CW 491 – Diane Kennedy – Why Income Property is the Most Tax-Favored Asset Class with CPA & NY Times Best-Selling Author

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Welcome to the Creating wealth show. This is your host, Jason Hartman. This is episode number 491. 491. Last episode number 490. We had Peter Sage on. And as you know, every 10th episode we go off topic and do something of general interest. So I hope you enjoyed that. But here we are going to focus on life's largest expense and how to avoid as much of it as possible. And what is life's largest expense? It is taxes, taxation and income. Property is the most tax favored asset class in America. So we have CPA extraordinaire. That's the title I'm giving her. And that is Diane Kennedy with us again. Diane, welcome. How are you?

I'm doing great, thank you, Jason. And I love that title. That's awesome. Thank you.

You can use that one. I'll, I'll license it to you little TM after it. Yeah, there you go. Exactly. CPA extraordinaire, Diane Kennedy. So, Diane, you know, income, property is so tax favored in so many ways. I'm engaged in a couple of 1031 tax deferred exchanges right now. And that's one of the seldom, I mean, you know, I guess it's talked about a lot, but you know, it's not used a lot because we only use it when we sell a property. But it is an incredibly beneficial thing. And over the course of several years, you know, if you're trading stocks, if you're buying and selling businesses or you're starting a business and you're selling it, you don't have this tax favored treatment. You know, you sell stocks, you gotta pay the gain. And when you look at it over the course of time, and I'd love to do some performance on this but we haven't. You know, if the government is taking a big cut out of it every time, if you're selling stocks, if you're selling precious metals, if you're selling your business, you're paying the government before you get to put that money back to work into something else with income, property. Ha. You can put it all back to work and defer the gain indefinitely.

Yeah, you know, it's great. In fact, there actually is a term for that. It's called tax drag. And it's something economists look at when they're looking, comparing countries and their potential for economic growth. They have to look at what the tax drag is. And so just as an example, you're just using there that. Let's say you sell a stock and you get capital gains, hooray. We get a lower tax treatment. But right now that's almost 24% you're paying at the highest rate. So that means you only have approximately 3/4 of that money that you get to then reinvest. And absolutely, that's something that hurts you. I have to comment on the 1031 exchange that you just were mentioning. You would just die. Jason, I got this email from a guy about a month ago, and he said he'd heard about the 1031, and he had a deal and his profit was about a half a million dollars on a property. And he said, yeah, we just closed escrow a couple of weeks ago, and now I'm wondering If I can 1031 into something. And you know what the answer to that is? No, he couldn't. It's too late. He closed escrow. And I was just like, oh, why didn't you talk to me three weeks ago? Because it was so close. And he said, well, I still have the money in the escrow company. Couldn't we do it? It's like, no, it had to be set up beforehand. So the 1031 exchange is something that, if anybody's listening to this and you've got a property that's got a lot of gain on it, or maybe you've held it for a long period of time, so you have a lot of accumulated depreciation. That means a lot of tax. If this is something you're interested in, check it out. Now. Don't wait to let the thing close, because then it's just too late.

But, Diane, you know that tax drag that you mentioned, that's a great term, by the way, the tax drag in all the other investments. When Einstein called compounding interest one of the great miracles of the Universe or something like that. He has some quote like that. It really is amazing because, you know, you're only reinvesting and if you live in a place like the Socialist Republic of California or New York, you know, you're reinvesting even less than three quarters of it. But you know, say you don't live in one of those states and only the feds are taking their cut or you know that most of the cut is from the Feds. You're only reinvesting about three quarters of that money. I mean, over the course of, you know, a couple of decades. I mean that is a major difference when you're buying and selling stuff and wow, that just kills you. I mean, compared to the income property, you get to reinvest it all and let it all keep growing and then even better when you die, which who would think that's better? But you know, for your, for your greedy unwashed heirs, they can fight over your fortune. You can really leave them a lot more. Because tell us what happens when someone passes their wealth on to the next generation. I mean, with income property, it steps up to market value, right?

Exactly. And so what we have, that's called a stepped up basis in the value of the property. So let's go back to that building. Maybe you paid a half a million dollars for it and over time you've depreciated it to where it's maybe only showing up as a book value of 250. You've depreciated half of it, but maybe that property is now worth a million. When you pass and your heir picks it up, they start all over at a million. It doesn't matter how much was depreciated, it doesn't matter what the basis was when they bought it, when you bought it. It just steps on basis.

So, so, so in other words, that means you have no depreciation recapture, correct?

Yeah.

Right.

Yeah.

Okay, so that is phenomenal. So you can basically, and this is by the way, not really the topic of the show, we're going to talk about real estate professional and depreciation and using it now. But because I'm involved in a couple of 1031 tax deferred exchanges myself currently, and we were, you know, talking about it on Facebook, some people were asking questions about that. It's just a phenomenal deal. So, so what happens there is your heirs get that. I mean, they don't recapture anything. They, it steps up to wow, you can trade it all your life basically tax free, technically tax deferred, but it's Tax free if you don't sell it. So you know, and you always exchange it, it's always tax free. You can do it as many times as you want. So it's not like you get to do it only two times. You can just keep doing it your whole life and then you can pass it on to your heirs and you pass it on at the stepped up basis. So they pay no tax. I mean, what, there's nothing else that does that, right?

You're absolutely right. You know, the other part of this though is there's a step in between. And like you said, I know we're not, this isn't the topic, but I.

Always get off on tangents. My listeners know that.

So yeah, it's called a charitable remainder.

Oh yeah, the crt.

The crt. Oh boy. Real quickly, the way it works is if you have a lot of property that's really appreciated and you've been doing your 1031s and the way that works is you roll over your basis of the prior property. And so it's not really tax free, it's just tax deferred. The basis keeps reducing as you continue to depreciate and you do a couple of rolls. And let's say as somebody gets older, they're now looking at these properties that are all depreciated and maybe they don't want them anymore. Well, the idea so you don't have to do another 1031 is you can put it inside of this type of trust and the of remainder trust. The idea is the beneficiary eventually is a charity, something that's a 501C3 or 501C9, something that's recognized as a charity. Then because it's inside that trust, you can sell it. There is no tax at all. And you set up the trust in a way that the income flows to you so you can continue to make money without that tax drag we talked about. And then down the line, typically what happens is you also buy life insurance that's paid through that trust so that your heirs don't end up with nothing because you've given it to a charity for the right property and at the right age, that's just, it's an absolute gift with something like that because when you donate it, you also get this huge charity write off. So as I said, if you're getting older, you have parents maybe that are a little older, with a lot of appreciated assets, this can be a great thing to put them in because they have a lot more money then do.

You believe in the whole life insurance as an investment concept? I remain skeptical. Even though I did buy a policy, I mainly did it for asset protection. I'm still not convinced about the investment angle, really.

Personally, I bought a plan 25 years ago, and so my insurance premiums were quite a bit lower. And it was a whole life policy. And I have to say, I don't even know. I don't sell insurance. I don't know what the plans are like now. But it had a guaranteed return in it. And after, I don't know, three or four years of paying it, I've never paid another premium. And there is a cash value that's built up in that that I've actually borrow to, you know, to go buy a car. So it's my own money that's in there, and I've been able to grow it, and it is completely. I mean, as long as I take loans out, it's tax free. So is it the best investment there is? Absolutely not. I make way more money on real estate. But is it another way of some asset protection? Perhaps, But I think you need to do this when you're younger. I mean, if you're waiting till you're 50 to go get a life insurance policy, your premiums are going to be higher. So I think it needs to be earlier.

Let's dive into the actual topic of today's show. Okay. And I want to talk again, and we've done episodes on this in years past about the real estate professional status. Because it is the thing we just get, you know, so many questions on. I know, Diane. You get many questions on it. And I will just say, in my opinion, it is the holy grail of tax benefits. It is awesome. It is phenomenal. I don't know that there is anything better under US Law in terms of tax benefits than the real estate professional tax benefit. Now, a couple things before we dive into it. I want to say, number one is you don't have to be in my business. You don't have to go get a real estate license. Although that may help you, it probably wouldn't hurt. But it doesn't mean you're in the business of real estate is the way you're probably thinking of it, Dear Listener. It means that it's an IRS designation of being a real estate professional, which really means that you spend a certain amount of time investing in real estate. And this, I want to say, may actually be worth changing the way you or your spouse engage in your own career. If you're going to take real estate on a serious thing in your life, and it's pretty worthwhile to do. So, so tell us what it is, how it works, and, and how someone might qualify for it.

DIANE sure. And let's start off with why we care. First of all, the way it works with real estate is there's a lot of things we can do that even though you're putting cash in your pocket, on paper, perfectly legally, we can say we have a tax loss and that's through the magic depreciation.

Beautiful.

But yeah, love that phantom expense. We love depreciation phantom expense because it doesn't cost you cash. However, if you make under $100,000 adjusted gross income, you can take a write off of that real estate against your other income up to $25,000. So if as long as you have less than $25,000 in real estate paper loss we created and your income is lower than 100, you're fine. However, if you make more than $150,000, then you can't write anything off between 100 and 150,000. The amount you can write off phases out. This is where the magic of that real estate professional status comes to play. Because if you are qualifying as a real estate professional, then you can take 100% of that real estate paper loss against your other income, no matter how much the loss is, no matter how much your income is. That's why we want to do it. Now, there's a million ways to do it wrong, and there's only one way to do it right. Three tests. The first is that you need to get at least 750 hours in real estate activities. And that could be just like Jason was saying, that could be you have a real estate license or maybe you are in construction. That counts as well. Maybe you're just managing your own properties. That counts too. At least 750 hours a year. And you have to spend more time doing that than any other job or profession that you have.

Okay? That's the hard part. Okay. Now, so let's review, just review that, say it all again because it went by quick.

Okay? So remember again, three tests. Number one is that you and by the way, if you're married, filing jointly, you or your spouse can meet this qualification and you get this benefit on your tax return. So you or your spouse have at least 750 hours a year and more hours in that real estate activity or real estate profession than any other profession. I have a story. A client of mine came to me and he was a very highly paid or not. He Was a cardiac surgeon. I tried to remember what his profession was. And you know, those guys make. I mean, he was making about a half a million a year net. His wife worked part time, like one or two days a week as a nurse because she just wanted to keep doing something. And they were buying a lot of apartment buildings and they tended to buy stuff that needed to be fixed up. And she spoke Spanish and so she, she was really good at going out and making sure the crews were all working. This was down in Miami area. And then they'd rent them up and they were making good money. Plus they had phenomenal write offs. But because of his income, they couldn't take any of those write offs. And the way it was, because of where she was working as a nurse, she didn't have enough hours in real estate activities to qualify as a real estate professional. So the first thing we did is had her quit her job.

And so that's what I'm saying, Diane, it may actually be worth it for. You know, this is one of the. And it may actually be worth getting married if you're single. Like literally just for this, because only one spouse needs to qualify for it. I mean, literally, this is if you have, you know, if you've got eight, ten, a dozen properties or more. And I'm talking, you know, when I say properties, I'm talking about single family homes. But. Or if you have a, an apartment building or something, this literally could be worth changing your career. And honestly, it could be an incentive.

To get married, get a prenup. Okay. But anyway, so she got really excited and they started working in this. And immediately, because of depreciation, because we also got great tax credits. She was providing low income housing. We got low income housing tax credits that went directly against the tax they paid within. I mean, the first year their taxes were cut in half, and by the second year they weren't paying any taxes at all. Now, half a million dollars, we're talking about about $200,000, about $150,000 in taxes wiped out. And by the end of five years, they had so many properties that they'd amassed, they made as much cash flow off of those as he did working as a doc. And that 5, because you make an extra 150,000 a year, you can put that right back into buying more real estate.

Yeah, it's just amazing. I mean, this is a big deal. So only one spouse needs to qualify. 750 hours total per year, which is only about 15 hours per week. That's not that big a deal. Really? And 500 hours of material participation. Right.

That's test number two. And that test is that you have to have material participations. And there's actually three different ways you can get it. But I know, Jason, you ran into this one because you had.

Yeah, because I was audited over it.

Yep. And you had the auditor kind of from hell there. And they were.

But. But I won.

But you won. But you won. You were tougher than the dogs of hell.

Well, you know, they wanted me to just give in. And, you know, when there's a matter of principle, I'll just fight till the end. You know, I'm just not. I'm just not going to give in to that type of thing because, you know, I kind of figure. And this is a little tangent, I kind of figure, how many people is the IRS doing this to? Right. And I sort of kind of view it as my duty as a citizen, you know, as psychotic as this may sound, to spend 30 grand with my accountant to fight the IRS. And I didn't know I was going to win. Now that I did win, I mean, you know, it was well worth it, obviously, because I got way more back than that. But, you know, I just viewed it as my duty for other citizens who were going through it, because, you know, if the irs, they view things like a business, too, and, you know, they don't want to spend a fortune auditing people. It costs them resources and time and money and so forth to do it. So I just figured I kind of had to do it to send the message, you know.

So the material participation, I mean, the one they were trying to hang you on was that 500 hours. But you can also qualify in a couple of other ways. One is that you have at least 100 hours a year on that property of material participation or multiple properties. Well, yeah, that's kind of. We get into Test 3, but in this case, we're just talking per property. It is possible to aggregate them, and I'll talk about that in just a sec. But that hundred hours and more than any other person, and this is where the IRS gets kind of upset, because they figure you're not doing as much as a property manager is you can win that. You don't necessarily have to get the 500 hours as long as you can prove you're spending more time than the property manager is. And then the third one is, is that you're spending more time than anyone else, than everyone else combined. And there is no limit on that. In the case that I was just talking about my client, she absolutely spent more time doing that because she was out there on the construction sites and was making sure you know, picking out the colors and doing everything as they were rehabbing all these apartment buildings. So it's possible to do one of the other three. But the other part of this, and this is step number three, the part three of this test, is that you have to have that amount of hours in each property unless you make an aggregation election. And that's an election you actually make with your tax return and say that we are electing to treat all of these properties as the same.

And I did that as a, as a single entity. My accountant did that for me years ago. So you call that an aggregation election. And all it says is that if you have a portfolio of a dozen single family homes, and there's that hundred hour rule you mentioned where you've got to spend 100 hours on. You said that property. And you also said something like more than anybody else. Right. So what you want to do if you don't have one big property, but you have a dozen small properties, a dozen single family homes, for example, is you want to take the aggregation election. And all that is because I saw it on my own tax return. It was just a page, a piece of paper attached to the return that says taxpayer elects to treat all properties as a single entity. I think that was the words he used. Does that sound right, Diane?

That's exactly correct. Yep. Then just a little tidbit here. I'm trying to remember exactly when this came about. It might have been right about the time you were having your audit. It used to be that the IRS did not let you go back and make that election. And so this was when of their little gotchas that, oh my gosh, I didn't realize I had to do this election. And you never did. So you're in trouble. But they now there's been a case law where they have to allow you to go back and make that election. So if you happen to get audited and you're going, I never even heard of this until this podcast. Don't worry about it. You can go back and do a retroactive election on this.

How far though can you go back?

Well, it's actually, you can go back as long as the year is open. And by definition, you know, the statute of limitations is running. By definition, if they're auditing you, it's an open year because they can't go back and audit a closed year.

Okay, but you can only, you can only go Back a year.

No, the statute of limitations for the feds is three years. So it would be. And that's all they would be auditing you is they can't go back further than that. So if they're auditing you, it's an open year and you can make that.

Election out of everything. You said if someone's a, you know, if someone's not a tax professional like yourself, what, what are they just going to miss about what you said? I just want you to kind of review again because I know that people are thinking aggregation, election, 500 hours, 750 hours more than anyone else. You know, one of the ways that will help you by the way, is to qualify for this is if you self manage your properties or at least if you self manage some of them. And let me just share my own rule and experience on that. I've talked about this on many prior episodes, but several years ago I was surprised to learn that I could self manage effectively a property I've never seen, a tenant I've never met. And it was 2,000 miles away from my home and I never really thought that was possible until I actually did it. And it happened to me by accident. What happened is the property manager got out of the business. He sent me a letter and in typical Jason Hartman fashion, I was busy and I didn't get around to hiring a property manager. And suddenly the rent check comes in with a nice note from the tenant. Hey, I hear the property manager isn't in the business, so here's my rent. I'm like, oh well, I guess I'm suddenly managing this property myself now. And he, you know, included his phone number and he said, if you need anything, let me know. And I'm thinking, wow, the tenant is saying this to me, isn't that a turn of tables? Like I, you know, we sort of expect the tenants to say I need something, you help me. But this guy was so nice and his name, I think his name was Tony by the way, as I recall, he's not my tenant anymore, but he was for several years after that and we had a very fine relationship as a self manager. And one of the things Diane, I discovered that amazed me is that when now I have many self managed properties around the country, you know, tenants I've never met, properties I've never seen, can't believe it's even possible and doable. But my criteria is that if the manager is good, I just keep them and everything's fine, leave well enough alone. But if I got a manager who's not that great. I just get rid of them and I'll self manage that property. And that's sort of my decision maker. The manager basically makes the decision for me based on how good or bad they are. Okay. What I discovered as a self manager though, on the properties I self manage is that the tenant, when you self manage, doesn't seem to ask for very much. And I think the reason is, is that when it's a management company, they view it as this big faceless entity and it's not a person. And they'll just ask for lots of stuff. You know, they'll say, hey, come over and fix this little piddly thing. But when it's you, you're a real person and they have the pressure, the social pressure of sort of wanting to maintain a good relationship with you, they won't bug you for stuff, they'll fix things themselves. It's kind of amazed me. It's been a pleasant surprise.

Yeah, you know, we actually self manage too, so it's like, it's interesting to hear your story.

Do you self manage long distance though?

We do, yeah. Yeah. We've got Phoenix properties and we live in Reno, so. And we don't right now, but we've also had properties in Colorado in the past. So yeah, we've been kind of all over with properties too. So the only thing is for us was getting them rented. But once they're rented, it's, you know, you find some people that are good to just take care of your maintenance and there you go.

And I just use a local real estate agent to rent them in between or a property manager to rent them, and they'll do the walkthrough of the tenant on the way out and the tenant on the way in. You know, they'll send me pictures and I'm like, you can really do this without a manager. It is amazing.

Well, and okay. And kind of putting it in that whole context of what we're talking about, how easy it can be to qualify for this. So you know that real estate professional status. And this is the part where people get confused. There's two different tests. One is that 750 hours or more than anything else, and that's any kind of real estate activity. It could be taking care of yours properties or it could be doing something else in the real estate field.

Can it be listening to Jason Hartman's podcast?

Well, okay, now this is interesting because if it's getting you.

Well, we know it's interesting, Diane. It's a great podcast.

It's a fabulous cat. But they have to take action first. So if they're an action taker, and now they're like already doing this, and now we're just listening to Jason Hartman to hone our skills so we can be better at what we're doing, so we can grow up and have a swank life or swanky life. Then that counts. Yeah, then that would count. But you also need, I mean, if all you're doing is listening to Jason Hartman, the IRS is going to get a little upset because they want to actually see you doing, putting that stuff into play.

They're just mad because Jason Hartman won that audit with him.

That's right.

And they wasted all that money. Oh, gosh, I'm teasing you. You know, probably teasing the IRS is not a good idea. I apologize. Don't come back and audit me again, please. That was a real hassle. Even though I won, it was a big hassle.

Avoiding the IRS audit is definitely the best thing to do. But on the other hand, do it right so you don't have to be afraid as you get through it. But the part that gets confusing, and I'm not even sure the auditors always get this part right, but it is separate that 500 hours or 100 hours or whatever material participation, that's for the property. But the real estate professional could be for the property or it could be for a whole bunch of other things. It could be getting a real estate license and showing other people property. It could be doing construction work. That's a great one. I have a lot of contractor guys who qualify as a real estate professional and then they're buying stuff to fix up and hang on to too.

So the self management will help you. Now one of the questions we get occasionally is does it matter or does it help if I have a real estate license? Like, you know, it's pretty easy to get a real estate license in many states, unfortunately. I'll say, does that matter?

You know, if that is what you're going to do and you're actually spending time doing that, you've got clients, you're driving around looking at properties, doing all that. Absolutely. That counts toward that. 750 hours.

If you're a Realtor, then, you know, if you're a full time realtor, I mean, you just automatically qualify as a real estate professional in the IRS's eyes. No.

Well, no, you got to meet those hours.

But if they're a full time Realtor and assuming they work a 40 hour week, you know, 2000 hours a year.

Yeah.

They qualify, but that's not really in the field of investing though.

Yeah, they would qualify under that real estate professional part of it, that test number one. But do they qualify then in test number two, which is material participation on their property?

Oh, yeah, because if they're a real estate agent and they have one property, they're never going to be able to say they spent 500 hours per year managing one property.

Boy, that would, that would have to be a hard prop. But that's, that's a case where they have to single manage.

They got to self manage.

Self manage, there we go. You've got to self manage it because then they can have more hours than anybody else.

So there's the next question, you know, and I know there's no actual number on this, but how many properties does someone need to have in order to make those hours legit? You know, 500 hours of material participation, 750 hours total per year. So, you know, think about it. That's approximately 10 hours per week of material participation and 15 hours per week of total involvement in the real estate investment business. And you know, you're not going to be able to qualify with four properties. There's no way the IRS will believe you. And when I say properties, I'm just assuming single family homes. Okay.

You know, actually, I think I would disagree. As long as you're getting that 750 hours. I know I disagreed with you.

Well, I'm glad. I mean, I want it to be. I want to lose this debate, but I don't think I'm going to.

Well, the real estate professional status will be the key. I mean, if all you're doing is taking care of these four properties and trying to claim real estate, that 750 hours, that's not believable. But if you're doing something else that's in that real estate field and that's the case where maybe it makes sense to get your license and you know, do you be a licensed property manager or be a licensed agent where you're out looking at properties. But I don't think that the 500 hours necessarily has to be a concern because of that other one in the material participation where you prove that you're self managing and then you're doing more hours than anybody else. And so it doesn't have an hour requirement. But it's hard with the property manager.

Yeah, the property manager is going to make it hard to qualify. So let's talk about whether. And the great thing is, if you're married, only one spouse needs to Qualify for both to get the benefit. Right. Does that matter if you're filing jointly or filing separately or. Tell us about that.

You have to file jointly. If you file separately, you just lose the opportunity completely. And it's not like one person gets to take it or anything. You just lose it. It's got to be married, filing jointly. If you're single, it has to be you.

Yeah. Okay, that's good to know. So what about if say you, you know, say you're sort of semi retired and you have a part time job but you spend most of your time managing? Well, maybe not most, but. Well, according to the irs, it's got to be most of your real estate portfolio. So if you have a job where you're working 20 hours a week or your spouse maybe who isn't the major breadwinner has a part time job and they're working 20 hours a week, that's pretty easy to qualify, right?

Well, it's possible. The place I see people kind of get in trouble with that is maybe they have a business and they might be making a big income and not really working that hard anymore. And the IRS might challenge on that. It's like, Yeah, I make $200,000 a year, but I really only work 10 hours a week. And that's possible. I've got clients that do that. But in that case, what we want them to do is track their hours, that they actually work at their job so that they can prove that. I mean, it's like you have to have two journals, one to prove you're a real estate professional and the one to prove I'm really not working that hard for the money I get.

Okay. Well, that's what they say about business owners. They always have three sets of books, right. One, one is the real set of books, the other is for the irs and the other is for the buyer of the business. Right. When they sell it someday. That's sort of an old cliche. I just know our listeners are going to have questions about this. First of all, Diane, give out your website.

Sure. Ustaxaid.com and that's US tax and aid.com.

Anything we didn't cover anything that based on our discussion today, you know you're going to get a, a phone call or an email about that. We didn't answer.

Well, actually, I want to throw another little thing in there to think about one of the issues if we were talking about that material participation. You've got to also look at how you're holding those properties. If you've Got them. In an llc, you want to have a manager managed llc, where you're named as the manager. If you, for example, had a limited partnership and all you are is a limited partner, well, by definition, a limited partner means you don't, you don't do anything in that. So you can trip yourself up just by the business structure you have for the property.

Oh, okay, this is good. I'm glad you brought that up. So if you invest, and you know, this is something we generally discourage, by the way, but it's one of the things I want to kind of cure with my, my mastermind group, the venture alliance, your financial friends. And I've talked about that a little bit on the podcast as well, and more to come on that. But that's the kind. The idea of investing in a fund, investing in a pooled asset, investing in, you know, basically someone else's deal. And there are a lot of apartment groups out there that do this kind of thing. They form an LLC and they're the general partner and they say, hey, you know, invest 50 grand into this deal and you can own part of this apartment complex or whatever. Right. So none of that stuff will help you with your real estate professional status, I assume. Right.

Unless you're the guy running it. Yeah, no, it's not going to help you. It's treated just like a passive investment in stock or something like that.

But what about when it's your own property and you put that property into an llc? That's really what you were addressing, right?

Right. Yeah, exactly. The very safest way to do that is there's two different kinds of LLCs. You can form manager managed or a member managed, and just have a manager managed. And then in the document, name you or your spouse as the manager. And then that just absolutely sews that deal, that question up. It goes away.

Now, does it matter if it's a disregarded entity or not?

Yeah, it wouldn't matter. Just when you form that llc, disregarded, in other words, it's like a single member LLC and you just have it come through on your personal return. But make sure that LLC document shows manager. Manager.

I tell you, folks, you start getting into this whole business of forming all these entities and life gets really complicated and there's no way we can address it here. And Diane is not an attorney. She's a tax advisor. She's a cpa. But. And of course, neither am I. I'm neither of these things. So get advice from someone good. But the problem is, you know, you got the most desirable state to set up the LLC or the other entity if it's a corporation, you know, but say it's an LLC and then you've got the state in which you hold the property and then you've got the state in which you're a resident. And that is complicated as hell. I'm just going to tell you that gets really complicated. And then sometimes the insurance company has a problem insuring you if the property's in an llc. And let me tell you, this stuff, in addition to separate tax returns, possibly and separate bank accounts, of course, that's a must. This gets complicated. So be careful. It's never as simple as the promoter makes it sound. The company out there promoting these LLCs, they just make it sound a lot simpler than it really is. Would you agree, Diane?

Oh, I absolutely. I'll tell you, I've got people now asking about, well, what if I have a Panama company own my property? It's like you don't understand. Now I know now we've added a foreign country and it doesn't do any benefit at all. I mean, you're still going to pay US taxes, it doesn't matter. But yeah, you got to be careful on some of that stuff.

Yeah, you really do. It is complex. Okay. So good stuff. Well, Diane, thank you so much for talking with us today about this very important subject. We'll definitely have you back on to talk about other elements of what makes income property the most tax favored asset in America. But you know, actually I think there's a big, a big elephant in the room. We didn't even mention when we started, we just sort of dove into this topic. The whole reason, and this is so great, I don't even think we covered it. So let's cover it now is that depreciation is the holy grail of tax benefits because and you did say this, you alluded to it that it's a non cash write off, it's a phantom deduction. And basically listeners, let me tell you now what I should have said at the very beginning here is that when you buy a property, when you own an investment property, and this only applies to income property, not the house in which you live, it's really not a single component. It's two components. There's the land and then there's the improvement sitting on the land. And that's the house or the apartment building that sits on the land. And the IRS basically and Diane, just interrupt me, correct me if any of this is not correct, but the IRS basically says, look, you know that improvement that house or that apartment building sitting on the land is an asset that will eventually become worthless. Eventually someday it will fall to the ground. It will be economically obsolescent. Okay? And so instead of taking a deduction at that time, we're going to give you this weird schedule and it's going to be an arbitrary number, 27 and a half years. It has nothing to do with how long the house will last or anything like that. But you know, we're just going to say that's the depreciation rate. And so if the value of that property is, the value of that improvement is $100,000, like a typical deal that, you know, you would buy@jasonhartman.com in the property section might look something like this, it'll be $100,000 improvement value. And I'm just estimating very roughly here, and a $20,000 land value. And this is one of the reasons we like these linear low priced markets, because most of the benefit or tax value is in the improvement. So you get the highest write off potentially, and that $100,000 can be depreciated. I'm just going to take $100,000 on my calculator here and divide it by 27 point. That means you get a $3,636 write off every year if you can qualify for it. And the way to qualify for it is either to have an income below $100,000 annually in adjusted gross income or be a real estate professional, or there's two other steps where you get part of this benefit, and that is if your adjusted gross income is up to 125,000, it starts, it phases out a little bit and then up to 150,000 you get some benefit. But over 150,000 AGI, it phases out completely, unless you're a real estate professional. So speak to that if you would, because that's really where we should have started.

So with depreciation, I love to call it the phantom expense, because it really doesn't cost you anything. You buy a property and you've got financing with that, the interest is deductible, and then you get to take that write off of depreciation. In the example you were using, there'd be $100,000 that was attributed to the property. I mean, the building itself, it's 27 and a half years if it's residential, 39 years if it's commercial. And in this case, commercial means like an office building or a strip mall or something like that. If you've got an apartment building, it's residential, so it's 27 and a half years. You can go even one step further and do what's called a cost segregation study. And in that case, you take the building. Let's say you've got a single family home. Inside that single family home are improvements that are depreciated faster, which means more depreciation.

And that's what's called a cost segregation analysis. And here's a question for you. Now we got another tangent, but why did you bring that up, Diane, you're complicating this thing. Is that even worth it to do on single family homes? It's worth it on a big commercial property. You know, you hire this firm that does these cost segregation studies and you pay them a kind of a fortune, actually. You know, it can save you more than they cost in taxes. And that's the idea. But on a single family home, I mean, the appliances, you can depreciate over what, five years or seven. The air conditioning, the H Vac.

Yeah, usually about five years, you can do it yourself. That's the other part of this. And there's some standard guidelines you can use. Just in your example, I was doing quick little scribbles. What you do is you don't create more depreciation, you just front end load it. And that would give you approximately $5,000 a year more depreciation for the first five years. So that's a great strategy. If you're going to be buying more properties every five years, you've got to figure you've got to buy another property because the depreciation falls off. You front end loaded it and now it's going to be much less. So as long as you're building property.

That'S not the whole property, that's just the appliances, though.

Yeah, correct. But you go from having a depreciation of, you know, 8,500 a year to maybe 2,500. That's a guess. I don't know if that's the right numbers. But because you front end and loaded it, the rest of the time, it's going to be much less on the depreciation. It becomes a way to. I'll tell you the place we can use. That is if I have a client that's maybe had properties for three or four years and then all of a sudden they qualify as a real estate professional. It's like, okay, great, and you had some income. What we can do is do the cost segregation retroactive and we do what's called catch up depreciation. And by the way, we're getting really fancy with taxes here, right?

This is some pretty complex stuff. You don't need to worry about all this, folks. This is what your accountant's supposed to worry about. Okay?

Let me just say if you are a real estate professional and you're paying taxes, you either one, don't have enough properties or number or two, don't have the right CPA working with you with this because you don't need to pay taxes if you have enough property.

Income. Property just rules the roost. Taxes are the largest expense anybody will have in their life. An income property is the most tax favored asset in America. So. And there are so many other reasons. It's great besides taxes. But don't get bored with this tax stuff. It really is important. Think about how much faster you can build wealth if you're not giving away, you know, 35 to 45% of your wealth of your income every year to the government. I mean, you can just go leave and bounds ahead of everybody. You know, if you can take that money and reinvest it and not pay the government and look, this is what the government wants. They're incentivizing you to do that. This is the most patriotic thing. You know, the government wants you to provide housing to people, do what they want. You know, this is my philosophy with everything. Align your goals with the goals of the most powerful entities on earth, governments and central banks. Okay? And that's why I talk about inflation induced debt destruction and I talk about, you know, gold and precious metals and comparing that to real estate and Bitcoin because those things are not aligned like income property is. You know, you want to do packaged commodities investing. Another one of my big philosophies. Look up the prior episodes on this. You can go to jasonhartman.com and just search these terms and you'll find all the, the prior episodes where I've talked about this stuff. But align your goals and your strategy with the most powerful entities on earth. That's what you're doing here. That's what I've been talking to Diane about here. So Diane, just great stuff. Your website ustaxaid.com right?

Yes, that's it. Thank you. This is fun talking about it, isn't it?

It really is. I get so passionate about this stuff. I love this stuff. It's just so great. Any final thought? Anything we didn't cover? Please don't go down another rabbit hole though.

We're not going to open any more rabbit holes. You know, the bottom line, I got to say, is just when you're involved in real estate, when you're buying it, just remember that one of the three benefits you've got besides cash flow and appreciation is tax savings. So do what you need to do to take advantage of all of those things.

Good stuff. Diane Kennedy, thanks for joining us, folks. Go to jasonartman.com if the show is valuable to you, please write us a review. Go to itunes, go to Stitcher Radio, SoundCloud, wherever you listen, and write us a review on the show. We'd really love to hear from you. And go to jasonhartman.com for properties, home study courses, anything else you need. And of course, we've got 490 prior episodes you can listen to as well. Those are all free, so check them all out. Jason hartman.com thank you so much for listening. Diane thank you for this great advice. Good topic today.

Thank you.

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