42. ROI TAX SERIES 6 OF 8 – REAL ESTATE AND TAXES

TAX SERIES 6 OF 8

Adrian   00:02

Hello and welcome back to the get rich slow podcast. I’m your host Adrian Shermer and I’m joined by my co-hosts, Lance Johnson, and Rob Delavan and today, continuing our series our eight, partner on taxes, the ever-exuberant Sue hort.

Rob Delavan   00:25

So this is episode six and an eight part series. This one is real estate and taxes. We could have 100 episodes just on this but we’re gonna just touch some high points for you guys today. Real Estate and taxes your questions answered and we’re gonna jump right into it but before we do, you can find us at our respective websites. Sue as our special guest hosts ROI-tax.com. Mr. Brilliant at the basics himself Lance J. at ROI-financial.com. Mr. Shermer, he’s brilliant too but lending isn’t basic mortgage.com and myself Delavan-realty.com and we’re going to be speaking with Sue with ROI tax and she’ll be answering some questions in regard to real estate and taxes. Again, this is six in an eight part series. In our last episode, we learned how to make standard deductions versus itemize deductions simple and it was a hoot, wasn’t it and warm welcome to Sue. Gentlemen, we’re in for a treat, there we go. Okay, I’m going to throw it. Adrian, why don’t I throw it over to you for questions? We have three questions. I’ll do the first one, what are the tax benefits of having a vacation rental?

Sue   02:10

Okay, so a vacation rental, as opposed to just a regular rental is where someone says, I want to own rental property, I want to have some tax advantages, I want to be able to have something to put money into gain some equity it’s a diversification from maybe their stock portfolio. But the important thing is that as a vacation rental, it’s in a place where you want to travel, where you get to spend at least two weeks a year just enjoying. But anytime that you go there to repair, fix up, visit, that can be used as a vacation as well. So, you’re getting some rental income out of it because you’re renting it during those peak times of the year. But you’re also being able to use it and enjoy it and maybe you want to retire there someday. But the important thing is that you’re getting some rental income and you’re also being able to use it. So, your tax advantage would be if it’s coming in that you’re losing on it, then you’ve got a loss that you could be able to use on your tax return. But it’s mostly a paper loss because you depreciate the property, even though it might be appreciating. I know its sounds complex, but that’s where people go when they’re looking to have a vacation, rental.

Rob Delavan   03:46

And, Lance, my question for you, because we’ve run into this many times is it typically in your experience, the first investment property somebody buys?

Lance Johnson   04:02

Necessarily, but let me piggyback on what Sue talked about, I do believe in diversity, I don’t think everybody should have just stocks and bonds. I’m a big proponent of real estate, as you know and the tax benefits of it. So, with that all being said, some common scenarios that occur is some people want a vacation home. But then it’s very costly to maintain a vacation home that you sometimes only go three or four times a year, but when you go you want to spend a week or two or whatever and so, the discussion becomes why don’t you make it a vacation rental so it’s your vacation home that now we morph into a vacation rental or you’re used to having a first time home buyer they want to upgrade their house so they make their own house vacation their first time home, they upgrade and then and we’ll talk about this, then they want to do something about that first home or the next rental as they enjoy the benefits of rental income. They explore either duplexes or quads or they do vacation rentals, depending on their personal priority of what they want in their portfolio and I really like vacation rentals, if I had my choice, I’d have 30 vacation rentals all over the world and so when I travel, there’s tax benefits and so that would be my choice.

Rob Delavan   05:41

So, the concept there and obviously, there’s lending. I mean, this is a whole episode series of episodes but to sum it up Sue, what I heard you say is find somewhere you like and probably have some tax advantage from depreciation and then you have an investment and then you’re diversified. In somewhere that is a personal benefit but it’s also probably going to appreciate over time.

Sue   06:11

Exactly and the beauty of having the vacation rental where you enjoy is, it’s not going to be in your next or neighborhood, it’s going to be at a place you enjoy going to. So, while you’re going there, you can deduct the travel to get there, you can deduct some of the meals and the time because you’re working on it, you’re doing a little bit of upkeep and maintenance and visiting and make sure the property manager is doing what they want. So, you’re getting a tax benefit out of something you’re also enjoying, plus you’re getting some rental income for the months that you’re not there. So, it’s a real nice thing to have in your portfolio.

Rob Delavan   06:58

What a win-win. So, jumping into the next question and Adrian, I wanted to kind of do this, explore this a little bit with you, from a tax standpoint, but I own multiple homes and rent them out. So, from a tax standpoint, starting with Sue, what should I do to plan properly for taxes and for the tax benefits there. So, we’ve gone from vacation home to now multiple properties?

Sue   07:32

So, I have several clients with that they’ve decided that they enjoy having that rental income, they’re happy, to have that. So, they’ve decided to expand into 2 3 4. So, the key is, there’s one of two ways you can go use a property manager, pay that extra fee. So, they’re taken care of so that you’re not the one who has to do all the work or get the calls on the weekends, fix the toilet. So, just make sure that if you’ve got that property manager, they’re giving you statements every year, they’re calling you regarding major improvements or repairs that you have to take care of and then tax wise, you’ve got some that are maybe making money, maybe you’ve paid off their mortgage and some that are losing money because they’re more expensive and you can offset those, but you’re still getting that rental income, then there’s the other side of the coin is if you’re somehow involved in real estate, for example, as a broker, as a property manager or something of the like, you can be a real estate professional if you’re spending more than 750 hours in a year working with these properties or in your profession and then you can deduct as much losses as you have during the year. Some years you’re gonna have more losses than other years but you can take advantage of that if you’re a real estate professional, a whole other direction that I could go into but there’s a couple of ways that you could use tax wise with rentals.

Rob Delavan   09:19

Lance and Adrian, care to expand or add?

Lance Johnson   09:22

Well, so multiple homes pose some opportunities like Sue said is depending on your other income so your regular income, not passive income. You know, there’s that $350,000 threshold where you can write off the losses. You can have some properties that cash flow positive significantly and others that don’t and so then you can offset positive cash flow with negative cash flow. If you have a negative you can carry them for future. So, that’s good and then multiple homes, there’s pros and cons and there’s single family homes, there’s duplexes, there’s quads, there’s eight plexus and so forth and so there’s just this progression when you get into rentals and you go down that, how is it just a bunch of small homes but then when you realize a good rental is one that doesn’t have a loss and so you’re looking for those and then when you have a bunch of those, you’re gonna get those in duplexes and quads because it’s the same land cost with multiple income streams and so then you compare that to running a business like an 8 plexus, 16 plexus or a vacation rental, where you hire people to manage it. So, it’s just, what’s the sophistication that this client wants to deal with in real estate and there’s a whole progression that can occur.

Rob Delavan   11:06

And throughout that progression, there’s a, hey, how are you going to do the next one if you’re in a portfolio that’s increasing if that’s how you’re been and that really gets down a, again, multiple episodes on this but Adrian, from a lending standpoint, you can’t write down too many losses because then you can’t get qualified for a loan right, for the next one.

Adrian   11:28

And sometimes I get this question; this is the worst question I got. I actually just got it last week, which was, how much income should I show so that I can get qualified for a loan? You can’t ask me a question like that, there’s a huge problem there. What can you learn from your lender about these kinds of write offs? Absolutely nothing, because we don’t know your full financial picture, the difference that being able to write off your overhead on a rental is for a person who made $30,000 last year and somebody made $300,000, last year is totally different. So, you’ve got to talk to your CPA and you’ve got to figure out what the pluses and minuses are to this situation for some people, rehabbing homes, doing renovations, you may find that you get that quote, unquote discount, because it is a write off and you make enough money, that you’re writing off the highest tier of your income but if you don’t have a lot of money and you’re purely on the income of your rental properties, then it might not be as much of a air quotes here discount is what I’m going to call it. You know write offs have compounding results, the higher up the income chain, you go. So, you’ve got to meet with your CPA and you’ve got to have the kind of CPA that you can meet with before the tax season. You’re not just looking back going, what could we have done better? You’re going forward and saying, hey, I’m looking at investing, I’m talking to my financial planner, I’m talking to my CPA, let me get the pieces of information I need from each expert and then make an educated decision.

Rob Delavan   12:51

How do we always come back to planning?

Adrian   13:09

All right, last one, 1031 exchange, I get this question all the time and once again, I’m just going to echo it. I always defer to the CPA, because if you’re asking your lender, just don’t, I’m sure some lender will give you the answer, but they shouldn’t, because they don’t know enough to give you the right answer. So, it’s kind of funny you ask enough people a question, you’ll eventually get the answer you want. We want the right answer, though. So, we go to the experts and we get the expert advice. Sue, what’s a 1031 exchange?

Sue   13:38

1031 exchange, you have one rental property. But if you sell it, it has a huge gain. So, you decide, I’m going to do a 1031 exchange where I sell the first rental property, the money goes to a 1031 exchange agent, almost like a title company, a trustee, it’s held there, I purchased the second property of equal or higher value, the money from the exchange goes to purchase that second property and I don’t have to pay on the game, as long as I don’t take any money out all the money goes into the second property but my second property now has a reduced basis on it by the amount of the gain from the first property, so I pay no gain now, I’m deferring it to later. That’s the purpose of the 1031 exchange, buy another property defer my gain until after I sell that second property or however that works out.

Rob Delavan   14:48

I’ll give you guys a scenario and this is fighting straight here how Lance and Sue talk about these things. So, usually where I run into them as a real estate broker is somebody has two or three properties and they’re smaller, like say they’re the houses that they bought back in the 80s, that were when they were cheap, or even in the last 10 – 15 years and they want to trade two or three properties that maybe are older or, you know, have appreciated in value and want to sell those, but of course, they appreciated quite a bit and then they want to consolidate into a bigger property, say, multifamily or a, go from residential to commercial or that sort of thing. So, comment on that. And, Lance, I know you have, you’ve experienced an incredible amount of that sort of thing, too so…

Lance Johnson   15:45

Well, so on 1031 exchange, I mean, one comment I make is it’s of equal value, or more. So, downsizing that that’s a trickier you can go from one property to two properties, but the total needs to be greater, right and then the, if you have loans, you have to have equal loan exposure or greater as and so that’s to qualify, there are a set of rules and instructions. So, the agent, everybody I tell that, let’s do some planning, let’s get with the agent and there’s a set of rules. You do not want to mess this up. There’s other worse than going in hoping that could go through this whole process and then you mess it up and you have to pay the taxes and you wish you never sold the original property.

Rob Delavan   16:36

No undo button here.

Sue   16:39

You don’t come to your CPA and say, I sold the property and then I immediately bought another one is that at 1031 exchange? There is no after the fact…

Lance Johnson   16:54

And then 1031 is a exchange. So, you get into issues of I’m in a partnership with three people and I want to 1031 exchange my portion into a single, I believe there’s some issues there can’t be done and so like exchange is very important part and it’s all about just pushing that tax bill down later on in life, instead of dealing it with it right now and so that’s just the key to it is going through the process of figuring out whether it’s vacation rentals, rental the rental and the rules of moving that and getting to, let’s just say our newer, better rental, whether it’s vacation, or single or duplex or quads or whatever, you’re just trying to take the original one and not pay the taxes on the gain with the depreciation and move it to a better one. That’s the goal.

Rob Delavan   17:53

And that’s the summation and over the course of 10 20 30 40 years of financial advising, tax planning, lending, real estate brokerage, I mean, this is an interesting topic, because we all touch it at one way or another. It’s probably a lot more common than a typical person would expect.

Lance Johnson   18:17

The goal is to defer until you die, right and you get a step up in basis.

Rob Delavan   18:23

And we pull in the estate attorney, right and then they tell us what happens then…

Adrian   18:27

The IRS rolls their sleeves up.

Sue   18:29

Yeah, that’s a whole another animal.

Rob Delavan   18:31

But this just dips our feet and by the way, we will have references for our material here. There’s a good article that defines things as we discussed on CWS capital.com. As its labeled, what is a 1031 exchange; also, the IRS.gov site has a lot of resources on that we’ll include those in our show notes, so that the audience can reference that.

Lance Johnson   18:47

And I like to make one comment about what are some of the applications on 1031 Some people ran to Oregon and then realize there’s a bunch of property taxes and taxes and additional taxes and now, as they get later on in life, they want a rental that’s not necessarily in the state of Oregon with all the extra taxes because there’s other states that have different taxes, that you’re looking for those like exchanges to improve your tax bill later on for estate planning and or income taxes.

Rob Delavan   19:39

Right, huge conversation, love these topics. We’re just dipping our toes in here but thank you so much Sue for gracing us with your presence during this tax season. We love ringing out every drop of wisdom you have to give to us. Thank you and the best way to find Sue again is visit our website www.ROI-tax.com that will also be linked in the show notes and please stay tuned for our next episode. In this eight part series with Sue in the next episode we will be learning about year and tax planning and why it’s important another barnburner, oh, boy, we’re gonna have a blast, until next time, thank you all for listening.