Creative Finance Consequences - How does Seller Finance Destroy you at Tax Time?

If you put no money whatsoever into any of your deals at all and you have non-recourse debt, you may not have a lot of write-offs available. You may be paying taxes on your passive income. Taxes and creative finance. If you are watching this, first of all, thank you for being one of the few people to click a video that has anything to do with tax. This is not one I expect to do well because the algorithm will hate this. However, I think this is super interesting. No one's talking about this. This has saved me hundreds of thousands of dollars and it's actually different. If you are using creative finance or plan to use creative finance and you have not mastered this, you are going to spend hundreds of thousands of dollars more than you need to on your portfolio. This is one of the most valuable pieces of content I've ever released. I've spent a lot of money learning it the hard way by actually doing— by the way, I've bought hundreds of rental properties over the last 3 years using creative finance. I started with $0. I made millions of dollars in real estate through investing in multifamily properties with creative finance. There's a few tricks to the tax that you may not know. Now, before you skip this video and you're like, oh gosh, this is a tax video, I don't know about this. If you do not know what inside or outside basis is in a deal, if this is a new term for you, you need to stick around. If you've considered using cost segregation studies but don't know if it's the right strategy for you, stick around. It may or may not be. I'm going to share a couple of tricks that are very unique to multifamily creative finance. So number 1, you need to understand what an external basis is and an internal basis, your inside and outside basis. So this here is your deal. I'm building a whiteboard in my studio, by the way. Give me, give me one more day. Just moved to the new studio. This is day 1 in the studio. So here's your deal. Your outside basis is what is actually on your operating agreement. If you have a partnership, this is how much equity you have in the deal. If you bought for $1 million and say it's worth $1,500,000 now, and you have a partner that you're 50/50 on. Your outside basis is your equity. You have $250,000 of equity if you bought this deal 100% financed. If you have no money in the deal, you have, and it's appreciated $500,000, you have $250,000. However, in the eyes of the IRS, they want to look at the money that you have in the deal. If I bought this deal and it was funded by the other partner, I put $0 in, you write off your active income. Against the depreciation of the property. By the way, on standard property, it's 27.5 years. You can speed that up in the thing I'm going to talk about next, the cost seg study. You can only depreciate though equal to or greater than your inside basis. If you have $0 in and you made a bunch of money on the deal, you don't get that magical write-off that people talk about in real estate. Now, you do get to claim the depreciation. It goes on your tax return, but you can't actually use it against your income above and beyond your internal basis. That is the cash you have in the deal. So if I wrote a check $20,000 down out of, say, $200,000 down, doesn't matter what the external equities are, it doesn't matter what the value is of the property or how the operating agreement is written or what my equity is in the actual deal internally. What is my internal capital account say? It says that I contributed $20,000. I cannot depreciate more than my personal inside basis on the property. If you've never heard this before, I certainly hadn't. We had hundreds of thousands of dollars of cost seg studies that we ran. It was this massive depreciation that we can write off against our income. We bought all these deals zero down, non-recourse debt. When we got to the accounting the first year, we had six figures of tax when we thought we had the write-offs. Now they rolled over to another year. I was able to make adjustments to my inside basis so that in the next year I actually did not pay tax. But my first year when cash is the most critical, you're in your build phase. We just made money for the first time. I really had money. I bought these properties, I spent the money fixing them up, and then we go, oh, by the way, government's going to take 6 figures more than you expected. That was a huge oops. If you do not understand inside and outside basis, one, talk to a CPA. They're going to guide you through it. Make sure they understand real estate. Two, you really need to understand the concept yourself. Like, what is inside? Like, have I put into a deal versus what do I actually have in equity in the deal? Both are important. For tax, until you sell that property, inside basis is the only thing the IRS is going to look at. So now let's talk about cost segregation studies. If we want more depreciation, let's say that we can get these write-offs. We have some of our own money in the deal, or maybe you borrowed money and then put it into the deal because borrowed money is still in the eyes of the IRS. It's still your money. You borrowed it, then you put it into a deal. Your basis is higher in that deal if you use debt instead of an equity partner. If you structured in a way where you can use additional write-offs, a cost segregation study essentially takes apart the pieces of your building and puts them on a different schedule. Now, traditionally you have 27.5 years from the purchase price of the building. Say like this house bought for $1 million. I depreciate this over 27.5 years, which means basically they're saying that's the usable life of the building. So I get 1/27.5 of the purchase price reduced every year as a write-off against income. Now on a rental property, you can do what's— and this is not a primary residence. On a rental property, a cost seg study basically says, hey look, your appliances do not have an almost 30-year life. Things are going to have a 5-year usable life. Water heaters, dishwashers, dryers, refrigerators, that type of stuff. Shorter depreciation. You can take the value of them and depreciate those faster. Is your roof going to last 30 years? Well, if you have a 20-year roof, you may have a different schedule. Shelving. They don't consider shelving as something that lasts 27.5 years. So you go through all these different itemized items and what you end up with is a, accelerated depreciation where a lot of things fall in the 5-year bucket, 10-year bucket, and the 15-year bucket. You can take bonus depreciation and actually take it off of your income. So you can speed up time, have extra write-offs. Now this is really helpful until you've depreciated the property to nothing, then you have to go and buy more real estate. But if you're in the build phase where cash is absolutely premium and you actually made some good money in real estate for the first time, you're going to want to write those off. To share one more thing that you really should know about real estate professional status. It's 700-something hours. Look up the exact thing. It's real estate professional. To be considered a real estate professional in the eyes of the IRS, you have to keep track of your hours, but it is buying, selling, and managing properties. If you do this full-time or can show that, hey, in addition to your job, you spend the required amount of hours doing these activities, you can qualify as a real estate professional. Not only do you write off the passive income from your properties, you you can write off against your active earned income. This is a way for professionals in real estate to, this is how the pros pay basically no tax often. Again, I had a big tax bill year 1. Year 2, I made 7 figures. I paid $4,000 in tax. I do want to remind you, I pay payroll tax, I pay property taxes, I pay more taxes than most people do. I'm not not contributing, but for the income that I generated on my properties, for that year where I got to roll all of those cost seg studies into the depreciation, I did not have enough to actually have active income. I think I paid $4,000 on a little over $1 million of total income. That is something that anyone can do. That's how, really, that's how the rich play the game. I'm not saying I'm super rich, I'm just saying I've bought enough real estate where it starts to matter. If you are starting day one, you need to know these concepts it may not be immediately applicable. Focus on buying your first property. If you're starting and you haven't bought your first property, focus on acquisition. If you haven't bought your first 3 or 4 properties, don't get bogged down by tax strategy. Do know that by October every year, you need to come up with a general idea of what you're going to owe in taxes. I would have a meeting with your CPA, who is someone who owns real estate and is a licensed CPA. They're going to file your taxes. Ask them their opinions of, is it time to use a cost seg yet? Or would you hold off? Their opinion is usually very valuable. And just understand, if you put no money whatsoever into any of your deals at all and you have non-recourse debt, you may not have a lot of write-offs available. You may be paying taxes on your passive income. Be prepared for that. Be ready for that. There are ways to increase your basis, but that is going to be a little bit more headspace than we're going to do in this particular video. But if you guys have any other questions or you guys want to do a deeper dive into how to prepare for taxes when you're using creative finance so you don't make a mistake, feel free to shoot me a DM on Instagram @ChristianOsgood. You can always ask in the comment section of this video, which by now, if you've watched all the way through video on tax, please for the love of God, like and subscribe to the channel if you haven't done so already. You got through our whole video on creative finance tax. If you found this valuable, I promise this is not the most exciting thing to talk about. It's just super important. So if you want more of this content, let me know in the comments. And thank you so much for watching. I'll see you all on the next episode.