#17: Real Estate Investing 101 - How to use real estate investing to reduce your income taxes (w/ Tim Gertz, CPA of ProVision Wealth Strategists)

Is it conceivable and possible to even not have to pay any personal taxes at the end of the year? If, if I've strategically worked with my CPA throughout the year on what I think I'm going to make, what the property investment looks like, is that even possible to, to not have to owe anything at the end of the year?

Yeah, definitely. If you plan accordingly and you look at the different limitations that you have, whether you have ordinary active income or passive income, you could be in a situation where if you plan for income event, whether it's W2, IRA distributions, sale of an investment, sale of a business, you might be in a position where you can take that real estate, whether it's, you know, sale of business, reinvesting real estate into, or reinvesting that gain into a real estate transaction that throws off a loss, or if your spouse is a real estate professional and you're a W2 earner, you could effectively offset your W2 income with real estate losses.

On today's episode of Heading west, we talk about how real estate investing can lower your personal taxes with our guest, Tim Gertz. Steve, we talked about in the episode, but when most people think about real estate investing, at least I know I did this, we often think about the passive income. We think about the asset value like, hey, I own a million dollar asset, whether it's retail or apartment, whatever. But it's not as often we think about the tax benefits that come along with that and then how you can potentially avoid paying taxes altogether. That's like, that's that one component of real estate investing that it's probably like off the side, like, oh yeah, there's depreciation, there's tax benefits. Like this is a really, a really big component that you could possibly pay. No taxes, no personal taxes if you've got this thing right.

Jake, the big thing is it's not how much you make, it's how much you get to keep. And with, with this episode with Tim, we, we covered bonus depreciation. We, we covered being a real estate professional, depreciation, all those things that can help you as a real estate investor to keep more of your money if you do it right. And Tim covered that.

Yeah, yeah, provision. They're the best. Tim is, is incredible at what he does. And, and if you're thinking about getting into real estate investing, this is a great episode for you because it, we talk down, we talk about, we break down how private real estate investing can actually have a massive impact on your personal taxes, which to your point, allows you to keep more money at the end of the year that otherwise would go to the government. And now you get to keep it in your pocket and or reinvest it into more real estate and the snowball just starts to grow and grow and grow. So 100% worth your your 30 minutes spent listening to this podcast episode. But let's just head west. Stay tuned as we discuss how real estate investing can lower your personal taxes with our guest Tim Gertz. This episode is brought to you by Skyline Point Capital. If you're anything like me, you're always considering where to invest your money. Stocks, bonds, crypto and rental home. The list is literally endless. As we've all seen over the past year, the stock market is unstable, the housing market is just weird and inflation is on the rise. In times like these, the clear place to invest my money is in multifamily real estate, AKA apartment complexes. Here's why. Returns on real estate investments have little to no correlation with the stock market. There's lower volatility, stable income streams, and the tax benefits are insane. And let's not forget that the apartments will typically appreciate in value over time, which means you can walk away with a pretty nice return when the complex is sold in three to five years. Best of all, multifamily investing is passive, so you get all the benefits without the hassle and headache of your typical rental home investment. Getting started has never been easier. Head to skylinepointcapital.com to learn how you can start investing today. Well, Tim, thank you so much for joining us on today's podcast. If if listeners have been tuning in the past few weeks, we've been really building these, these building blocks on how to get started passive real estate investing. And today we've got Tim Gertz on. He's an expert in our next topic, which is talking about how private real estate investing reduces your personal tax or has the potential to reduce your personal taxes. And Tim, when most people think about real estate, they simply think about the passive income, the fact that they actually own an asset, whether it's a second home or it's a retail strip or whatever. But not too often do they think about the tax benefits that come with owning again, a retail strip, an apartment complex, a secondary home. So I'd love to just jump right in on this topic is what kind of impact broadly can real estate investing have on your personal taxes?

It's boundless. I mean, you can, you can, you can have it efficiently and effectively minimize your tax in any given year based on how you proactively plan for it. So, you know, people talk about real estate, professional people talk about depreciation, people talk about shifting tax rates or, or going from capital, ordinary income to capital gains. You know, ultimately, effectively, if you plan proactively and you plan accordingly, you could be in a position where you're efficiently paying tax year after year based on income events, using real estate to do that.

So is it conceivable I'm going to act as if the. I'm going to act as if the person who knows little about taxes and there's little about real estate, Is it conceivable and possible to even not have to pay any personal taxes at the end of the year? If, If I've strategically worked with my CPA throughout the year on what I think I'm going to make, what the property investment looks like, is that even possible, to not have to owe anything at the end of the year?

Yeah, definitely. If you plan accordingly and you look at the different limitations that you have, whether you have ordinary active income or passive income, you could be in a situation where, if you practically plan for income event, Whether it's a W2, IRA distributions, a sale of an investment, sale of a business, you might be in a position where you can take that real estate, whether it's, you know, sale of business, reinvesting that real estate into, or reinvesting that gain into a real estate transaction that throws off a loss. Or if your spouse is a real estate professional and you're a W2 earner, you could effectively offset your W2 income with real estate losses. So, yeah, I mean, if you, you know, tax planning is just building that puzzle, putting that puzzle together, putting the pieces together. So as long as you proactively plan for it and you're in tune with that, then you should be able to plan accordingly year in and year out to effectively minimize or be as efficient from a tax perspective as possible.

Yeah, that's music to my ears because there's been, most of the time I've actually gotten money back from the government, which means I'm overpaying throughout the year. But this might be one of those years where I actually get dinged quite a bit. And I might. Oh, so this is, this is music to my ears that, hey, there's actually a possibility where I might not have to pay taxes going forward if I do the right thing throughout the year and work hand in hand with my, with my tax professional. But I'd love to, I'd love to take a step back and really talk about what's the, what is the, what's really happening with this real estate that allows for the reduction of personal taxes? And, and I know it to be depreciation, but can you talk about like, what is depreciation, how does it work? And then how does that sort of work play through with the, on a personal tax basis?

So depreciation is just your ability to deduct something that you paid for. And you know, in, in tax law, the IRS looks at different aspects of how long is that asset where you know, going to live or what's its useful life and when you are able to deduct it based on that useful life. So if you think about like an insurance policy, you buy an insurance policy, you prepay it for 12 months. Well, you can deduct it in that tax year, you prepay it for three years. They're going to say, okay, well we're not going to allow you to deduct it over, you know, in that first year. You're going to have to amortize it or deduct it over three years. Same thing with assets. The IRS has a class life or a list of class lives, basically how long they think that an asset is going to live. And you're allowed to depreciate it over that. So you go out and you buy a commercial real estate development and they say those last 39 years. So you're going to be able to depreciate that over 39 years. And at the end of 39 years, it will have a zero basis because you've exhausted its life. Rent, residential rental, same thing, 27 and a half years. So if you don't segregate out certain assets and you put that asset into service in 27 and a half years, you will have an asset that has no basis because in the eyes of the irs, it doesn't have a life after that. Doesn't mean it doesn't, you know, you sell that asset 10 years down the road, the person that bought it from you starts back over at 27 and a half. So you've got a hundred year assets that have been depreciated over and over and over and over again just based on what the IRS deems their useful life to.

And Tim, how does that fit into with the depreciation over the 27 years? But there's a thing called bonus depreciation. And if you're in real estate, that's one of an important thing. Can you talk about that, how people take advantage of it and what are some of the Pros and cons. If you have a shorter property and you want to sell it in three years, as compared to maybe holding it from five to seven to 10 years.

Yeah, definitely. So bonus depreciation came out in 2002. And what it was designed to do is to spur U.S. manufacturing. So the initial iteration of bonus depreciation was if you've got asset that has a class life of less than 20 years. So most personal property, a computer, a vehicle, cabinetries, refrigerators, all have a class Life less than 20 years. And it was manufactured in the US and its first life was with you, you could write it off immediately. Well, that provision is what they call a sunset provision. So it goes away after a period of time. Well over the last 20 years, it just continues to get picked back up and picked back up in different iterations. The one that really created this boon in real estate was in 2017, it became a hundred percent deductible. So you're allowed to deduct a hundred percent of the asset in the first year, which had happened prior, but it had gone through a 50, a 30, 100 iteration. And it didn't have to be first use, it could be used assets. So now we've opened this world up to depreciation or being able to 100% deduct tangible personal property inside a piece of property. So cabinetry, flooring, dishwashers, refrigerators, we can take that and we can write that off in the first year when we buy it. What that does is it creates this huge loss in the first year. So you know it. A prime example is you go out and you buy an asset and you put 70% debt on it. So you buy a million dollar asset, you put a $7700,000 loan on it, you contribute 300,000. Well, if you do a consequence study, let's say 30% of that of that asset that you purchased is tangible personal property, short life assets, we get to write off 300,000 immediately. So you've effectively written off your entire investment from a cash position in that first year. Fantastic. You have a huge sale transaction, you've got income to offset, you throw it into real estate, you get that huge loss in the first year, you write it off against other income. Great. Fantastic. In like what you had said, Steve, it's, it has its benefits and its curses because when you depreciate an asset, you have to recapture that depreciation. So in that example, if we buy a million dollar asset and we write off 300,000 in the first year, well now our basis in that asset is $700,000 because we deducted 300. If we sell that asset year two for a million dollars. Well, hypothetically speaking, we have no gain, no loss. We sold it for what we paid for it. But since our basis is 700,000, we've got $300,000 of depreciation recapture. And so that's kind of the nuances with it. And especially with the real estate market where it had been in the last, you know, five years, 18, 24 month turns, you were seeing a lot of this where people were taking the deduction and then having to recapture that in, you know, two years. And so then you had to snowball it and effectively reinvest and reinvest and reinvest.

Tim, it's interesting you say that we had a property where we did a cost segregation study on it and we were going to put the bonus depreciation and take that. Well, like happens, you get an offer you can't refuse. And so we sold the property and the money we spent for the cost segregation just turned into an expense and off we went from that side. But you mentioned cost segregation. What is that? So can you explain what that is and, and how someone uses it? And is, is the cost segregation study the same thing for a multifamily or a retail or industrial or how's that work? Class A, class C. So ultimately a.

Cost segregation study is you are, when you buy an asset, you buy a piece of real estate. So you buy a multifamily. The IRS says that is code section 1250 property, real property that is a 27 and a half year life. The land is non depreciable. So you've got two buckets, you've got your land that's non depreciable. You've got this 27 and a half year asset that is 1250 depreciable, straight line over its life. Well, a cost segregation study goes in and says, well, yes, this is real property, but within that real property, I've got dishwashers, I've got refrigerators, I've got cabinetry, I've got toilets, I've got flooring, I've got whatever it might be, that is what's considered tangible personal property. So the way I like to say it is if you can pick that asset up and easily relocate it somewhere and you continue to utilize it, that's tangible personal property. So toilet, refrigerator, cabinets, things of that nature. Tile, not so much, because you can't pull a tile unless the tile person did a horrible job. But so that gives us the ability to ultimately take that. And now we've taken those tangible personal property assets out of the real property asset, and those have a shorter life. So now we can ultimately take those and apply bonus depreciation. And to your point, no, you know, no, Apple is created the same. Everything's different. So when you're looking at a piece of property, a single family house has a different, you know, percentage that would be applied for bonus depreciation because there's only one refrigerator, there's only one dishwasher. Multifamily has 300. So now you've got a larger percentage that is being allocated to tangible personal property. Commercial is different, industrial is different, RV parts are different. So everything is completely different. You know what I say, from a conservative standpoint, single family, you're looking 20 to 25% is going to be tangible personal property in the first year. Multi is 25 to 35. Restaurant and commercial is about 40. RV parks, you're looking at about 50 to 60. And then there's special assets, gas stations, car washes, those you can write off 100% in the first year. So it just really depends on what, what you're investing in and what that asset looks like.

And if someone owns a property and they want to do a cost segregation study, is this something they just get out a spreadsheet and do it themselves? Or how does one get a cost segregation study done?

So they have to be done professionally. So there's two parts to it. You have to have a CPM CPA involved in, an engineer involved, and they basically all follow the same prescribed format that the IRS has laid out and said is allowable. So you've got an engineer and a CPA that goes in and actually does a study. It's not something you can do on your own. It's something that has to be done by a professional. So, you know, in order to get one done, you just need to engage with one of those professionals to get that work done. Great.

So it sounded like, if I understood you correctly, on a, on a cost segregation study, you've got your normal depreciation over 27 and a half years, 30 years. With cost segregation is that you're essentially a front loading or putting on a different timeline. So it essentially front loads a lot of that depreciation to the first few, three, five, seven years. Is that, is that sort of how it works?

Correct. So it's giving you the ability to ultimately use time value, money and tax deductions to generate more wealth and more income. So but yeah, you're essentially, if you do a cost segregation study or you don't do a cost segregation study, if you hold that asset for 27 and a half years, they're both going to end up at zero. It's just you're taking a huge deduction in year one where with standard you're taking it over 27 half years equally.

Yeah. Which is, sounds like it's super beneficial if you intend to only hold it for, you know, less than, let's say less than seven years. Cause you've got all that front loaded and then sell it at seven years. Is that is there's more opportunity there in that case. Right.

Yeah, I, I am under the, the school of thought that you should always do a cost segregation study. Unless you're going to buy and sell that in the first year, even if you're going to do it over a 24 month period, the deduction you get today is going to be worth more than it's going to be in tax two years from today. Because inflation, tax rates, things of that nature.

So, so if, if I held a property for 10 years, you know, I can depreciate it over 30 or 27 half years, but if I hold it for 10, does appreciation stop on my personal taxes at year 10 after I sold it or will it continue to run after I've actually sold it?

Once you sell the asset and no longer hold that asset, the depreciation is gone.

Gotcha. Okay, that makes sense. So this is interesting. I think I led us off by saying that we're on this journey. We're taking our listeners through getting started in private real estate investing. And one of the topics obviously is how it affects your personal wealth generation and your taxes and things like that. Um, this, this sounds like this is something that should be done early on in, in, in someone's journey to invest in real estate in that they should talk to someone like you, Tim, when they want to get started investing in real estate, they should talk to their financial advisor for sure. They should talk to their, their CPA and figure out okay, what is your, what's your long term goal? What does your income look like? And therefore what should you be looking for from an investment standpoint to offset your, your taxes? Would you say it's fairly accurate that this a conversation with you should happen fairly early on in their journey to invest in real estate?

A hundred percent? I think it's important to sit down no matter where you are, but if you can get to the infancy of your journey. Yes, you Want to sit down? You want to look at what are you trying to do? And also look at, I mean, we talk about real estate as an asset, but what is real estate? Is it investing in as an lp, is it investing in commercial properties and investing in Airbnb? Is it, what is it? And what do you want to do? Because ultimately, what you're trying to accomplish will dictate how we utilize that real estate and what we use that real estate for and how we use it to offset your tax.

In my, my beginning journey in real estate, one of the first things I did, I went to my accountant that did my tax return. And I quickly, as I start going through that, I was asking questions about, because I kept hearing, to really take advantage of all this depreciation and all and to reduce your taxes, you need to be a real estate professional. And at that time, I was selling a business and et cetera, still chairman of the board and et cetera, and I had to get the 750 hours, and we want to talk about that. And there was no way to do that. And the IRS would come back and look, yeah, you're not a real estate professional. You're chairman of the board of your existing company, and there's no way to do it. So I, I kind of left somewhat dejected because I'm buying real estate. I ran into somebody that was really knowledgeable about real estate, and they said, well, what's your wife doing? Well, she's staying at home. She doesn't have a job. She's taking her, taken over, taking care of a character like me. And he says, well, there's your real estate professional. I had no idea you could do that. Can you describe what that means? Because if, if I'm correct, and please help me on this, is that to really take advantage of all the tax deductions year after year after year after year, if you're not a real estate professional, you're only able to offset your passive income. If you're a real estate professional, you can offset your ordinary income and anything else you have in the family. Is that right?

Yeah, 100% correct. And so, and to add to your conversation, you had, I always like to say, first and foremost, happy spouse, happy house. So everyone says you're, you know, your wife, your husband can be a real estate professional. And my first question is, do they want to be a real estate professional? Because if they don't want to, I mean, that just, yeah, you got the tax saving, but it's going to create, you know, strife in the House. So. But ultimately you are 100% correct. And so the tax law, and a lot of tax law change is just a, a reaction to bad apples or performers that are doing things that the IRS or Congress doesn't want them to do. Passive activity loss rules which deem that rental real estate is inherently passive was a result of that. In 1986 they enacted 469 code section 469 which created these rules saying if you're not actively involved in a trade or business, then it is passive. It can only offset other passive income. Well, they had a little carve out that said rental real estate is inherently passive 100% of the time and it's not even considered a trader business unless you hit those, you hit those tests to be a real estate professional. And like you had said 750 hours. And you do that more than any other activity. So yeah, if you are doing something, if you're a full time. I always use myself as an example. I'm an at, you know, I'm, I invest in real estate, I and practice what I preach, but I'm full time at Provision. There's no way I will ever be able to be a real estate professional. I hit over the 7:50 hour rule, but I don't do it more than I do my work at provision or so using someone else in your household is a huge powerful tool if you can make that work. Because yes, if you are active in your trade or business and your spouse wants to be a real estate professional, well that creates a huge opportunity because now we've taken that inherently passive activity and we've made it active. We made it an active trader business. And losses from that trader business can offset active income from your trader business.

When, when you're trying to think about being a real estate professional, can you elaborate more? And what are the requirements and what are, you know, there's 7:50 hours and, and what is the activity? Do you have to record? Are you tracking mileage and expenses and your hours and it sounds all so confusing.

It is, it is, unfortunately. And it is highly scrutinized because the benefit is huge. So you have to spend more than 750 hours in what they deem real estate related activities. Very broad. It's development, redevelopment, investment management, acquisition. So it's extremely broad and I think it's designed that way so that they can, you know, so the IRS can ultimately look to activities and say this really doesn't qualify. So you've got to spend more than 750 hours in real Estate related activities. And you have to do that more than any other income producing activity. So those are the two tests and to your point, yes, you need to track needs to be thorough, it needs to be detailed, it has to be daily, it has to be hourly. You know, I've gone through audits where they disallowed because they say it doesn't have enough detail in description of what you're doing or it's rounded to the nearest hour. So for me, what I say is figure out what is the easiest for you to do. It's like mileage. Gotta track your mileage if you're gonna take business use of your vehicle. Well, what's easiest for you is a daytimer where you can track your miles or your hours. Is it a spreadsheet? Is it one of the apps on your phone? Whatever it is, make sure that it's something that you will do and you want to do because it has to be maintained and it has to be maintained daily. It's not something you can go back.

And recreate and does that reset every year or is it something that once you hit it, you got it?

Nope, it's an annual test.

Gotcha.

So you can be real estate professional this year or not next year.

Tim, this sounds bonus depreciation, cost segregation studies. I want to buy real estate and any all these different things coming at you. Can you describe your customer? A new customer coming in. What's the journey? You guys at Provisions are considered one of the tops in real estate accounting and you work for a lot of syndicators and GPs and you've got a great reputation. So you've probably seen a lot of different customers and a lot of different from small gps to bigger ones. Can you describe the journey? What's that like?

Yeah, definitely. So we are proactive plan our first, tax preparer, second. So in our eyes, preparing a tax return is ancillary to what we're doing. It's just the report card. How well did we plan for you? So when you come in, depending on where you are, we look at where you've been, where you are today and where you're headed. And so when we say where you've been, both, what have you been doing? What entities do you have? What tax returns are you filing? How are you filing these returns? Are they efficient? Can we go back and amend them and get you, you know, low hanging fruit as we call it? And then the next step of the journey is really where are you today? What do you have going on today? Is it as structured as efficiently as possible? Are we filing too many returns? Do we need to minimize the amount of returns? Can we consolidate returns? Are we educated in what we're doing? So we know, hey, we've got to have that blog for real estate professional and this is how we can do that. We are taking these deductions, we need to record these deductions. We need to do this, we need to do that. Basically the second part is efficiency today and structure today. And then from that point it's sitting down and saying, well, where are you trying to go? What is your 5, 10, 15 year goal? If you're at the end of your life cycle and you say, you know, I've done all this and this is where I'm heading, well, maybe it's focused on estate planning and generational wealth. If you're in your infancy, maybe it's okay, I'm trying to get out of my day job. Well, how are we going to do that? And while you're doing that, what can we invest in that meets your criteria but will give you the efficiency that you need? So really for us, it's being that team member that is going to help you move through the plan and build that plan as efficiently as possible.

So you sound like you're the first phone call to make. That be about right.

I would say that sounds smart.

Yeah, definitely a smart move. Call Tim.

First call Tim. That first phone call Tim, you use, you mentioned something about LLCs and I know in the real estate is every property another LLC and things just keep going. Can you give some advice on.

The.

Thought process of how many LLCs do you really need? And I know guys that have LLCs and they've got 20 some returns and really they could simplify it. But everybody in this, in this space is thinking, how do I protect liability wise, they're not so concerned. I understand that. But from a tax consequences and the tax returns and trying to keep everything going, if you're just trying to start out fresh, you're a new investor, can you give some guidance on llc, the number and how that affects their taxes?

I mean, one of my themes is comfort, everything. You've got to be comfortable with what you're doing. You've got to be able to sleep at night. So that's really where I start is what's your risk tolerance? If your risk tolerance is that I can't lose a dollar and I live in a state like Arizona where it costs $45 to set up an LLC, well then I'm going to tell you just Go ahead and set up an LLC for every single thing you have because it's cheap and the cost benefits there and you can sleep at night. If you don't really care about the risk tolerance, then maybe it's just one. Or if you live in a state like California where it's $800 per entity, well, cost benefit, you know, if you're buying single family houses and it costs you $800 a year per LLC, well that whittles down at your returns. So that probably doesn't make sense. So really what I look at is from a tax perspective, an LLC taxes a partnership or taxes another flow through entity. The tax aspects of that LLC are going to be the same. Everything is going to flow through to your personal return. So everything is going to be the same. It's all going to be taxed at your individual level. So if you don't need the complexity, why create the complexity? So that's really kind of what I look at and what I would say is number one, risk tolerance, comfort and then efficiency. Because ultimately I, I'm working with client right now, came to us had, I think two management c corporations, a holding company, three partnerships that were all owned by the same exact people and I eliminated three of them. So now instead of having seven returns, we've got four returns. And to me that's efficiency. Yes, I lost money by doing it, but I really don't care because I want efficiency and I want growth. And if we can make you more efficient and more comfortable with what you're doing, then you're going to be more successful at what you're trying to accomplish.

And as, as the bigger you become, if that's your goal, you're buying more properties, more things. Simplicity is critical to stay on top of this. So that's, that's good to hear from that side.

Well, Tim, we're coming up on the end of our, our time together, but I wanted to, to recap for listeners the importance of what we're talking about. That just as a super high level, if you're thinking about getting into, into real estate investing, your first call should be to Tim and his team at Provision or your tax advisor because they're the ones who are going to help you understand. All right. I know it, you know, it sounds flashy to invest in real estate, but how does this really fit into your, your overall plan this year and the years going forward? So again, key takeaway is talk to your CPA right off the bat because they'll help you walk through this. They'll point out all the, all the red flags for you. Tim, thank you so much for your time today. If you're looking for tax and wealth strategies, be sure to go to provisionwealth.com to talk to Tim and his team. They're the experts in this, in this field. If you're looking to learn more about real estate Investing, go to skylinepointcapital.com but again, Tim, thank you so much for sharing your wisdom, sharing all the knowledge that you have that's made you guys the best at what you do. And I know our audiences has learned a ton from it.

Thanks. Glad to be here, Tim.

Tim, it's been a pleasure having you on. Thank you.

Always. Thank you.