Advanced Tax Strategies for Savvy Investors

In this episode, Jason Hartman interviews Amanda Han and Matthew MacFarland, authors of Advanced Tax Strategies for Savvy Investors, about tax write-offs. They talk about 1031-Exchange and whether it will be removed now that Biden is in the office. The three also discuss deprecation and how to take unlimited deductions, regardless of income.

Announcer 0:01
This show is produced by the Hartman media company. For more information and links to all our great podcasts, visit Hartman media.com.

Announcer 0:12
Welcome to the American monetary associations Podcast, where we explore how monetary policy impacts the real lives of real people, and the action steps necessary to preserve wealth and enhance one’s lifestyle.

Jason Hartman 0:29
It’s my pleasure to welcome Amanda Hahn and Matthew McFarlane, they are the author of two great books on tax strategy. One, the most recent is the book on advanced tax strategies. And we’re going to talk about several things that apply to real estate investors today. And Amanda and Matthew, welcome. How are you? Good. Thank you for having us. Yeah, we’re so excited to be here. It’s great to have you. So I really enjoyed your book, first of all, and you know, there are just not enough competent people out there in the tax world that really kind of focus on run real estate especially. That’s why we’re excited to have you today. And there’s so much we could talk about, as we discussed before we started here, you know, we could talk about self directed IRAs, we could talk about a zillion things, but we do have an election coming up. And some pretty significant changes are in the wings, if Biden wins. If he doesn’t win, I think we’ll just see, you know, more of what we saw a couple years ago, my biggest fear is the 1031 exchange would go away. And a lot of people are talking about that one. Biden wants to get rid of it. He stated that. Do you have any thoughts on that? and its impact?

Amanda Han / Matthew MacFarland 1:36
Yeah, that’s an interesting one. Because, you know, actually, under the last tax reform, the tax cuts and JOBS Act, there was a big change that was already made to the 1031 exchange where, you know, used to be eligible for other assets. But But now, it’s only specific to real estate. So my guess I think it’s not hard to imagine it just going away altogether. And that would be unfortunate, because real estate has done so well, in the past couple of years. And you know, in our office, I don’t know how many 1031 exchanges do we see on a daily basis. Now,

Amanda Han / Matthew MacFarland 2:06
we joke with our stuff is like, hey, we’ve got another one, you know, so

Amanda Han / Matthew MacFarland 2:10
yeah, so many exiting California going to other states or exiting one state to another, we see that all the time.

Jason Hartman 2:17
Yeah, it’s really something I think that would be very bad for the economy, if the 1031 exchange went away, I think it would discourage investment, it would also make the market more stagnant, because people that would otherwise sell and create income for so many people, accountants, of course, 1031 exchange accommodation companies, the lawyers, the tax experts that, you know, when when people buy a property, they typically improve the property because they have different ideas for it. So all those contractors, all those appliance companies, etc, it would really change. Let’s hope that that doesn’t go away. Why don’t you go ahead and share your screen and tell us some of the other stuff you’re thinking about?

Amanda Han / Matthew MacFarland 2:57
Yeah, so we wanted to put up a slide, first of what the current tax rates look like, just so we can, you know, get an idea. And you can see the current tax rate on the on the highest level,

Jason Hartman 3:09
for those of you who aren’t watching on video, if you’re listening only try and elaborate on the slide. So someone with audio could understand them. But they will be on our YouTube channel.

Amanda Han / Matthew MacFarland 3:18
So yeah, the first thing we kind of just touch on real quick is is looking at, we’ve got a picture of tax rates at a glance right now. So we’ve kind of put some colors of this where you can kind of see if you’re single person, you can look at your income range on the left or the married, you can look on the right, but you can obviously see that the highest tax rate right now is 37% for the IRS, and we’ve got the capital gains rates broken out. But what’s interesting about this is that, you know, as you were kind of talking about, you know, maybe potential changes, you know, I think Biden wants to Biden’s planning goals, increasing the highest rate back of the 39.6%, which is what it was two or three years ago before the tax cut and JOBS Act. So yeah, it’d be interesting to kind of see what comes to the election and what comes of any potential tax changes.

Amanda Han / Matthew MacFarland 3:58
Yeah. And also part of the, you know, potential proposed change would be capital gains, you know, right now, or capital gains, the highest rate is 20%. So there are talks of that even increasing back to ordinary income tax rate, which could be as high as 39.6. And this is just on the federal side. And I know, Jason, you used to be from California, right? Yes. Fortunately, I’m

Jason Hartman 4:21
not. But if California gets the way it gets their way with that, back taxing people for 10 years, they would get the last year I was there because I left in 2011. I could be like, I can’t imagine that’s constitutional. But that’d be a long discussion.

Amanda Han / Matthew MacFarland 4:42
So let’s move on. Yeah. So yeah. So, you know, that’s what’s unknown when we don’t really know what the future of tax rates and deductions are what’s going to go away. But what we do know now as of today, is that there are still a lot of great tax benefits for real estate investors specifically for this year. And so those are going to be the main things that we touch on.

Amanda Han / Matthew MacFarland 5:03
Yeah, it should come as no surprise. But obviously, people with you know, the same amount of income are, can and do pay a very different level of taxes. And, you know, that’s going to be that was the case three or four years ago, that’s still the case. And it’s probably going to be the case a year from now, depending on what what happens. But, you know, just because you make 200 grand and your neighbor makes 200 grand doesn’t mean you pay the same amount of taxes, obviously. So I think a lot of people know that. But I think dude, some people do forget that actually. So

Jason Hartman 5:27
and that’s one reason you need a good tax preparer. You need to have your own knowledge about taxes as well, so that you can talk intelligently with them.

Amanda Han / Matthew MacFarland 5:36
Okay, good. One of the reasons that we see real estate investors continue to overpay their taxes, even though they already are investing in real estate, is that, you know, they’re not viewing themselves as a business owner when it comes to taxes. So you know, everybody knows, like, as a business owner, you get to write off all sorts of things. And what we have on this line now is home office deduction is one of them, right? People know, business owners can write those off. But a lot of times real estate investors don’t think of themselves as business owners. So they maybe think, Oh, well, I can’t take that deduction, maybe because I don’t have an LLC, or I don’t have a corporation, or I’m not a real estate professional, and all those things are actually incorrect. So as a real estate investor, you are a business owner in the eyes of the IRS. So for the vast majority of deductions that you hear people talk about, you know, as an investor, you are able to take them but whether or not you have a legal entity, whether or not you’re claiming real estate professional, these are all still legitimate businesses. So let’s do some home office first, because I think that one, most if not all, investors, we know have the eligible home office.

Amanda Han / Matthew MacFarland 6:37
Yeah, I think this is also one that gets unfortunately overlooked a lot just because people either don’t know enough about it, or maybe even don’t even think it adds up to be enough of a deduction. But you know, obviously, based on our experience of preparing hundreds of returns every year, this can add up very quickly to to $3,000 deduction, so I can put on all the savings. So I essentially the home offices, if somebody’s got a dedicated office space at home that they’re working from, you know, a dedicated space that is not shared as a kitchen or a dining room table or something, then they would be eligible to take a write off or a portion of the things that they don’t otherwise usually get to write off. Because we all know, you know, real real estate owners investors, you know, your primary residence, you know, you’re writing off your mortgage engines using your property taxes. But it’s the other things that now you can take a percentage deduction on your utilities, your insurance, HOA fees, repairs and maintenance, cleaning, things like that.

Amanda Han / Matthew MacFarland 7:30
I don’t know if you’ve heard this before, Jason. But we always hear clients tell us like oh, my CPAs that I can’t take this because it’s a huge audit flag. And that means I will be audited. And we’ve actually seen no truth to that at all. You know, we have so many clients claim home office, really haven’t had one that was audited for home office deduction purposes. And nowadays, everybody’s working from home especially right. Yeah,

Jason Hartman 7:53
I think in the current environment, the home office will not be very scrutinized at all going forward. So good. Let’s move on from the home office.

Amanda Han / Matthew MacFarland 8:02
Yeah, I think another way that we kind of help our clients are looking at them focusing on is what we call income shifting. But really, it’s a way to incorporate your kids or other family members in your business, because we get the question a lot as well. How do I deduct my kids? Well, it’s probably not phrasing the question the right way, right? It’s like how can I How can I pay my kids to take a tax deduction is kind of the better way to look at it. Right? You can do that by incorporating them in your real estate business. So it can be having them help you with, you know, advertising for your rentals, or putting fliers out or doing internet research or whatever it is that they can do to help you in your business. It’s a way that you can start paying them to take a tax deduction for saving money as a family, because we all know that you’re you’re obviously giving the money to kids anyway, already. Right? So now it’s looking for ways to get a tax deduction for doing that.

Amanda Han / Matthew MacFarland 8:52
Yeah, I think the older the kids are, the more expensive they get, you know, when they’re younger, you get them little toys, they get older, they got cars, they got tuition. So it’s a really great way because if you just bought your car, generally it’s not deductible. But if you instead pay them to help out in your real estate business, then that’s a deduction and your kids can take that money and pay for their own car or,

Jason Hartman 9:13
you know, pay for their college and all those good things. So and you’re also hopefully teaching them some more of the life skills. Right. So that’s good,

Amanda Han / Matthew MacFarland 9:21
right? And I like to think in this picture that this kid is showing the dad how to use zoom, you know, first, and maybe the dad’s teaching the kids on but I don’t think so.

Jason Hartman 9:30
Yeah, your tech consultant. All right. What else? Let’s make sure we touch on real estate professional. I know that’s a big one for a lot of our listeners.

Amanda Han / Matthew MacFarland 9:38
So for I know, you talked a lot about depreciation or you have in the past, you know, with respect to that being a great benefit for real estate investors. And, you know, one of the things I think a lot of people are confused on is for depreciation. One of the things we love about depreciation, it’s that it’s a paper loss, but it’s not just on the down payment that you made to a property. It’s actually based On the purchase price, so we like to look at it as, hey, you’re getting a write off on the base money today. So if you buy $100,000 property, it’s the same depreciation, whether you paid $100,000 cash, or it was 100% leverage. And so, you know, when we have clients that have high numbers, okay, well, how do you wipe out the income with a lot of write offs? You know, if I have $100,000, to invest, if that could turn into a $300,000 property, or $400,000 property, the tax deduction could be three, four times what it would otherwise be, if you’re just doing the, you know, all cash deal.

Jason Hartman 10:36
Amanda, I’m so glad you said that. Because the depreciation number one, it’s in my eyes, it’s the holy grail of tax benefits. I mean, it’s a non cash write off, like you said, it was a paper loss, I call it a phantom deduction, whatever you want to call it. But you also get the leveraged advantage of that. Meaning that if you know, if you put 20% down on the property, you get to multiply that depreciation deduction times five, because you know, it’s not only the money you put into the deal, but it’s the 80%, the bank put into the deal. So you get to depreciate all of that. And again, as long as you can 1031, exchange it and never recapture that depreciation. That is a beautiful, beautiful thing.

Amanda Han / Matthew MacFarland 11:18
Yeah, one way we like to look at it too, is, you know, it creates tax efficient cash flow, right? Like the goal is obviously good positive cash flow. And then but if you can use depreciation and you know, home ops income shifting to all these other strategies, the idea is that good enough production to bring that lead at the very least down to zero. So you got taxed with money in your pocket, right. So but, you know, obviously, with depreciation, kind of the standard way of doing it, you know, a lot of people know, some people know, residential properties, they write it off evenly over 27 and a half years, non residential, you write it off in 39 years, but there are ways to kind of what we call, you know, a supercharged, right like, and that’s using a cost segregation study. So a cost segregation study is just going into the property and looking at how do we break out the components of the building so that I can take faster depreciation or shorter depreciation lives, I can, you know, write it off over five years, seven years, 15 years, over the life of the property, you’re getting the same amount of depreciation, it’s just the goals, how do we take more of it sooner than later,

Jason Hartman 12:15
you get to accelerate that depreciation, because different components of the property depreciate on different schedules. So the appliances are on a faster schedule than 27.5 years, for example. Now, the reason you you do the cost segregation study is because you’re segregating out these faster depreciation, depreciating items, and then you can write them off more quickly. But the problem has typically been that this is economical on a larger property, it’s been commonly used in large commercial properties. I’ve used it on a couple of apartment complexes that I’ve owned. And, you know, I remember the last time we did one, we paid $28,000, to have a cost segregation or cost StG study. And it was worth paying $28,000, because the tax benefit was much bigger than that. But on a single family home, you know, I have done some shows some episodes where I’ve had people on that charge between 500 and $1,000, to do a cost saving study on a single family home. And with that, you can save more money than you spend on that study. And that’s great. And you say you know some others. Again, this is a pretty small world of people providing these cost saving studies on single family homes, at least economically. So please send those over to me, and I’ll put them in the show notes. And everybody can look at them on the show notes for this episode. Okay, if we get them in time. So that’s really great. And

Amanda Han / Matthew MacFarland 13:49
I think it’s a common misconception. We have clients who, you know, own five, six or a dozen single family rental properties, and they’re under this assumption that, hey, those only four multifamily large multifamily doesn’t give me a benefit. At the end of the day, like with anything else in business and investing, it’s a cost benefit analysis, right? If If you have five single family homes, each costing, you know, three, four, or $500,000, that building basis might be much larger than one apartment that you own in Ohio, right? So it’s all based on, we know what the purchase price of the property is. So we put together just an example, what costs that can do especially in this year, where we have bonus depreciation, meaning not only can you accelerate some of these assets into shorter lives, but you can actually claim an immediate deduction for a big part of the purchase price of that building. So, you know, so for our example, we so if you let’s say you purchase a rental property for $300,000 as a $60,000, downpayment, right? Yeah, we don’t care what the downpayment is, but we bought it for 300,000. And let’s say the building value is 250. With

Jason Hartman 14:56
cost segregation, the land is 50,000 right? You know, that kind of California property? Right, right, right, obviously. But we don’t recommend investing in California properties anyway, because they’re too darn expensive. So. So you basically got a $250,000 improvement value or building value 300,000 total price, meaning that by deduction, the land is $50,000. And you put 60,000 down, and you’re saying the first year with a cost segregation study, you could potentially get up to $75,000 in deductions for depreciation, right?

Amanda Han / Matthew MacFarland 15:33
Correct. So your your write off is more than your downpayment, even in write big note,

Jason Hartman 15:39
so it depends on your tax bracket. Now. So here in this example that we’re looking at on the slide, if you’re seeing the video on our YouTube channel, it’s a 37% tax bracket, meaning you would get a first year tax savings of $28,000. When you put 60,000 down, so you get like half your down payment back, which is pretty awesome. But what if you live in? And no offense? Because I used to live there two months, my life, the Socialist Republic of California. And you and you pay, say 13.3%, in state taxes? Do you get an additional deduction for the state tax component? Or no,

Amanda Han / Matthew MacFarland 16:19
no, unfortunately, California is one of those few states that does not allow large rental losses, Calvin is not recognized real estate professional.

Amanda Han / Matthew MacFarland 16:29
Also, it also doesn’t recognize bonus depreciation. So that’s why I’m a big insurance. So

Amanda Han / Matthew MacFarland 16:34
so that’s gonna be then in our scenario, you see, we didn’t include the state. But of course, if you live in another state, maybe that’s more reasonable, right? Maybe it could be federal as well as state taxes. So okay, it’s huge when you kind of add, you know, layers upon layers of different strategies to see what the potential tax benefits is going to be.

Jason Hartman 16:53
Okay. Very good. All right. Keep going.

Amanda Han / Matthew MacFarland 16:55
Yeah, I think it’s you kind of alluded to this earlier, I think, you know, we think, you know, based on experience, cost segregation and real estate profession, when you can combine them together, that’s, that really is the holy grail of tax planning for real estate investors. And you know, real estate professional, what we’re talking about is, you know, a lot of people may not know, but when, you know, if you have if you’re generating losses from rental properties, and when we say losses, we’re talking about paper losses, right worlds, where you’re not losing money on your cash flow. But if you have losses from your rentals, the goal is obviously to be able to use those losses offset your other income. Now, the IRS said, you can do that, to some extent if your income is below 150 grand. But if your income is above 150, then what do we do? Right? Well, that’s where a real be real estate professional can come and play. Because if you or your spouse if you’re married, if one even qualifies a real estate professional for tax purposes, then any losses you generate in the current year from your rentals can be used to offset all of your other sources of income without limitation. So you got WTO, you’ve got no interest dividends, there’s no income from other businesses.

Jason Hartman 17:53
So let me just explain that a little bit more for people. So basically, if you are designated by the IRS as a real estate professional, now, don’t confuse that with being a realtor, or selling real estate for a living. I think, you know, it just basically means you’re a professional investor. And there are some hurdles to jump through to get that not everybody will be eligible. But normally, the passive loss, mostly depreciation, we’ll just call it depreciation. Tax Benefit phases out when your adjusted gross income is above $150,000 per year, correct me if I’m wrong on any of this, okay, you guys are the experts. I’m not. But this gives you a way, if you’re a real estate professional, if you have that classification, like I do, then you can take unlimited deductions, regardless of your income, you can make $10 million a year and take just an unlimited amount of deductions on these passive losses are mostly depreciation. So did I say that correctly? Yeah. Okay, good. So the question is, how does one qualify to become a real estate professional, and I know, look at you, we’ve done episodes on this before with other CPAs and, and so forth. And this can be a bit complex. Okay. So you know, we don’t have an hour to discuss it right now, because there’s no ifs, ands, or buts. But just basically, tell us how that works. If you would, in a nutshell,

Amanda Han / Matthew MacFarland 19:20
well, I think you hit on the nail, right? People are confused with being licensed. So having a license or not really have no impact whatsoever is strictly an hour’s test. And so the key criteria are that this individual, again, whether you or your spouse have to spend at least 150 hours in your in real estate in general. Okay, so at least 150 hours. That’s the first hurdle. Now, the other requirement is that you have to spend more time in real estate than your other income activities. So if you have a job, you have an escort, right? Then we look at how many hours are you spending in those activities collectively, and you have to spend more time in real estate than that. So if you have, you know, another part time job and spend 1000 hours on what You need 1001 hours in real estate to then be a real estate professional.

Jason Hartman 20:05
Amanda, by the way, I just want to make sure I got this. Did you say 150? hours? Or did was that? Uh, did you miss speak? Or was 750? Yes. Yes, that’s the number I know. So 750 hours. But the kicker is that at least the way it used to be unless this change 500 of those 750 hours have to be considered active participation? And yeah,

Amanda Han / Matthew MacFarland 20:30
the term is the term is material and participation, material participation. Yeah, essentially, you need to be kind of boots on the ground and, you know, involve, for lack of a better term in the day to day operations of your own rental properties, right, get to that $500 Mark, and then you know, if there’s other things you’re doing for your kind of your real estate business, you can use that to get to your 750.

Jason Hartman 20:51
Like, with your 750, you can consider education to be part of that, right? If you go to a conference or attend our conference on zoom, right? You know, you can call that part of your 750. But it won’t help for your 500 500 by real participation.

Amanda Han / Matthew MacFarland 21:07
Yeah, the way we look at is that 500 hours really needs to spend on properties you own not like, you know, education, and those kinds of things are just more kind of overhead related. But yes, of the and it’s the same time, sometimes people are confused and say, Oh, I need some 50 and 500 900 is part of

Jason Hartman 21:24
the 750. So it’s not not that hard. But what about income? Like, what if someone is, you know, a doctor and say, they are not working that many hours, and they’re not married, okay. So they don’t have a spouse that can qualify, it’s just got to be them. But say they make $300,000 a year as a doctor, but they don’t work that many hours. So they can still get 750, you know, in and, and we’re teaching a lot of our clients how to self manage their properties, so that they can materially participate in them, you know, people can self manage their properties, long distance, it’s actually quite easy. We teach people how to do that all the time. Can they qualify with that $300,000 doctor income, even though it’s not that many hours,

Amanda Han / Matthew MacFarland 22:12
there’s no income, you know, when you look at real estate professional status, again, it’s strictly a times and activities test, they don’t really I’ve not seen them to take into consideration how much other income you’re doing. Now, having said that, you know, for this physician, their time has to be reasonable, right? So they made $200,000. In reality, how many hours do they spend, and that would be the number of hours that is compared against Real estate professional status. Okay. We know we have a lot of clients that are now involved in short term rentals, I don’t know which your clients probably have as well. So there’s a little loophole in there that a lot of people might not know, with respect to using rental losses from short term properties to offset other types of income.

Amanda Han / Matthew MacFarland 22:55
Yeah, we have clients that maybe they can’t qualify as a real estate professional, just based on their, you know, the hours were, but if they, they happen to have a couple of short term rentals, and they can meet the short term rentals or, you know, kind of treated differently in the tax world. And when we say short term rental, we mean, you know, when you look back over the year, if the average customer uses seven days or less, then you’ve got a short term rental property. So you know, Airbnb, one of those type of things where people are booking for four or five days at a time, that type of thing. But if they can materially participate in their short term rentals, and they’ve got losses on those rentals, those short term, they can use those losses to offset or other income without having to qualify as a real estate professional. And we’ve gotten a lot of clients kind of going that route just because they like that marketplace. They like Airbnb model, if you will, for lack of a better term. But so that’s an opportunity. I think they can they

Jason Hartman 23:44
can and we do a little bit in the short term rental world, and I gotta just give a caution. A lot has changed in that world due to Korea. So be careful. Okay, make sure you’ve listened to our podcasts for a lot more on that. But go Go ahead. Okay, anything else on real estate professional that you want to share?

Amanda Han / Matthew MacFarland 24:01
You know, I think the key to being real estate professional claiming it correctly is to document write document your time, I always recommend doing it throughout the year, because normally when people get audited is not going to be right away. You know, after you file a tax return, it’s going to be two or even three years after the return is filed. And you know, if anyone’s like me, I can hardly remember what I have for breakfast two, three days ago, but it’s gonna be difficult two, three years from now to figure out what do I do on this particular date? For real estate professional self, documenting time is sort of, you know, going to be an insurance policy to claiming it correctly and legitimate. Good point.

Jason Hartman 24:37
Okay. Good.

Amanda Han / Matthew MacFarland 24:38
Yeah. So, you know, like we talked about, you know, the current tax law, you know, highly favors real estate investors. It’d be interesting to see what happens with the election and whether that changes, obviously, but it you know, we do tell people all the time, it is important to work with our advisor throughout the year, not just you know, right before April 15, because you know, if you come to us on April 1 How do I save time last year, your options are severely limited compared to if you’re talking to him in October or November for that matter, you know,

Amanda Han / Matthew MacFarland 25:07
yeah, tax laws can change anytime. So get to take advantage of it while you can. Good.

Jason Hartman 25:13
Any questions I didn’t ask you or anything else you’d like to share? And then let’s wrap it up.

Amanda Han / Matthew MacFarland 25:17
I think, you know, being the time, you know, obviously, this is changing times, you know, in the country, but also just my tax perspective, too. But one thing is always stands true. You know, Matt mentioned proactive tax planning. But you know, before the end of the year is really a great time to do your own planning, because this is the you know, this is the last kind of the last ditch effort was okay, how are we doing on real estate professional time? You know, do we need to buy more rentals before the end of the year so we can get more depreciation, she went to cost segue. So you know, before the holidays, tried to allocate some time, meet with your tax advisor, and get some action steps in place so that you know, you’re sitting pretty by next April.

Jason Hartman 25:57
Good stuff. give out your website.

Amanda Han / Matthew MacFarland 25:59
Our website is www dot Keystone CPA. com. That’s KYSTONE cpa.com.

Jason Hartman 26:07
All right, Amanda, and Matthew, thank you so much for joining us. Thank you for having us. Appreciate it. Thanks, Jason.

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