#152 Maximize Your Tax Benefits With Passive Real Estate Investing

Hey everyone, Tax season is upon us and in this episode we're going to talk about all the ways that passive real estate investing, like investing in syndications and funds, can benefit you from a tax perspective as an investor. So stay tuned. Welcome to the Passive Income MD Podcast, where we talk about creating your ideal life through multiple streams of income. I'm your host, Peter Kim. If you enjoy hearing about this stuff, make sure to hit subscribe so I can bring it to you every week. Now let's get on with the show. Foreign. Hope you've had a great day. It's been a whirlwind this last month or so. I spent time going to several conferences all on real estate entrepreneurship, talking to different investors. It's been a fascinating time to just hear how the sentiment is out there considering the market today. Where is their optimism? Where is their pessimism? Where's, where do people feel like the opportunities are? How are people budgeting their own investments and their own capital and talk about what everyone's doing with their cash? If I got to meet you in person over this last month, just want to say hello again. I got to meet hundreds of you again in the real estate space, the physician space, and it was just a blast doing all of that. Before we dive into this week's episode, I just want to remind people I am not a tax professional. I am not a cpa. I'm not a trained professional in that area. So I'm just sharing information with you today that this is not professional advice. So talk to your cpa, your tax professional, make sure that everything I'm talking about today makes sense for you. The goal is to equip you with some things to think about to maybe bring up in terms of questions for your tax professional so you can take max benefit of the tax benefits that are available to you as an investor. Now in previous episodes I've talked about the tax benefits of investing in real estate, especially when it gets time, when it gets around April or later in the fall, whenever taxes are due, whether you're doing it on time or whether you're doing extended. We also are thinking about how can we save on taxes, as many of us are health professionals, our physicians, high income professionals, a lot of the tax benefits that might be available to business people out there, you hear about it all in the news, are not quite available to us and unfortunately we feel like we get the short end of stick. I don't know if you feel that way as somebody who works hard, puts in their time and then a huge chunk of your income gets taken and as taxes. I live in California, so you can imagine I get a bigger hit than some of you who might live in Texas or Florida where you might not have any state income tax. So it's really up to us to educate ourselves, partner with the right professionals to make sure that we're able to minimize and do it in a way that's legal. Now, I don't think that minimizing your taxes is an issue in terms of morality or ethical. It's actually using the tax code as written to take action however the government wants you to. I see that the government writes this tax code as a series of incentives that they want you to do X, Y, Z because they know it's a beneficial for society, it's beneficial for the government. Ultimately they get more taxes in the way of payroll taxes and other types of taxes that might be involved. And so it's important for you to know how to navigate this world. And the more informed you are, the better off you're going to be. So the benefits that I'm talking about today are specific to passive real estate investments like syndications and funds. For those of who aren't familiar with the concept, I talk about active versus passive real estate investing. When I talk about active investing, I talk about being your own landlord. You own the property yourself, you make all the big decisions. You worry about financing, dealing with property managers, vendors, whatever it might be. That is all on you as the active investor. When I'm talking about passive real estate investing, I'm talking about investing in somebody else's deal. They are the ones that are operating the deal from top to bottom, finding the properties, fixing it up, coming up with a business plan, finding property managers, dealing with financing, dealing with tenants, all, all of that together and ultimately dealing with the disposition or sale if that's the case. And then you invest in them and leverage all of their experience, their capital, their knowledge, whatever it might be. As a passive investor, for many busy professionals that makes a lot of sense because you are already using up your time to do your day job. And it's probably the best use of your time in a lot of ways because you have spent years and years becoming an expert in it. And, and so what happens is that you can probably make the most income from doing that, but maybe you're able to funnel that income, that doctor income into these passive investments and be able to really truly leverage your time. I'm assuming that whatever time you have left, you probably want to do it. Spending the things you love doing. Whether it's certain hobbies, spending time with your family, or whatever it might be. So for many people out there, passive real estate investing might be the way to go. In fact, whenever I poll audiences, I get about 75% of people who say they prefer passive versus active investing. And now myself, personally, I do both because I like to take advantage of both the pros, all of the benefits that come with both. I try to maximize that while minimizing the amount of time I put in. But you have to figure out what it is for you. So. So investing in passive real estate investment opportunities like syndications or funds, I mean, there are a lot of different tax benefits and strategies available to you. Now, it's important to note that the tax laws vary by jurisdiction, by state, by sometimes county. So it's really important for you understand the full implications and the tax implications of your investment. So let's talk about some of the common tax benefits available to you as a passive real estate investor. Hey, everyone have a question for you. What if there was a way to make your money work for you instead of the other way around? Let me ask you, are you looking for a way to create passive income and secure your financial future? Or maybe you stayed away from real estate because you don't have time to be a landlord? Then I want to introduce you to Passive Real Estate Academy. It's the revolutionary platform that we created that teaches you how to invest in real estate passively with little or no effort on your part. In just four weeks, our comprehensive course will teach you everything you need to know about passive real estate investing and help build that confidence in you so that you know that you're making a great investment choice. We created this course for busy people like you, and we're going to guide you from every step of the way, from understanding even the most basic information to understanding the jargon and understanding underwriting so you can make sure that you're making a great investment, that you're maximizing your returns and minimizing your mistakes. And the best part, you can do this all from the comfort of your own home with absolutely no prior experience required. So it's time to prepare yourself and learn so that you can be ready for these deals that you see. Because the time is coming. So don't let the demands of your job or the current economic climate dictate your financial future. So join Passive Real Estate Academy and build that confidence to know that you're making a great investment when it comes to syndications and funds. So visit our website at passive realestate academy.com to learn more and take your next step to financial freedom. Now back to the show number one, there's this concept called depreciation. Real estate property, it depreciates with time, meaning that the value of it goes down with time. First was depreciation. Real estate property usually depreciates with time, at least in the government eyes. There are buildings, there are carpet, there's stuff in the place which has a lifespan. There's. The government allows you to write that off year over year as the value of those decrease over time. Those who are active investors, meaning you own your own properties, you know this quite well. But did you know that as a passive investor, you can absolutely take advantage of this as well? When you buy into a syndication or fund, you own a share of the actual building. You are actually an owner, meaning that you own a percentage of it. So when the syndicators go out there, they find out what the depreciation cost is. So when the sponsors. So when the sponsors go out there and they try to figure out the. The impact of depreciation, then you can benefit from that as well, since you are one of the owners. Now, if they take advantage of something called cost segregation, where they go in there, actually get a study done, they pay extra money, somebody goes in there with a clipboard, essentially finds all the things in the building and really decide, you know, what the lifespan of those are, then you're able to really delineate the value of the building and everything in it from the land itself. There's something currently in place called bonus and accelerated depreciation that you might want to find out about, where it allows you to take a lot of this value, this depreciation value, and instead of, like spreading it out over many, many years, you're able to squash that in the front end of your investment. So, for example, maybe something that you would have to depreciate over 10 years, you could actually depreciate in that first year. So when you ask a sponsor about losses in that first year from depreciation and cost segregation, I think it's an important thing to do because you want to understand exactly whether they're going to do cost segregation or whether they're going to actually take advantage of depreciation and what they think that paper loss is ultimately going to be. And I'm going to explain why it's important for you to know that coming up here soon. Now, on paper, all of this creates something called passive losses. Just to be clear, your day job is active income Active losses investments such as real estate are passive income and passive losses. The government puts a wall in between those two so that you can take the losses from your real estate passive losses and, and then offset your day job income. Back in the past, people used to do that, use it as an offset. High income professionals like ourselves would take advantage of this and not have to pay any taxes. And the government got smart to that and they didn't want us doing that. So they create this wall and this barrier between active and passive losses. So let me give you an example of this. Over the last few years, I made some investments into syndications, some apartment buildings, and they said they were going to take advantage of depreciation and cost segregation. Especially now because the Tax Cut and Jobs act, it allows for a significant amount of that to be accelerated early in your first couple years. So I made several investments of $100,000 into some of these syndications. And the amount on paper at the end of year one, it would vary the amount of losses that it would show up on that K1, which is your essentially your ownership statement. Sometimes I would see a $50,000 loss, a $70,000 loss. It all depended on how aggressive the sponsors wanted to use cost segregation and depreciation and the building itself and actually create those paper losses for people. Now those are passive losses. What was I going to do with $70,000 loss on paper? What can that passive loss do for you? Well, one thing is it can offset any gains that you get from that property. Any distributions. Imagine that you're starting. It's like starting your net worth at zero, less than zero. You're starting your investment with a negative $70,000 balance. Any sort of dividends distributions that you get from that in terms of profit get eaten up by that negative 70,000. For example, let's just say you got $20,000 of distributions. That's all profit. You already have a negative $70,000 loss. That's basically now you have a negative $50,000 loss. So you don't actually pay taxes on that even though you're receiving that distribution. And that happens throughout the lifetime of the deal until the point where you make enough profit and oftentimes it's just at the sale that actually is bigger and larger than that initial passive loss. Everyone wanted to tell you about FlipMD. It's a competitive marketplace where physicians can source and secure consult gigs. Jobs come from a broad range of clients across all major industries who are looking for medical experts in their field like you and me. Now FlipMD allows physicians to pick and choose the consulting work that fits their schedule and their interests so you can continue to provide quality patient care while exploring new opportunities. And here's the coolest part. You get to set the parameters for your work, including an hourly rate. So join the thousands of physicians who are diversifying their income streams and expanding their careers with FlipMD. With FlipMD, you can pick up consulting work whenever you're available, try to non clinical career, or even do something completely outside of the realm of patient care. It's a centralized source of well paying side gigs that will help you build your physician brand. Join now and see why new physicians are joining every day. Visit flip-md.com again. That's flip-md.com now back to our show. Now those passive losses can also be used against not only that deal, but it can be used against other deals that you have going on. For example, let's say you have other deals where they either exit or they have other deals which are giving you distributions. All of that is lumped into that whole passive side and those losses can start to really offset other gains. Now, it's a powerful technique for a lot of passive investors and they make sure that they line up a lot of those losses with a lot of the gains that they're going to have, which creates a situation where you don't end up paying a lot in taxes even though you are getting something in terms of profit. This is what some people refer to as the lazy man's or the syndication 1031 exchange. We're going to talk about 1031 exchange in a moment, but that's again another way that you can really defer your capital gains or defer your gains by kicking that tax can down the road. And that can be a powerful strategy, especially if you have multiple syndication deals going on at the same time. You can ladder them for full effect. Here's an example of that. If you know that a certain property, for example, another syndication, is going to have a massive gain, or you can have a gain in a certain year, you're able to actually invest in that exact same year. Again, it just has to be the calendar year. And make sure you invest in one that you know will create a nice loss for you and then you know that that's going to offset that gain from that other property. People do that all the time. Again, talk to your CPA about the best strategy around that. But that's something that I use, I often call it the syndication ladder to be able to ladder these investments so the losses and gains Coincide with each other so that you can ultimately not worry about paying taxes and continue to kick that can down the road. The thing I love the most is gaining tax free profits. I can make use of that now, sure, maybe pay taxes down the road or maybe never pay taxes on it. But that becomes a huge benefit for me, especially as a high income professional where normally every, all the income that I receive, it gets taxed extremely heavily. Now let's talk about the 1031 exchange. You may or may not heard about it. Again, people who have active investments understand this. It allows investors to defer capital gain taxes by reinvesting the proceeds from that sale into a property. And they call it a like kind property within a specific time frame. So what does that mean? You have a sale of a property, it gets put into this separate kind of escrow, separate account and you're able to use those proceeds to use into another deal. Now when you use that into another deal, the government, if you do this right, and you follow the qualifications and you do this in the correct way, it allows you to avoid paying taxes on it at that moment. So you get to again kick the tax can down the road and maybe you exchange again at your next time. And so what ends up happening is that the time you actually end up paying the taxes on this is when there's like the final disposition or exit of that investment. But some people, what they end up doing is they end up passing away and they never actually realize the full investment. And that amount gets actually passed along as an inheritance. And why that's a powerful thing is when you're, when somebody inherits that and they inherit that investment and the capital from that, they get what's called a stepped up basis, meaning that it's like they receive that money at the current value, not at the value that originally was at. And that all that profit that had been baked in, all those taxes that had been kind of reserved, that was supposed to be paid by the person once they exited that investment. All that is wiped. So the person who gets that from day one, they get basically a brand new investment. And that is the basis that all future kind of sale of that investment is based on. So just for example, to use round numbers, let's say you invested $100,000 that became $1 million in terms of real estate. You go ahead and pass that to your kids. When you pass on and they receive that million dollars in terms of investments, they don't have to pay for that $900,000 gain. They get it at $1 million. So if they were to essentially sell it at day one, it'd be like they didn't receive any sort of profit. Now that's a huge benefit and you could ultimately see why. Real estate creates generational wealth and you probably see it pass on from family to family. And that's one of the advantages of the current tax code in the country we live in. Now. I know what people ask all the time, is this available and possible with passive real estate investments? And actually the answer is yes. There are some strategies around this, but it's important to know this before you enter any sort of deal. Everyone have a quick question for you. Are you looking for a secure and reliable long term investment strategy? Meet Eckerd Enterprises. It's a family owned and operated firm with over 35 years of experience specializing in US energy and alternative investments. Here at Passive Income MD, you often hear me talk about the need to diversify. One of the safest investment strategies available today are mineral rights. And with Eckerd Enterprises you can diversify your portfolio. Their team is committed to helping private investors like you and me identify and develop successful diversified portfolios with an average return on investment of over 24% across their portfolios. The Eckerd team is dedicated to helping you build and protect your wealth through long term passive income. All of this while minimizing the risks associated with traditional investments. So check out Eckerd Enterprises if you want that great investment experience, go to eckerdenterprises.com again, that's eckerdenterprises.com thanks. And back to the show. When you're about to enter into a syndication, one thing to ask the sponsor is is this eligible for 1031 either into it and also out of it. Maybe that's something you're looking for and maybe it's not. And if it's not something you're looking for, don't even worry about asking, I guess. But you never know because at the end you may want to exchange it. Now, many sponsors don't set up a situation like this because it does get a little bit more complicated. But there are sponsors for which this does happen. Now I want to share with you an example of somebody that I heard that use this 1031 exchange in passive syndications to amazing effect. Now, a friend named Jeff and his uncle has been been investing in his syndications for many, many years. He told me this story, actually. We went through the numbers and I thought it was fantastic and amazing. I thought, I want to share it with you. So what he did is he took $60,000 he invested back in 1995. Now that was quite a while ago, but he invested $60,000 for his initial investment. That property 1995 was eventually sold in 2001. At that point he didn't pull the money out. That got exchanged into the next property there in 2001, and that was held until 2016 for another 15 years, at which point it was sold again and they exchanged it to the next property. And then in 2020 it was sold again. Now in 2020, he was able to take the proceeds from that and invest in two different real estate investments. So now he's invested in two different syndications. Now today, if you currently look at his asset value that he started with that initial $60,000, what he has in the deals right now is equivalent to $2.36 million from that initial 60,000. And the reason why I was able to compound over time because of these 1031 exchanges, that's not even the best part. My favorite part about this whole story is that he received throughout this deal. Now since 1995, he's also received $1.6 million in distributions, meaning profit from this deal. There have been several refinances which also don't get taxed throughout these passive investments. And, and he was able to cash out on another $1.6 million for that initial $60,000 investment. So you can see the power of this. Start with a $60,000 investment, you end up with an asset value of $2.36 million invested and also received about $1.6 million in tax free cash flow. Who wouldn't love having $1.6 million in free in tax free cash flow? It's amazing that this is even possible. Again, this is one story, but I want to show you what's even possible with some of these investments. How many of those $60,000 investments would you need to make in passive real estate to reach your goals if the numbers look something like this? Now again, if you want to take advantage of 1031, you have to ask before and after. Again, there's some complications where everybody might have to move into the next deal. But there are certain sponsors and syndicators who make a point to offer 1031 exchanges in every one of their deals. Another one tax benefits, is that you can use these tax deferred accounts. So it's like investing in your 401k. There are self directed IRAs, self directed 401ks, and you got to talk to your tax professional people who are operating and running these accounts, but you're able to often invest in real estate using those. That's a benefit. Now, you may not get a lot of the tax benefits that are available because again, these things are set up to be really tax efficient. But you can invest using your retirement money if you want, and of course, benefit from kicking the tax can down the road. All the, all the profit that you make can be compounded over time. Now that's something you can take advantage of as well. Now, lastly, I want to talk about how to take full advantage advantage of real estate professional status. If you listen to podcasts before, you know, I've talked about real estate professional status quite a bit. It's where you or perhaps your spouse or partner is considered a real estate professional by hitting certain criteria in terms of time and the amount of involvement you have in your real estate deals. Again, and it's got to be more than your current day job. But if you're able to do that, you're able to remove that wall that I talked about between active and passive income. What that means is that you're able to use the losses on your real estate, that is passive losses, to offset your day job income. And that can be a powerful thing for people who make a good amount of W2 income, even 1099 income throughout your day job. Now, people always ask with passive investments, can you take advantage of that as well? And the answer is absolutely yes. Now, you're not going to qualify to be a real estate professional using passive investments only. You have to have that active management be actively involved. But for some people that do qualify as real estate professional doing enough active investments, they're able to now invest in passive on top of that, invest in syndications on top of what they're already doing, use those losses from there and then offset their gains. Now that's something in a strategy that I use quite a bit. Again, I like investing in my own properties and having some, but I know that it comes at a significant cost of time, energy, headache, stress. So there's only so much time and energy that I want to put towards it. So I typically, when I've done years past this, I've invested and spent my time in my efforts enough to be a real estate professional. But everything when it comes to investments after that, when it comes to real estate investments, I've done it in a passive way. And I felt like that was the best way to leverage my time, my income, my capital, take advantage of those losses and still offset my day job income using whatever the benefits are of depreciation and cost segregation. So that can be a powerful technique and strategy for people who already have real estate professional status that they can tack on passive real estate investments like syndications and funds and also still take massive losses on their capital and invested income. Now, I just want to remind everybody, tax laws can be complex. It matters what state you're in, what area you're in. So all of these things may or may not apply perfectly to you, but the reason I brought all these things up is to get you started thinking about it. It's to ask the right questions of your tax professional to help guide you along the way. I want you to let you know that these things are available for you and if you can take advantage of it, it will absolutely impact your bottom line, which is which you get to keep in your wallet at the end of the day. And again, us as high income professionals, we make good incomes, but oftentimes we're not in control of our time. And so using these investments, hopefully that can change for you if that's the situation you're in. If this helped you in any way, just let us know. We're here to support you. Please remember to share this podcast with people that you think would get value from this. Have an amazing week. Let's talk again soon. Bye. Enjoy the show. Let me know by dropping a review in the podcast app you're listening to us in. And if you haven't already, make sure to hit subscribe. Are you a part of our community yet? Join thousands of physicians who are also on this journey to creating their ideal lives through multiple streams of income. You can join us on our Facebook group PassiveIncome Docs and you can always learn more at our website, passiveincomemd.com thanks again for allowing me to be a part of your journey. See you next time.