance. And if it doesn't, it's part of the home.

Oh, interesting. Oh, that's a great way of looking at it.

That's a good way to look at it. I think that's the simplest way. With the air handler, I don't— maybe I don't know enough about them, but there's, there's components of air handler that are home, and there's part of air handlers that are, that are appliance. Some people lump it all together and do 10 years. I'm not looking. What do I know? Sounds good to me.

Yeah, no, I mean, but this is okay. So we are identifying that the house is a complex, comprehensive entity in lives, and it is— we have a lot of options on how to manage it, even from a financial capacity. Oh, it's amazing.

This is just the home. We're not even talking about how best to own a property. There's different ways to own a property that are beneficial tax-wise. So you want me to keep going, or you want me to keep— you want to talk more about the rental property deductions?

No, let's keep going. So one thing I do have a question on though, because we're on kind of this topic of renovations before we get into owning a home is there are improvements that you can do to a home which are expenses, and they can, if you've done them in a certain period of time, if I understand it correctly, they can reduce your capital gains on the other end. Is that correct? Or how does, what does that, tell us a little bit more about why, how these projects can help us or not.

Let's go through that. So that's a really good question. Here's the thing is people kind of think it's an all-you-can-eat buffet when it comes to when it comes to home and taking deductions, and everybody's really, really happy as you're depreciating the house and you're taking bites out of the buffet of getting those deductions in the form of depreciation. But remember, just like, just like when you, uh, own a stock—

Yes.

Maybe it's a good word if people know the words basis. Basis is an important word, right? You own stock, that's your basis. The basis is the date, the value on the day you buy it. Homes are the same thing. They have a basis, which is The value of the home on the day you buy it. But there's things you eat away at that basis to make it a lower basis, and that's called depreciation. You're taking bite-sized pieces of that home in slices of 27.5 years for the whole home, assuming you don't do a cost seg, but it's 27.5 years. You're taking slices away and reducing down that basis to eventually zero if you own it for 27.5 years or more.

Yeah.

Now you have no basis in that home. Oh my gosh. Well, what just happened? My home value is going up, right? But my basis is going down because I'm using it as an expense over the lifetime of the home. So now what you're doing is you're creating a long-term capital gain in larger increments because as you eat into the home's value, you're lowering your basis. And the lower your basis is, the bigger your gain. So let's use that example.

Sure.

You said about a $275,000 home.

Yeah.

Okay. You buy that home and the day you buy it, it's worth $275,000. You put it into rental. And now let's just say you don't rent it at all and you sell it that day. You have zero basis. Bought it for $275,000. You sold it for $275,000. You made a mistake. You didn't want to own it. You owned it for one day. There's no gain. Now take that same home in 30 years from now and you depreciate it over 27.5 years. Now you have zero basis in the home. I don't want to get too weird, but you can't depreciate land. Land isn't depreciable. So let's just, just say the home is worth $275,000. Forget about land. I know CPAs might be listening and say, what about the land? Well, yes, there's a component of land. Let's just talk about the house. House is $275,000. You slice away at it in little increments. All of a sudden, 30 years later, you've depreciated the entire value of the home. You're zero now. Zero.

Mm-hmm.

Zero. Now, when you go to sell that home, you have to recapture that depreciation in the form of the sale proceeds minus your depreciation equals your gain. And there's 2 types of gain. There's short-term gain, which is less than 12 months, and there's long-term gain, which is more than 12 months. 90% of people that own rental properties— I dare say 99% of people own rental properties— it's going to be long-term. You don't usually buy out— rental property and 2 months later sell it. Typically, you keep it for long term. So we'll stick to the idea of long-term capital gains. So when you sell a home, it's whatever your depreciation— depreciated remaining balance is, right? So if you're in the middle of a 27-year cycle, let's say you're in year 10, you're going to have some asset left, you're going to have some basis left. It's whatever the remaining basis your CPA tells you it is. He's in control of that, kind of what your depreciation is.

Sure.

Minus whatever you sell it for, that's gain. Then you take that cap gain and there's different levels based on how much income you make. So the first X number of thousand is 0%, and the next is 12%, and 15%, you go up to like your 20% max on that. But that's what you're going to pay. You're only paying no more than 20% capital gains on the sale of that house because you're— that's your long-term cap gain rate. But there's depreciation recapture, gets a little bit, you know, convoluted there.

Sure.

Be careful. I always joke around and say people eat at that buffet of depreciation. They're all excited and gobbling up that depreciation, and all of a sudden in year 12, you're like, I'm selling the house, why is my gain so big? Well, because you ate away at the home and that full-on buffet of depreciation lowered the cost value of the home. Now all of a sudden your gain's much bigger because your basis is lower. You ate away at that basis in the form of depreciation.

Okay, so that makes complete sense. And I think we're giving people some more information so they can make better decisions when they want to sell their house.

I like visual buffets.

That's a weird— It totally works. But then if people add to their home, so whether they made additions, they've made renovations, what's the impact of those renovations on that tax basis?

Beautiful.

So now we have a, again, a situation where you have a $275,000 home, you're eating away at that with depreciation. Now, If you decide in year 12, you know what, I don't like this half of my house, I'm going to knock this house— this half of my house down, and I'm going to renovate that house, that side of the house, for $200,000 or $225,000. Let's make it a nice number. Now the home has been bumped up to a basis of $500,000. That's the new basis because you add that depreciation, you add that value into the asset to be depreciation.

So, okay.

Any renovations to the home, major improvements to the home, add value. They increase the basis, increase the value of the home, which give you a higher basis. Now, when you go to do— this is interesting— now, when you go to do a renovation to a home, you can ask the contractor for more of a breakdown on all the specific things he's done.

Yeah.

Give it to your CPA, and he can say, all right, these walls, it might be 27 years, but the Floors are this year, the carpet's 10 years, and let your CPA maybe work on kind of his own little cost segregation of, of what renovations have been done so we can take those new improvements and break them into different groups— 5-year, 10-year, 15, 27.5— so you can depreciate them faster for you because you're doing the— you're doing the renovation yourself.

Yes.

You don't have to treat it like when you first bought the house, all 27.5. You now can own that different blocks of what kind of depreciation to do for the home.

Yeah, okay, so that makes complete sense.

So it's, it's all communication with your CPA. Talk to the CPA as you're doing it so you can understand what's happening.

Totally, because everything has an impact if you decide to sell your home from a tax basis, and then depending on your capital gain, like everything is connected.

It is all interconnected, and it's really important that you do that. Now, another thing when it comes to the renovation is you want to make sure that, I guess, when it comes to like the land portion of your house, if you're eating into some of the land, if you're adding more space into the land, because land is not appreciable, right?

Right.

Land itself. So, every time you buy a home for rental real estate purposes, Your CPA is going to allocate a portion of land, which we know land's not going anywhere. It's earth. Hopefully that's not going to depreciate. You can't depreciate land. And the other part's home. Home has a depreciation to it. But if you expand the footprint of your home— footprint means you have a square box in your house. And if you just move the kitchen and make it an open floor plan kitchen, you're not changing the footprint of your home.

Right.

But if you add in another 1,000 square foot in-law apartment, you add in a bigger bedroom, you add in— you eat into the land. Make sure you work for— work with your CPA, because then he'll reduce down the amount of land you have to make more of the home depreciable. So you have, again, more depreciation to take. Less land, more home gives you more deductions because land's not depreciable.

Okay, that's, that's, that's a good tip. Yeah, huge tip.

People forget about that, increasing the foot— we call it the footprint, whatever you want to call it, the, you know, expanding the home past its certain parameters of the walls. Yeah.

Any renovation, the key is keeping clear communication of what renovations you are doing to your house with your CPA/accountant. Yeah, whoever is helping you financially manage this, your tax structure.

Absolutely. There's so many clients come to you last day and, you know, um, they're like, oh yeah, well, we're gonna do my taxes, here's all my stuff. And then they send you a load of receipts. I'm like, what's this? Oh yeah, we had A major renovation of the rental property. It's like, well, did you talk to me during the process? Did you have a conversation with me? Did we have any plan? No, here's all the receipts. It's like a shoebox of stuff. You're like, what? There is no organization with it. It's a shoebox. I don't want a shoebox on the day I'm filing your taxes. Number one, I didn't talk to you about how to do it. And number two, I don't want a shoebox. Let's have a planning meeting about this. And I want to talk to your contractor and organize the paperwork better. It's like nobody wants a shoebox. That's not fun.

Oh my gosh, this is so funny how you and I are totally on the same page. Just People. Everything is about planning.

Yes.

Planning.

Planning.

Preparation.

Yes.

That's so funny. So we started to go down this— so we've talked a lot about some rentals, we've talked a lot about renovations, because I find that just so fascinating how that's very complex. But also we wanted to talk about how is it that you live in your home? Yes.

Okay.

And own your home, and what are the tax implications?

There's some tax implications on living in your home. There's 2 parts to it. The first part is if you— let's go over— let's leave a second part. The second part we'll talk about in a minute about is how to—

Sure.

What ownership you should have the home in. It's important how you own the home, the ownership portion. But as far as the home itself as a deduction on its own, if you don't rent it out, you really need to look at the components of— it kind of comes back into the real estate taxes. That's a big piece of it. Your mortgage interest, that's another big piece of it. And the sales tax on renovations and major improvements to the home. What's happened is the government just got sick of dealing with the Schedule A itemized deductions and all the bull poop poop that goes around now with people trying to slip things in that they're a bit on the, you know what I mean, the shady side. The government says, right, we're going to increase everybody's standard deduction. Now like 75% of people can't itemize their taxes because they bumped it up to like $33,500 for a married couple. It takes a lot of deductions to get to $33,500 of itemized deductions. Usually—

Yeah.

The 2 things I see are these people that usually tithe to a church, or they give money to a church with major charitable donations, or they're very sick and they have a lot of medical expenses.

Those—

both those end up on the itemized deductions. But the average person that owns a home and that's their main expense, and they have a— again, we're using that $275,000 example. I don't know why, I'm just going to stick with that for this whole conversation. Yeah. But a $275,000 home with real estate taxes, mortgage interest, that usually is not enough to exceed a married couple's $33,500 standard deduction. So you got to kind of go in the situation. Now, if you have 2 homes, if you have a vacation home and you have a main home, There's certain rules in the second home, but let's just assume they all fit the parameters. You can take the combination of both of those together, even if you don't rent the second home, it's just a vacation home. Take those. Now you have 2 sets of real estate taxes, 2 sets of mortgage interest. And if you have any renovations, you can add the sales tax for both of those together. Now you might be hitting that $33,500.

Okay.

So remember, 2 homes, you can add both those deductions together on your one itemized deduction to try and beat the standard deduction. Hmm.

So you made a compelling point for everyone to buy a vacation home. Yes.

Buy a vacation home, rent it out for a few months, put it in Hawaii, fly out there and visit it once a year. Here we go. This is hilarious. Invite me once a year too if it's in Hawaii.

This is hilarious. No. So, okay, so this is starting to make sense. We identified some of the elements that you can deduct: real estate taxes, mortgage interest, sales tax on renovations, etc., etc. But But when it comes to owning the home, a good example is a lot of people are always confused about the mortgage interest deduction.

Okay.

So explain a little bit more about the mortgage interest deduction, because some people, and I'll just say this, some people choose to keep a mortgage on their house.

Right.

Because they would, they, the interest rate is so low that they would prefer to borrow against it. And that's very common for a lot of people. Whereas other people are like, nah, I'm gonna pay it off, right? If I ever get the opportunity, I'm gonna pay off. And there's two— it's just how you feel about it, and it's two different schools of camp. Yeah, but help people understand the whole premise of mortgage interest deductions.

Yeah, I mean, mortgage interest deduction, you're taking a portion of the home, obviously, as you pay your house off, as the mortgage, and a portion that's gonna be principal payoff, the other part's gonna be the interest. So that, that fractional amount that represents interest That's because you have the actual mortgage. That part becomes deductible. And is that really good debt? Some people view that good debt because you can write part of it off. And some people think it's bad debt because, well, I could take that money instead and start putting it towards an investment or real estate, you know, investment 401 in the future. But like you said, a house is an investment, right? It is a major, major— and for some people, their largest investment.

Yes.

So investing in yourself makes sense, and a fraction of that then becomes deductible for your taxes. Provided again you meet that threshold, you're trying to beat that standard deduction. That little bit of threshold of mortgage interest is important to you because that becomes then a deduction for you on the back end. It's not just wasted money, it could help lower your taxes, right, as your itemized deduction.

Yes.

So in the real estate taxes, but mortgage interest is something to keep an eye on. And there's 2 parts, maybe 3. There's 2 parts of mortgage interest. When you see your— it's a form called a 1098 you get from your mortgage company. And on there, there's one, one line that says mortgage interest. The other says points. I believe it's points where you can buy, buy down points of some sort.

Yes.

And there's a third part, and it's escaping me right now, that's on the mortgage statement that's also deductible. So make sure you advise with your, your CPA the 3 different parts of a mortgage interest statement that are deductible for tax purposes, not just that one line. There's 2 or 3 different lines in there that are very important. to make sure you're speaking to your CPA about those.

So mortgage interest deductions is also a good reason for people who are on the fence about, oh my gosh, mortgage rates are high. They're not, people. This is the average, by the way.

Yeah.

So it's whether they're investing in someone else's rental, so they're paying rent somewhere else.

Right.

But mortgage interest is also a consideration for your own tax purposes. If you're on the fence of, oh my gosh, the rates are XYZ and do I buy a house or don't I? This is actually a thorough discussion more with financial planning.

Right.

To help you understand that buying a house, even with interest rates at 6%, 7%, 8%, and we're not there at 8% yet.

No.

Even though we're there, it's actually not a bad thing. And then you eventually could refinance in the future.

You absolutely could. Absolutely could in the future. And you can refinance it. And if your mortgage is high, that just means you're getting a bigger deduction. So it's lowering your taxes. So while it hurts you out of your pocket, it's also helping you lower your taxes because you're getting the higher mortgage interest, the higher interest rate, your mortgage interest is more deductions you can take on your taxes. So it's a, it's a weird backend benefit. You know, from a CPA's perspective, I see high mortgage interest. In a way, I'm not happy for them, but I'm happy, oh, they're getting a deduction. This is helping out their taxes. I'm happy for that deduction. And like you said, it's a good debt to have because you're investing in yourself. You're not renting and paying someone else's mortgage if you can afford it.

Correct. And the whole concept of owning a home is the long-term asset value that you have.

Right.

And, you know, I also had a conversation on a side note with, with, um, with someone. She was so— it was a loving conversation about reverse mortgages. When you're older, using a home when you maybe need it when you're older because of some other scenario that may have occurred, you get that opportunity. If you don't have a home, you won't have that opportunity to use the equity in it to pay for something, health services, anything else later in life.

Right, right. No, that's right. That's exactly right. And the nice part about it, if you do well, when you have your own home, then you have an asset you can borrow against, reverse mortgages, if that's something you want to do to get money out of it later on. But it is an asset, and you own that house and it's yours. And being that you're not renting it out, the good thing is you have a very solid, stable basis because it's based on the day you bought it. You're not eating away at it like you would if it was a rental property.

Yeah.

You're eating away at that, but it's a solid foundation. And as you said, every time you have a renovation to your home— renovations to homes, we were talking about earlier, is different repairs. That same rule applies to your main home. If you add renovations to your home, it increases your basis. So, when you go to sell your home, talk to your CPA and say, right, I did these renovations to my home, new kitchen, new bath, new this, new that. So that you can increase the basis of the home over time. And you can take that, you can increase your basis so you have lower capital gains on the back end. You have to make sure you keep track of all your improvements on your main home over time so you can increase that basis. It's very important that those improvements are tracked.

Oh yeah, we can do that in Homesy.

There we go.

That's all my projects.

Keep track of that because your product will help people in the long end save money. Whatever it is you're, whatever it is you're doing, it doesn't matter what you're charging, it's going to save people so much money. It's almost a no-brainer to get it. It's a no-brainer to get that product.

Absolutely.

Oh my gosh, that's brilliant. So, so people keeping, um, a record of all the, the enhancements that they've made to their house renovations, etc. People understanding their tax basis is also one of these beautiful things to know prior to selling. Are there any other tips that you can offer people prior to selling a home, main home, to manage their property?

You mean your main home? You mean your primary residence?

Yeah, well, I, I would say the main home, yes.

Um, if you're gonna do— like, a lot of times people end up doing things to their house like, um, landscaping and, you know, make things look pretty in the front of the house. From a tax deduction standpoint, it may look pretty and it probably is a great thing the realtor wants you to do, but none of that's deductible. So all those landscaping and do all sorts of plants and trees and things, it's probably not your best option. You want to do, if you're going to do anything to your house before you sell it, do some kind of maybe a little bit of renovation somewhere.

Inside?

Yeah, inside the house. Get something done a little inside the house. That's more tax deductible.

Okay.

So when you sell it, you can increase the value of the home. Maybe redo one of your bathrooms. If it costs you $5,000 to do landscaping renovation and $5,000 to do maybe 2 bathrooms, that $5,000 is better spent on improving a capital asset as a renovation. Now you've increased your basis and you made the house worth more. You've done 2 things now.

Yep.

Increase the value of the home by a renovation, and 2, you probably increased the value of the home because you renovated a bathroom. Landscape's great, but it's just curb appeal. It's not going to get you a lot more for the house where a new bathroom might. You know, renovations— yeah, landscape might, but I'm saying that with With the kitchens and bathrooms, those things will get you more money and it'll get you a bigger tax benefit because it increases your basis.

Yeah, and we call those the money rooms. I mean, not only do they cost more to renovate, but they are literally what people look for when you are selling a home. Buyers are like, oh, do these look updated and fresh and lovely? And yeah, can I use them?

Yes, because they don't want to see a house that's— some, the opposite, some people want to see a house kind of war-torn and torn down and kind out of sorts because they want to buy a house and improve it, and they think they can add value to it. But most people want to walk into a move-in-ready type home and see everything fresh and clean. And you then, as the homeowner, can get that deduction. So that's something you can do as a homeowner before you sell, is to do a couple little rooms, even if it's a bathroom shower. It might be a couple, couple hundred dollars or $500. That might totally improve the value of your home, and you get a higher basis for it, for the house.

Yeah, that's brilliant.

Yeah.

That's absolutely brilliant. So, um, so we just talked about selling, and one of the other questions I have, um, and I know we're starting to come at time, but if someone is inheriting a home—

Okay, good.

I mean, this is because this can get complicated because there's inheritance taxes and stuff. But if, if someone or multiple people are inheriting a home, what do others need to be prepared for?

Right. So, when you own a home, there's 2 different ways you can inherit a home. One is if your family had the foresight to work with a CPA and you put it into like a revocable trust.

Yes.

So, revocable trust is something that you own free and clear. It's yours free and clear while the person is— Latin term— inter vivos, which is alive among the living. When they're alive, the revocable trust is yours, the asset's yours. Let's just say your parent. Let's use an example saying your parent, right?

Sure.

So in this example, your parent has a revocable trust. It's theirs. They're alive. Everything's fine. As soon as they pass, what happens is that the trust kind of has like a big cap around it. It all of a sudden becomes like now it's an asset of the actual trust.

Yes.

So it doesn't go through probate. That's a fancy term for going through the court system. It goes right from your parent to you. No probate. Correct. What you want to do, and this is really important, what you want to do as soon as that mousetrap of the trust Goes around the house, bam. You know that game Mousetrap? It dropped down on top of the—

Yep.

This is it. The trust drops. It's revocable.

Guess what?

Now it's irrevocable trust. Mousetrap done. You want to sell it as soon as that asset goes into the trust. Get the trustee to transfer that asset out and sell it because the day that asset goes into the trust, bam, that is your new basis. The date of death of your parent Whoever it is, or sibling or family member, whoever— doesn't have to be a parent, I'm just using an example.

Yeah, yeah.

Whoever is your parent, they die, it goes from revocable, bam, to irrevocable. It doesn't go through probate, but that now starts your trigger. That value— you need to get a realtor that day, get the value of the home. That is now the official new fair market value of the home on that day, right?

Ooh.

Get it out of the trust. Get the trustee to get it out of the trust to sell it. As quick as possible through the trust. Because if you hold it in that trust for the next 10 years and that asset goes up $300,000 and it's an asset of that irrevocable trust— bam, mousetrap, that example— as soon as it goes to that revocable trust, the trust owns it and the trust tax rates are through the roof. You're going to pay so much more tax on it. Let the irrevocable trust grab it. No probate, but sell it as quick as possible. Do not let it sit in that trust. Even if you're going to sell it to get the cash to buy another house, do it. Don't keep that real estate in there because—

That's good to know.

Trust me. Because we want to keep it—

because a lot of people think that, oh, when you have these trusts, because it does protect against probate, which is a good thing, and I've known people who've had to go through that.

Yeah, right, right.

But from a tax implication, No one realizes this, that you need to make sure you're moving things faster.

Get it out of there, right? Get it out. Even if you got to buy it out yourself from the trust, if you have to, because it's the same day. Even if you buy it out of the trust to you personally, get it out of the trust, because as soon as— longer it stays in the trust, every, every month, year, whatever it is, increases in value. Now the trust has to pay a gain on that because the date of death is the basis. Get it out as close to the date of basis as you can. Get it in your name or transfer it and you know, however the family wants to own it. Now, if it's a family-unfriendly situation and nobody wants to, you know, say, oh, I'm going to take it, I'll buy it, I'm going to own it, and nobody trusts each other and it's different, it's a $10 million house somewhere in Hawaii and it really is worth something and the whole family wants to keep it together, then sometimes you're stuck with a trust just because a trust protects you from yourself. That's the term.

Yes, totally.

That is the purpose. And it's the decedent speaking from the grave. These are all the fancy buzzwords around trusts. They're protecting you from yourself, right? If it's 5 siblings that don't get along and it's a place in Hawaii and beautiful, worth tons of money, and nobody trusts each other to— I'm gonna buy it and give you the money for it. I don't trust—

Right.

Keep it in the trust. It's protecting you from yourselves and let it do its job. Understand it's going to cost you, you know, more tax in the future, but it's kept the family cohesive and happy and you keep it in the family for generations. If that's your purpose, yeah, yeah, then leave it. But if it's there just to avoid probate only, mousetrap only, Get it out of there as soon as you can. Get it in your own name, because the longer it stays in there, the higher the, the higher the cap gains and the more tax you're going to pay on it.

That's a really big tip. Yeah, that's a really big tip, because even I didn't realize that. That's a really, really big tip. So, um, we're coming to the end of this, and I've had so much fun. And as anyone can tell who's watching our video, I've been taking notes. I'm totally into all this, um, because I want to know more.

Yeah.

And then, and I'm not a, uh, an accountant because that's why I invited you on here, because I wanted to bring experts to help other people. So what— so just to end this, because I want to give people some actionable steps, right? What 3 things or tips do you need from your customers when they are going through their tax filings for the year so we can get ahead of things?

Well, one is sales tax. I think people forget now that the $40,000— now that the $10,000 tax rate rule has been lifted and it's now $40,000, so many of my clients are itemizing deductions. They don't realize that sales tax is deductible on certain items, whether it's car payments, renovations to home, things like that. It's all sales tax deductible.

Sure.

Plus, the government gives you a standard rate, but you can add specific things over that, or you can add up every You can also, if you want— here's something interesting, nothing to do with houses— but you can take every sales— everything you bought for the entire year, put it in an envelope, add it all up, and you can deduct every single dollar of sales tax you paid for the entire year on your tax return. Nobody knows that.

I'm gonna have a good tax season. I don't know if you want to do it.

When I, when I, when I was, uh, married before, my, my ex, she would give me that receipt and I would go through Every single thing we bought for the year. And I was really good at my calculator hand. We learned that in accounting, so I could do it really quick. And I'd have every single thing, and I would add up— we wouldn't use the government's table, we would use the actual— we'd add up groceries, everything we bought in sales tax is all deductible. So that's a little trick.

Brilliant.

If you're, if you're really OCD and you want to find a new deduction, there you go. There's a new one. So no one knows that actual sales tax is deductible.

Perfect.

There's number 1. Um, number 2, Let's see, for home-related, you mean?

Sure.

Yeah, home-related, you could do— let me try and think of a little trick, something people don't know about for home purposes. We talked about the renovations of home being sales taxable. We touched on that. People may not know that. As far as home-wise, keeping track of your basis through your software is the best place to do it. Trying to think what other things for regular homeownership, not rental real estate.

Sure.

Trying to think. I want to give some good advice on it. I'm just trying to think of some other things. The sales tax deduction, keeping track of your basis. Obviously—

Make sure you have all your renovation details.

Your renovations.

With your accountant during the process.

Yes, and using your software to track it.

Totally.

I mean, it's a no-brainer. You got the best of two worlds, a CPA and the perfect software to track it. Um, I mean, this is nothing to do with real estate. We're off track a little bit, but charitable donations that you give in kind, people forget that that's deductible. So keep the receipt.

Yes.

I have so many clients come to me saying this year especially, oh my God, I didn't keep my receipts because I forgot you told me they're going to be tax deductible this year if I can itemize. They're always tax deductible, but You know, they thought because of the real estate, the tax threshold was $10,000, that maybe you qualify. But now that's gone higher. A lot of people itemize. Anything you donate in-kind, keep track of those receipts. People forget about that. Really important.

No, I, I'm to your point about that. Like even myself personally, because, you know, I'm super organized.

Yeah.

I have a file folder in my system.

Yeah.

In my email box where I save all of that.

You do it all.

As a backup, because I'm kind of anal retentive that way.

That's great.

My husband has a different file for our accountant, and I'm like, oh, I'll print it too. Here you go.

Yes.

Here you go. And then I'll review them before we have to submit our data. I'm like, oh, we're missing some. Let's make sure we get it all.

There's another one I just thought of. We're talking about, um, There's also an, I guess, energy credit. Maybe we didn't touch on that for the homes.

Oh, that's a good one.

If you buy certain appliances that are Energy Star rated, it's the AC unit, certain kind of skylights, windows, doors, solar. Make sure you're tracking that. Talk to your contractor, talk to your accountant. And sometimes that becomes deductible for tax purposes over and above itemized deductions. Nothing to do with that. Separate area for Energy Star credit energy appliances. They can be deducted for taxes as a credit. Now, credit's different. Credit is a dollar-for-dollar reduction of your tax. A deduction is a dollar-for-dollar reduction of what's going to be taxable. That's your income. But a credit is much more powerful than a deduction. So tax credits are amazing. They're so much better.

So this is— so you heard it here. Make sure you're tracking all your energy efficiencies.

Yes.

And all the projects you've added and your Energy Star appliances, because these credits apply to your tax situation. So this is a good— this is a big one.

That is a really big one. People forget about that all the time and they'll be like, hey, do you have any energy? Oh yeah, I did 3 new air conditioning units. And then I'm like, oh my God, what are we doing here? You know, you didn't tell me about that. Let's go. Give me the receipts. I'll take it.

Oh my gosh, that's so funny. This is big. So, Craig, I'm so excited. I had so much fun in this conversation. I learned so much with my note-taking because I just love my note-taking. Yeah, I noticed you were taking notes.

You were note-taking crazy.

Oh yes, feverishly. And I love my blue pen because I remember. But, um, so where can people find you? We'll put your contact information in the show notes, but where else can people find you?

Okay, thank you. I appreciate that. So our firm is a virtual firm. We've gone virtual probably about 6 years ago, after the pandemic, a lot of my clients— we had an office. I kind of backed away from the office. Now my firm and all my employees are all virtual. So you can find me on my website, which is crestvilleaccounting.com. That's C-R-E-S-T-V-I-L-L-E accounting, crestvilleaccounting.com. You can go to my LinkedIn under Craig Sheets. You can email me. My email address is the same as my website. It's craig@crestvilleaccounting.com. That's C-R-E-S-T-V-I-L-L-E accounting.com. They can call me on my, my phone, which is 407-310-1847, and they can, uh, send smoke signals. I don't know, I'll find them somehow. You send them to me, I'll find them.

Yes, and Craig also has his own podcast too.

Yes.

Which we will send in the show notes as well. So you can also hear from him because he's talking to all kinds of business owners in various industries, which is very fascinating.

Can I say the name of it on here? Do you mind or no?

Absolutely.

Go for it.

Okay. It's called Behind Closed Books.

Thank you.

Kind of a little tongue-in-cheek for closing your books, but called Behind Closed Books. It's on Spotify, Apple, and YouTube. Thank you for letting me promote that. Absolutely.

This has been absolutely a blast and very informative. Thank you so much. And for everyone else out there, if you thought this podcast was so valuable, please share it and send it with whomever you think might find interest in this or needs these tips. I think a lot of us do when it comes to homeownership. And by all means, follow us, like us, share us, come back and see us again. This is Beth Dotson from Be a Smarter Homeowner Podcast. See you next time.

Thank you for listening to the Be a Smarter Homeowner Podcast.

Be a Smarter Homeowner Podcast. Visit BeASmarterHomeowner.com to sign up for our newsletter and find out more about software to help you save time, save money, and manage your home.