EP36: Passive Investor's Guide to Maximize Real Estate Tax Savings with CPA Thomas Castelli
16 Feb 2024 · 44 min
CPA Thomas Castelli explains how passive real estate investors slash taxes through depreciation and cost-segregation studies. A cost-seg can reclassify building portions into faster depreciation schedules, unlocking 60% bonus depreciation in 2024. Qualified Real Estate Professional status lets you offset W-2 income with rental losses if you log 750 hours annually in real estate work.
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Sometimes called a phantom expense because it only exists on paper. And what it does is it reduces your taxable rental income, often creating a loss for tax purposes, despite the fact that the property might be generating positive cash flow. So in other words, you're putting money in your pocket, but you're telling the irs, hey, I lost the money. So now this rental income is it could be taxed at that same rate up to 37% because of this non cash expense called depreciation. You're actually not paying taxes on this income. Are you frustrated watching your hard earned money ride the knee jerking Wall street roller coaster? Are you looking to diversify into alternate investments and set them on autopilot to achieve financial freedom? It's time to learn the ways of the wealthy. It's time to Think Outside the Stocks with your host Madhvi Jain, an immigrant from India and ex IT professional who will bring you industry experts to illustrate a passive and holistic financial approach to build not just passive income, but also your generational wealth. Madhv is on a mission to change the financial trajectory of one family at a time. And a thousand more to go. Are you going to be part of this vision? And now without further ado, here is the host of Think Outside the Stocks, but Madhvi Jain.
Hey, hey, hey. Welcome back to Think Outside the Stocks. I am your host Madhvi Jain and I have here with me a cpa. Yes, a cpa. Thomas Castelli from Hall. Cpa. But before we go ahead, I do want to mention that this is information and education purpose only. Whatever we are providing as an education on this podcast, please be sure to do your own due diligence on it. Consult your tax professionals, your lawyers, so that you can implement strategy in your financial structure. Welcome Tom to the Think Outside the Stocks podcast.
Hey, thank you for having me. It's an honor to be here today.
Thank you so much. And listeners, if you have a question that if you're investing into real estate, does that passive loss actually help you as a W2 earner or an active income earner in some other category? So we are going to dwell much into that today that how can you actually benefit from this passive losses the real estate syndications are bringing to you? So I'm excited about that conversation, Thomas with you. So let's jump into it. But before we go there, I do want to always, always welcome my guests with three interesting facts. So here are three interesting facts about Thomas. Number one, like many of us, he is also inspired by the book of the Nation. Rich Dad Poor dad. Yes. Even the CPA could get that inspiration and change the direction a little bit to make that humongous leap. So Thomas, it's great to hear that, number two, that he is not only a cpa, but he is also a real estate investor himself. An active and passive. And that's why it's really, really important to know from his perspective how actually those passive losses can be implemented if you have this, you know, humongous active income in something completely different like a CPA field. So that's fact number two and fact number three, Thomas just was mentioning that he loves kickboxing. That's amazing. You know, there' many different sports that we kind of bring our life balance to. But kickboxing, it's quite interesting. I Thomas, quite honestly, I tried it myself, but I found that very, very difficult. So would love to know more about that. So with that, let's jump right in. But let's begin with little bit about your story. Do you mind telling our audience, introducing yourself why you are doing what you are doing and how did you get here?
Yeah, absolutely. So my name is Thomas Castelli, I'm a CPA and I help real estate investors reduce taxes and I work with real estate investors of all types, passive investors, active investors and everything in between. And kind of how I got here was when I was going to school, I went to school for accounting and I realized somewhere along that, that college path that going and getting a job alone was not going to be able to get me to where I ultimately wanted to go in life. So I picked up books like the Rich Dad, Poor dad book and kind of found that real estate was a common theme amongst people who built wealth. So I decided to start going to monthly networking events and meetups and what have you, and eventually met a group of people who were doing a three day weekend on real estate syndication. So I went to that three day weekend and I learned everything about real estate syndication, fell in love with that business model, started going to their monthly events and eventually investing with members as a limited partner. So as a limited partner I was actually able to see some of the behind the scenes stuff and kind of learn the ropes a little bit. And group that I was working with at the time said, hey look, if you find a deal, we'll syndicate that deal with you. So started building broker relationships and sooner or later deals started to come my way. And one of those deals penciled out, brought it to the team and we ended up syndicating it. So that was 82 unit, 82 units. In Jacksonville, Florida that since went full cycle. So that's just a little bit about me. And around that same time, I actually met Brandon hall, the founder of Hull cpa. And I was, I said, hey, you know, I'm about to start either my own firm or about to go and find a search so I can go and do taxes for real estate investors, kind of marry the two together. And long story short, took a job at Hull cpa. Now I'm a partner and get the privilege of helping a lot of different real estate investors reduce taxes. So it's a great place to end up.
That's amazing. Thank you so much for sharing that story. Congratulations, first of all, for the first full cycle deal and being active. And one thing, you know, I learned from story, from my story, from everyone else's story, that, you know, there's fun in carving your own path, but there is actually, you don't have to reinvent that wheel. So it's always good to leverage other people's expertise. And you know, it's great that you actually got to do that active deal and which is humongous work by the way. Good to know that. Whatever it takes to complete that deal. But listeners, if you are, you know, listening to this, you don't have to reinvent the wheel. If you want to go into something active, test the waters, being passive, ask you first and test the waters, ask all the questions, learn everything that you need to educate yourself and then jump in, which, you know, Thomas, looks like you also did. So that's incredible. And congratulations on the path to Hall CPA as well. Great firm. We have, you know, in this, our net small network of real estate investors. There is a lot of reputation and there is a lot of education, membership that you actually provide, which help passive investors tremendously. And you were mentioning how you help investors which, you know, have probably one investment to hundreds of investment. Right, so let's talk about that. And people actually think that, you know, tax filing is a job, but tax planning and tax strategy, it's highly, highly important. So let's talk about the tax strategies portion of it. Why is tax strategy so important? And how can, you know, passive investor leverage that expertise from somebody like you?
Yeah, absolutely. So start off like this. I think the best way to kind of break it down is like this. So when you, when you have your tax return every year that's going to get filed, if you made money, chances are you have to file the return. And a tax preparer simply takes the information you provide them, puts it on the form and makes sure everything is filed in compliance with the IRS standards, the tax code, and all that, and then ships it off. Right. So they, they prepare your taxes and that's it. That's their job. And most tax preparers are so busy doing that that they don't have time to ever provide advice to their clients. Right. So the tax return, again, that's just the tax return is like a report card of the income and expenses and the activities you did from the prior year. Whereas tax strategy and tax planning is looking at your facts and circumstances. So what you have going on today, where you're looking to go, so what are your future plans and saying, okay, well, based on where you are today, where you're looking to go, here's the moves you can make, here's the things you can implement so that when it comes time to file your tax return, you're putting yourself in a very favorable position. So I guess to summarize that a tax return is just reporting what happened the prior year, kind of like a report card. Here's how you did. Right? Whereas tax strategy and planning is actually influencing what that report card is going to say, in many cases, you're going to need to do that before it comes time to file that tax return. For the most part, once it comes time to file your tax return that year, the prior year is already closed. It's like 2023, for example. It's over. You can't go back and do much else. So tax strategy and planning is important to making sure that when you file your tax return, you're minimizing your taxes.
I love that. I love the report card analogy. Thank you so much for that. So given that, what's a great time to start doing that tax planning?
That's a great question. Really, as soon as possible. I mean, in an ideal world, you're doing tax planning in the beginning of 2024, right. You're doing it in January, perhaps February, and then that's going to help set the tone and give you what you need to go ahead and execute during the rest of the year so that when it comes time to file your 2024 returns in 2025, you're in good shape. Having said that, we've seen success with people starting at any point throughout the year. So really, the sooner you get started, the better and the more Runway you're going to have in terms of what you can execute.
Right? Yeah. I always talk to my investors, especially when it comes to investing, that, you know, you should have the end goal in mind Right. So once you have the end goal, you almost kind of reverse engineer and carve your path that, okay, this is where I want to be. You have that goal in mind, that okay, if I don't do anything, this is going to be my tax liability and kind of reverse engineer that how I can diminish that tax liability. Right? I think that looks like it. So given that, let's jump into our topic for today to understand that passive investor implication of taxes. And how can actually the commercial real estate project, syndicated project can help them, you know, with their tax liability. And typically at least I kind of look at that if there is, you know, some dollar amount being added to their income with cash flow or any kind of returns, at least that becomes efficient, at least that becomes tax smart. Right. So let's talk about, and I can literally throw in bunch of words here and people who have not heard about it yet that could just sound like jargon if I start talking about cost segregation or bonus depreciation and things like that. But it's a good time to actually take a minute, talk about it, kind of decipher for them. So can we talk a little bit more about how the tax benef in commercial real estate works in a very, very simplified language?
Yeah. So I'm going to break it down like this. So for passive investors, limited partners who invest in syndicates and funds like me, I'm in the same bucket. There's really two tax benefits you get from doing that. A is the ability to shelter the income that's being generated or the cash flow from the syndicates from tax. And I'll talk a little bit why that's important in a second. The second thing is the ability to shelter, to use the losses that are generated from these investments to offset passive income from other perhaps passive investments you have, including gains on the sale of another property or another investment. So let me kind of dive into that a little bit and unpack it. So if you have a job, if you have an active business you're running, you're generating active income, they call it or non passive income. And this is typically taxed at up to 37% at the federal tax bracket. And then when you add on state taxes and perhaps local taxes, if you live in a city like New York and you add the FICA taxes, it's not uncommon to see high income earners paying 40 to 50% of their income in tax.
Incredible.
And it's painful. It's painful. I see people do it all the time. And so the first benefit is when you invest in a syndicator fund, well, the rental income that you're generating from the syndicator fund, well that's also taxed at 37%. However, there's this non cash expense called depreciation, sometimes called a phantom expense because it only exists on paper. And what it does is it reduces your taxable rental income, often creating a loss for tax purposes, despite the fact that the property might be generating positive cash flow. So in other words, you're putting money in your pocket, but you're telling the IRS, hey, I lost the money. So now this rental income is, it could be taxed at that same rate up to 37%. Because of this non cash expense called depreciation, you're actually not paying taxes on this income. So to give a quick example of this, let's say that you had a property and it generated $10,000 in rental income. Now let's say you're fairly good operator. So you're operating at a 45% expense ratio. So that means you would have around $6,500 left in income or cash. Now, in most businesses you'd pay tax on that $6,500 of income. But now let's say you have a $7,000 depreciation expense, which is not at all out of the ballpark. So now what happens is you have a loss of 500. So that means you did not pay tax on that $6,500 that you put in your pocket. And now you're telling the IRS, well, I lost $500. So that's kind of the example of the first aspect of it, the ability to generate tax free income from.
And if that's saving you about 40% of taxes, so that's significant amount that's saved. Right?
Right. That's a big deal. And that's like the first benefit that often gets overlooked. Now where the confusion or the FR frustration in some cases comes in is, well, what happens to that 500 loss in this case? And sometimes the losses are much bigger. But what happens to this loss? Well, as a passive investor, this loss cannot offset your W2 or your active business income. Unfortunately, that doesn't work. We'll get into a little bit, I'm sure, on how that, how you can do that, but generally speaking, that's not how it works. So a lot of people get frustrated and say, well, if I can't use this loss to offset my W2 income, well then what's the point? Right. Well, we just kind of went through how to get the shelf your Rental gun from tax. What ends up happening with this? Plus if you can't use it in that year, it gets suspended and carried forward to future years. So it doesn't just disappear now. It can help you offset future rental income. It could also help you offset the gain on sale of a rental property. So say, for example, you sell one of your syndicate investments is, you know, you're invested in it, they sell it. Now, typically if it went well, you're gonna have a capital gain. So you can actually use passive losses to offset that capital gain on sale. So it's just another way that you can use it.
Yeah, I love that. And you know, we were talking about the rental losses, which is also possible if you are a landlord and if you have a rental property. Right. So between the rental property and actually the syndication, the commercial real estate, when they start investing into that, there is kind of, you know, kind of a steroid treatment on the taxes. Right. So let's talk about that, you know, the cost segregation benefit and how that can actually supercharge their tax savings with the depreciation.
Right. So basically, again, you know, what happens is like when you have a rental property, whether you're an incident kit or you own it yourself, you're going to depreciate that property. Now with multi family property, for example, or single family, so residential property that's typically depreciated over 27 and a half years. So that means that if to kind of just paint a picture with an example, let's just say you had a $500,000 property. Just to keep the, the math easy. Well, lands never depreciated, so, so part of that $500,000 property has to be allocated to land. So let's say it's 20% allocated to land. Well, that would leave you with $400,000 left. That represents the building. And the building is going to be depreciated over 27 and a half years. So every year you're going to get roughly $14,545 worth of a depreciation expense. So that's nothing to laugh at. But here's the thing, right? So the entire building is not just the structural components that are depreciated over 27 and a half years. There's other components in that building. There's going to be things like carpeting, light fixtures. There's going to be pools, decks, sheds, appliances. All these things are depreciated over a shorter period of time than 27 and a half years. So what a cost segregation study does is it goes into the property. Think of it almost like, of like an inspection of sorts of where an engineer comes down to your property surveys, it goes back to their office, generates a report and says, okay, well, of your $400,000 building, 20%, for example, just giving examples here, is five year property. Another 10% is going to be 15 year property. And the good news is, is not Only can this 5 and 15 year property be depreciated over a much shorter period of time than 27 and a half years, but it's actually eligible for something called bonus depreciation. So if you have property that's, that has a depreciable life of less than 20 years. So for real estate, that's typically that 5 and 15 year property that can be depreciated in a much faster way. So to kind of paint this picture here, say this $400,000 property, well, usually somewhere between 20 and 30% of that building can be reallocated to this five and 15 year life. So let's go ahead and take that 25%, that's a hundred thousand dollars. So now this hundred thousand dollars is eligible for bonus depreciation. Now currently, as of this recording in 2024, bonus depreciation is 80%, excuse me, 60%. So that means is that you're going to be able to take 60% of this $100,000 and depreciate it all in the first year.
Right.
So now if you take 60% of a hundred thousand, you're going to have a $60,000 depreciation expense which is quite sizable and in most cases is going to give you a quite a large loss that you're going to tell, you might tell the IRS, we have a loss of $55,000 this year. And what that does is those losses, because they're so substantial they can help you offset. That's really, for passive investors, this really becomes powerful in a situation where you're selling a, where perhaps one of your investments is being sold in that year, because now you're gonna have this big loss, let's just say $55,000. Well, if you have a capital 75,000, just for example, well, now you're only going to end up paying $20,000 taxes on $20,000, that capital gain, because that 55,000, long story short, will ultimately offset that gain. So that's the, that's cost segregation, that's bonus depreciation. And kind of why it's so powerful.
I love that. And I love that you give that example because, you know, I'M a very numbers person and listeners, you know, they have a lot of analytical mind too. So the numbers and the examples really, really help a lot. So thank you for elab. So just as a comparison, right. I mean if you're looking at. And again listeners, please remember these are numbers only. These are examples just point in time. It's not specific any of the situations that you might be going through that every situation is different. But just to give us an idea, Thomas, if, I mean you were explaining about if a rental property probably, you know, gives 10, 20% depreciation benefit, what do you see the multifamily or the one with the cost segregation and bonus depreciation benefit can give you? And by the way, 60% can be done first year. So where does that rest 40% go? Does that get rolled over to the next year and the next year or does that basically, you know, get distributed over the rest of the years for that?
Yeah, that's a great question. So that remaining 40% that didn't get bonus depreciated, that will be depreciated over its remaining useful life. So five years for a five year property and then 15 years for the land improvements for that 15 year property.
That helps.
There's a simple way to look at it is to think just that will be depreciate over 5 and 15 years. Just straight line. But there's actually something called the double declining balance, which I'm not going to go into here, which actually accelerates that depreciation towards the front of that five year of those class lives. So it doesn't disappear, you'll still get that depreciation. It's just going to be over a five or 15 year period.
Yeah, that helps. And isn't there like a discussion going on to bring down that 100% bonus depreciation back because not too long ago, two years back stock, it was 100% last year got to 80% this year is a 60%, it's kind of declining from there. So do you have any thoughts on, you know, what kind of discussions going on and where would we see it going?
Yes, so basically there was A. You're 100% right. There was 100% bonus depreciation from the tail end of 2017 all the way through the end of 2022, but then it begins to phase out 20% per year. So 80%, 2023, now we're at 60%. However, there's currently a bill that was passed by the House, so it was by the House of Representatives. It's now sitting with the Senate and we're waiting to see if and when the Senate will vote on it. And if the Senate votes on it and they pass it into law in its current form, it will bring, it'll retroactively bring back 100% bonus depreciation to 2023. So in 2023 it wouldn't be 80%, be 100%, which is great for many people. And then it would also bring it through 100% for 2024 and 2025. And then in 2026 under this bill, if it passes, it would be at 20%. We'll see what happens then and in between then. But, but long story short is if this bill is passed by the Senate, which we don't know if and when it'll be voted on, you would have 100% bonus appreciation for 2023, 2024 and 2025.
That's excellent. So cross our fingers. Let's see where that goes. Something is better than nothing. Thank you for sharing that. And you know, going back to my question, I think it just kind of got lost because I asked another about what is the comparison between the straight line depression in a rental property and a commercial? What times do you see that difference? You know, if it is like a 10, 20% in rental, how much person do you see typically in commercial properties?
Yeah, so kind of just two things there. So for residential property that's depreciated traditionally over 27 and a half years, for commercial it's 39 years. So a little bit longer. Now as for the actual amount, say 20 to 30%, it really varies on a property by property basis.
Yes.
And you'll see a lot in multifamily compared to say single family, you'll see more higher percentage is eligible for bonus because there's a lot more components and stuff that are in there. And when it comes to commercial property, there is something unique about commercial property that is differs from residential property. That's something called qualified improvement property. So qualified improvement property is certain types of renovations which are actually a large renovations that are done to the interior of a commercial property fall under this, this qip bucket disqualified improvement improvement property. And that has a depreciable life of 15 years, which means it's eligible for bonus depreciation. So you can see the amounts on commercial properties being much higher depending on the type of commercial property size and to the extent of its interior renovations qualify for this. So that's harder to give a percentage. I mean I've seen properties go as high as 70% in some cases and with like car washes and with certain types of properties like car washes and gas stations for example, which do kind of fall under that commercial property, property bucket up to 100% of that can actually be eligible for bonus depreciation thanks to special carve outs in the tax law for those specific types of properties.
Yep, that's interesting. Yeah, sometimes I do see at least 2x3x, you know, depending on again type of property compared to the rental real estate just being a landlord and just being a rental house. So that's one of the like I would say the tax benefit on steroids. Now let's go back to our original question about passive investors being able to apply this Saks benefit and how can they utilize, I mean you all already addressed the two portions of it as how they can do it in passive income and their other losses, other gains like a sale from a property, et cetera. How can they go a step further and be able to apply this losses instead of just rolling it to next year?
Right. Okay. So being able to use it against the Non passive like W2 and active business income. So there is a way to do is a very thin way to do it. And what I mean by thin is like there's a very, you have to, there's a very fine line. So the way this works is you have to qualify as what's known as a real estate professional. And then there's another step and I'll, and I'll explain that as well. So to qualify as a real estate professional, you have to work more than 750 hours and it's the big one, more than half your total working time in a real property trader business. So this rule is actually designed for people who work full time in real estate. Why it's called the real estate professional status. So if you have a full time job, this is going to be nearly impossible to qualify for if your full time job is outside of real estate and you don't own the real estate company. But extremely challenging to qualify for. It's one of the most litigated areas of the task code with over 500 tax court cases. And basically no one with a full time W2 job has ever been able to qualify and win an audit at least to end a tax court case with the irs. So that's kind of the first thing. Now the good news is you can have a spouse qualify. So if perhaps you can't qualify as a real estate professional, maybe your spouse can. And if you file a joint tax return, then both of you will qualify for the real estate professional status.
So let's, let's take a pause here a little bit. Let's just go back and you know, just kind of reiterate what you just said.
Yeah.
So the qualified real estate professional as we call it, Q rep. Right. So if you have heard about that term, this is what it means that you know, you are your spouse, if you can get that designation, that's an IRS designation, qrep. And in that case, if you have a passive loan loss on your commercial real estate property or any of these passive losses that you have, you can actually take that loss. So say for example, if you invested 100k in a commercial real estate project, which as we were discussing would get you, say for example, it gave you about 70% benefit. Again, that's a paper loss, that's not an actual loss. As Thomas was explaining, it's a phantom loss. So you see, if you get that 70,000 in paper loss and if you have 10,000 or 20,000 income and you were able to apply only 20,000 of that as a passive loss in the current year, now the 50,000 is left over, right, for you to able to take that and apply it on the active income of the spouse who's working W2 job, either doctor, engineer, whatever profession that is. Right. If the other spouse house qualifies for that Qrep designation, now you can take that 50,000 and if you have 200k income, you can apply that on it, reduce the AGI and then that reduces your tax liability significantly because now that's the higher tax bracket. So that's really that 40, 50% including the state taxes, that's getting impact, which is a huge impact. So thank you so much for bringing this in, Thomas. Let's dwell a little bit deeper on that because you know there are many of the investors, their spouse is not working and in fact they're actually dealing with real estate. But you know, most of the times they just don't know what it takes, right. To be a Q rep. So let's talk about that. If a family and husband and wife, they are into real estate, what kind of activities can qualify them? So I understand There is a 720 hours requirement and you know, more than 50% of any job that you are doing, it must be mostly in the real estate. Right. And then there is a material participation requirement as well. Right. So let's talk about some examples of how these families can, can qualify for that designation.
Yeah. So basically I'll give a few different scenarios that I've seen work. Well, so the 750 hours, let's assume one spouse is working part time or perhaps not working at all outside of real estate. So let's just assume that that 50% of your total working time is irrelevant here. And in my experience it's often the case. So the question is, how do you get to 750 hours? Right. One way to do that is by managing, is by acquiring rental properties and just managing your rental properties. So in other words, you're kind of, you're self managing. You might have some people helping you out, but you are for all intents and purposes the property manager. And in some cases with as little as one property, you can make that 750 hours. Now if you're only gonna have one property, the way I've seen this work is someone buys a property usually local to local to them, so within driving distance and they go and they're finding that property. It's usually distressed or not up to market conditions. And they're spending a lot of time either doing the renovations themselves or coordinating those renovations and making sure everything's going on to get those properties up to market standards. And then they're going to go ahead, rent it out afterwards and be the property manager. And usually between the rent to time spent on renovations and the time spent as the property manager, you can get to that 750 hours. Now we've seen that happen before. Now it becomes easier with more properties. So if you have more properties, the easier that that becomes. So that's one path going, the pure rental path. And really that's, if you're going to have one property, it's going to, you're going to probably need to have a lot of renovations on that property. Get to that 750 hours.
Yeah. And then, you know, that may happen in the first year that you have renovations, but the subsequent years might not actually give you that designation because what we are thinking about about 14, 15 hours a week, you know, approximately that you need to be spending in that property. So one property, once you renovate it, you're not going to spend so much time into it.
Right. And that's what makes, makes it so challenging to qualify. So this is where the next part comes in. So here's another strategy. So some people will work in another real property trader business in addition to their rentals. And very common example is going to be when we see somebody become a real estate agent or broker and begin to start, you know, transacting deals for themselves as well as for others that can help you get up to that 750 hours. So very common path. We'll see one spouse become a real estate agent agent, they'll go out, start selling houses, properties, whatever the case is, and then that will help them get to the center of 50 hours. Then they're just self managing their properties after that. So that's another very viable path. And we've seen people do it, fix and flipping, wholesaling very similar ways. We've seen some people do a property management too. Like they'll actually do third party property management for other people. But I would say that jumping in as a flipper or wholesaler or agent, probably the more popular ways to get that 750 and then it's just basically self managing your portfolio from there.
Right, right. So even if it's a real estate agent. Right. You need to have some kind of material participation that you just can't just sell it for just others. Right. You need to have maybe something, some properties that you're buying and selling for your own portfolio as well. Right. So that's kind of the tricky. How about a short term rental? Because you know that kind of needs a little bit more management.
Yeah, so that's a great question. And there's a totally separate kind of way to look at short term rentals. So short term rentals, according to the, according to several tax court cases, short term rentals do not qualify for the real estate professional status. And there's some reasons for that, but that's kind of the way it's viewed. So for short term rentals, if your property has an average stay of seven days or less, then it's not a quote unquote rental property anymore and it's not passive by default. So you don't need to qualify as a real estate professional to turn these losses non passive. What you have to do is you just have to materially participate. Now there's seven material participation tests, but three that are typically most relevant to owners of short term rental properties. And that is you spend more than 500 hours on the property. The second one is you spend more than 100 hours and nobody else spends any more time than you do. For example, you spend 101 hours and somebody else spends 50. You met that test. The next one is you do substantially everything for that activity, meaning you're a one person show, a one person band. And so again for short term rentals, average stay of seven days or less and you meet one of those tests I just mentioned. Well now the losses are non Passive and can offset your W2 and active business income, et cetera, without having to qualify as a real estate professional. So you don't need to work full time in real estate to make this work. So we see a lot of people who are, you know, who have full time jobs or perhaps both spouses are, have full time jobs or businesses. They kind of opt for sometimes this strategy of acquiring short term rentals as a tax saving mechanism because you don't need to work full time in that
business and you can apply only the depreciation benefits of that short term rental to the losses of that property. Or can you apply actually the other losses coming from for example, syndication or other areas to that short term rental income as well?
Yeah, that's. That's a great question. So typically, not typically, it would only be the losses from that specific property or your short term rentals if you have more than one and you're meeting these tests because that's because short term rentals, they basically that seven day or less rule does is it moves it from a rental real estate into the business category so it's treated more. So yeah, that's kind of how that works.
Thank you so much for explaining. That was a little bit tedious, wasn't it?
No problem, no problem.
Thank you so much. So what are the other ways? You know, for example, most of these investors, they want to invest into commercial real estate, right? So being in the part of commercial real estate, there are LPS in it. So how can they create some other portfolios to be qualified and continue participating into the commercial real estate properties to
continue to qualify as a real estate professional? Really what we see there, the big way to do that is to continually qualify would be to run another business that is a rental real estate that. Excuse me, that is a real property trader business. Like being an agent, like actually becoming an agent, actually making that a business that you're running. That's one way we see it continually happening. The other way is just continue to build your portfolio, continue to buy properties, more properties, bigger properties that need the ongoing renovations and maintenance and what have you to be able to reach that 750 hours. So really that's the two ways we see people sustainably do it. Either just continually acquiring rental properties year over year over year and they're able to get to 750 and. Or they're working as an agent or a flipper or something on a regular basis year over year. That's helping them get and maintain that status. That's kind of the two major ways I see it happening.
No, that's helpful. And I do want to clarify though that you know, just being a real estate agent will not qualify you for the qualified real estate agent. Right, that's not. We are talking about here. We are talking about that material participation and that 750 hours. So let's keep that in mind. Right. So again, this is just an education and information purpose only. If you want to get involved into this and you want a cure up designation, you know, Thomas is a good resource or you know, anybody else that you think, but the CPA to guide you through this, that's really helpful. So please keep that in mind. So given that you know what kind of tracking is needed for that 750 hours, do you have, you know, any templates typically are available? How do they track that? You know, okay, I did spend 750 plus hours this year.
Yeah, absolutely. Typically, according to the IRA, according to the tax code itself, it says that there's or the regulations rather that you could prove you materially participated by quote unquote, any reasonable means. Which can mean calendars, it can mean time logs, it can mean appointment books, it can mean all different types of ways you can potentially do it. However, what we've seen through audits and through tax court cases is typically the best way to substantiate your time is going to be through having a time log.
Okay.
Like a time log. And, and one way to do that is an Excel spreadsheet. It could be very straightforward. You have the date, the amount of hours you spent, the activity you did like fix the toilet for example, and then the property that it was associated with. And that could be just a log and that could be good. Right. Other people, we use time tracking software and there's a lot of different software out there that can do it. QuickBooks has a time tracking software. Toggl is another popular software and there's others, but those are. Having a time log is probably the most credible. At least that's what it appears based on the task for cases and then how you go about using that time log. Like again, it could be very simple like a spreadsheet or an application that could, that you could track your time.
Yeah, that's really helpful because you know, the time tracking is really important. And yeah, there are so many software apps which are, some of them are free as well. It's a good time management tool. Use as a time management as well. Just helps me understand where am I spending my time. Right, that's really helpful. Do you have any templates or something that you could share with the audience probably so that you know they can learn from it.
Yeah, we have a time tracking spreadsheet. I don't know where it is right now, but I'll tell you right now. Put it up there for this.
That's great. Maybe you can send it to me and I can just link into the show notes. This is great. You know, great conversation. Thank you so much for sharing all of this. So with that, the CPA and tax discussion can go on forever. But unfortunately we do have to, you know, come to the conclusion of this podcast and go into our next segment, which is one of my favorite segment Thomas. So thank you so much again for this conversation. My next segment is called Think Outside the Stocks. And I love to ask my guests that in terms of diversification, in terms of putting those right tools and techniques in place in terms of the investment opportunities or even estate planning or things like that. I'd like to ask Thomas, how do you personally in your strategies, think outside the stocks?
Yeah, absolutely. I'm a big believer in alternative investments. So I tend to make a lot of investments as a limited partner partner into syndicates and funds that are investing in multifamily real estate and industrial real estate predominantly right now. So that's how one way I diversify outside of stocks. And then also I made an investment recently that was kind of an interesting investment for me. I invested in an ATM machine fund which also has depreciation and every all the good stuff we talked about today.
Absolutely.
But what that does is every month I get get deposit into my bank account and I made that investment because it pays roughly an 11% return, give or take. And I'm going to use it to finance a car. So rather than going out and taking cash and buying car cash, I'm going to go get a loan on the car. The loan's going to actually be lower than 11%. So I make a nice little spread. And now that car is going to get paid off by the atm. ATM machine.
Absolutely.
That's one way.
Yeah, absolutely. I love that. And in fact, think outside the stocks. We have a diversified fund and our fund, we do have the ATM investment which is, is, you know, a little bit higher cash flow than what you explained here. But that's exactly how I'm using. And in fact I practice infinite banking. So in addition to what I have done in similar to in your case, what you have done, I have, you know, put the money into the infinite banking system, which is compounding tax free, taken a Leverage from there, put it into use for my daughter's education because now she's taking the education loan which is a little bit smaller and again take that money from the infinite banking and put IT into the ATM investments which is giving over 20% cash on cash and that's, you know, creating that money in my bank account every month which is helping to pay these loans. In addition to this loans, once it's crossover, there's going to be some extra that's going to come out. So I love that thought that you actually harnessed your expenses and that's my theory that you know, think outside the box box that harness your expenses, the expenses can grow too. So I love that. Thank you for sharing. It kind of reiterates my philosophy as well. So with that, you know, we are kind of coming to the last segment where kind of I asked a few fun questions, you know, and just quick answers to that. So are you ready for that? I. I call it a rapid fire round.
I'm ready to go.
Absolutely. So Thomas, the first question I'm going to ask said, what is the most memorable and fun vacation that you have taken so far?
Most memorable and fun vacation. That's crazy. I mean, that's a good question. I'd say Las Vegas last year. And last year I went to Las Vegas for seven days and I'll tell you that going to Las Vegas for seven days a little too long. But between the shows and the excursions, like we did a lot of different crazy things. It was fun. It was fun. It was the most memorable event vacation that I had. And I just got back from la, so.
So was it any. Either you lost too much money or you gained too much money. What, what makes it memorable?
You know, it was. I actually didn't gamble that much.
Oh, that's good for you.
It was the shows, it was the weather. So it was like it was cold here in New York, where I live at the time. But it was like beautiful. There's like 100 degree weather and it was very like. It is not humid there, so the weather was just awesome. We went and did multiple shows which were great shows like the Beatles show. We went what's ATVing in the desert? We did gamble a little bit, but it was just the overall experience of Vegas. All, everything there is to do. It's just amazing. I just love it.
The life is full of experiences, right? It's not about money gains and losses, but it's about experiences, what we collect over the period of time. So thank you for sharing that what is the upper outrageous amount or percent taxes that you have saved to one of the clients? And they were like after they came to you in that year that you implemented the tax strategies and just a crazy story kind of.
Yeah. So I mean there was a few clients that we had that were high income earners and I know one of them. This is when 100% bonus depreciation was in full effect. But the, and this is before a rule called the excess business loss limitations prevented this from happening. But we, I think they ended up saving like $200,000 in taxes because they were buying big multifamily properties and they were just using bonus depreciation to all and they qualified for rep for the real estate professional status and they were able to use it to offset their W2 income which was quite significant. So 200k I think is the largest I've seen on paper, at least that I remember. And then we've seen other clients like doctors and dentists and, and stuff. They're routinely saving 100, 130, $150,000 in taxes using reps or the short term rental loophole which we talked about before. And those are kind of crazy stories. Now one more story I'll share is I seen this one client have to pay almost a seven figure tax liability. So seven almost because they had a property that was trapped in an S corporation and they had to restructure it. I forgot the exact reason why they needed to pull the property out. But when you pull a property out of an S corporation, it's treated like a sale, as if you sold it to somebody else and you're gonna have to have.
There is no basis or anything.
This property was put in the S corporation back in the 90s.
That's crazy.
And it appreciated significantly. So there's a very big tax bill and that was a wild story. We tried everything to get it out tax efficiently but there's only so much you could do.
Wow, thank you so much, so much for sharing that. Yeah, that's pretty wild capital gain versus the actual income. Right. So that could be significant change. So thank you so much. So with that, you know, how do the audience get in touch with you if they need to reach out?
Yeah. So yeah, I'm on Twitter @ThomasCastelli underscore. But really the best way to get in touch with me is I have a page has all my links, all my, all the ways to get in touch. It's thomascastelli.com links. You go there. I have my social links. I have my contact you request a consultation, that's probably the best way.
Thank you so much for sharing and thank you so much for this conversation. Again, I'm so grateful to have you on my show. Thank you so much for your availability.
Thanks for having me.
Yeah, and thank you and listeners. You know, go back and look at all these strategies, the tax benefits, especially the W2 earners. How can you implement different strategies utilized for different capital gains that you have from real estate transactions? Or if you plan to take a notch up and want to qualify for that Q rape, there is a, you know, a ton of bits and pieces on how you can qualify for that. And if you want, get in touch with your CPA or Thomas, you know, feel free to do that. Again, thank you so much for listening and keeping the Think Outside the Stocks podcast going. It is because of you. We are so grateful to have your support. Thank you so much, Thomas, again for coming on this show and thank you so much everyone for listening.
Thanks Kim. Thanks for tuning in to the Think Outside the Stocks podcast. If you enjoyed today's episode, please like and subscribe. MADVI is on a mission to change the financial trajectory of one family at a time. With a thousand more to go, we hope you'll be a part of this vision. Please join our growing community and to get your journey started, visit thinkoutsidethestocks.com to download your free guide on active income with passive real estate investments. If you learn something new, please share it with one person today. And if you have 60 seconds, please leave. Leave us an Apple review to help us reach more people like you. Tune in for the next episode.
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