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With so many real estate tax write-offs, it’s no wonder that CPA Brandon Hall says rental real estate is one of the most tax-advantaged assets on the planet. But, even with so much free-flowing information on how to pay less to Uncle Sam, most real estate investors are missing out on a MASSIVE tax deduction that could be saving them thousands, if not tens of thousands, on their tax bill. What’s the write-off that even our host, Dave Meyer, didn’t know about? Stick around, or walk away from a HUGE tax savings.

Brandon Hall is a real estate investor-focused CPA. He knows the deductions, write-offs, and audit red flags that could be helping or hurting you. Today, he’s walking through whether or not you need a tax professional (a LOT of people DON’T), why you need to start tax planning BEFORE you buy your first property, the biggest real estate tax write-off that most people miss, and why you should WAIT to file your taxes to see if a MASSIVE real estate tax benefit is making a much-awaited comeback.

Need a tax professional to help you make the right tax moves? Find one for FREE with BiggerPockets Tax Finder.

Dave:
Hi everyone, and welcome to the BiggerPockets podcast. I’m your host, Dave Meyer here, wishing you a happy early tax day. Now, I know probably most of you are thinking you don’t wish people a happy early tax day, but in the real estate investing industry, taxes are actually one of the benefits that we enjoy as real estate investors. So whether you’ve already filed for this year or you’re just trying to get in that last minute return, we’re gonna be talking about taxes today and giving you some advice on how you can use your real estate investing portfolio to optimize your tax situation. To help us with this topic, we’re going to bring on Brandon Hall. You may have heard him on the show before. He’s been on this podcast many, many times to talk all things taxes as they relate to real estate investors. And Brandon is one of the best in the business.

Dave:
Today we’re gonna talk to him about when you need a tax professional in the first place, and when it’s okay to do your taxes yourself. We’ll discuss the benefits of real estate and how it can help lower your tax burden. And we’re gonna get some updates on bonus depreciation, which is one of the most coveted tax benefits that real estate investors enjoy. Now, in conjunction with this show and tax season, we also wanted to announce that BiggerPockets has a brand new tax finder tool. This is a matching service. You may have used our lender finder agent finder in the past, and this is pretty similar. It’s a matching service where BiggerPockets will connect you with an investor friendly tax professional. These are tax pros and CPAs who truly understand what real estate investors need to be thinking about when it comes to their taxes and help you set a long-term strategy for your taxes. So if you want to get matched for free, visit biggerpockets.com/taxpro, that’s biggerpockets.com/taxpro. Alright, with that, let’s bring on Brandon Hall. Brandon Hall, you are a veteran of the BiggerPockets Podcast Network, but it’s always great to have you. Thanks for joining us today.

Brandon:
Thanks for having me on, Dave. I appreciate it. Excited to be here.

Dave:
Well, we’re excited that you’re here to talk about taxes. Now, many of our listeners are either first time investors looking for their first deal or maybe have one to three properties and taxes at that point may still be relatively simple. So do you think those types of investors can continue working with an online service like TurboTax or at what point do you recommend graduating, so to speak to a tax professional?

Brandon:
That’s a great question and it’s really tough to answer that question. So personally, I’m a big fan of learn how to do things yourself to a degree. If you buy one rental property, the risk of, you know, making a mistake on your tax returns as long as you spend some time studying the law, reading some, and really stepping through it and understanding what you’re recording on your tax returns, um, I think the risk is, is there to make a mistake, but it’s not as large as if you bought like a 50 unit apartment building and you made a mistake there, right? So, so it kind of depends on the type of property that you’re buying. If you’re buying small duplexes, single family homes and you’ve got one or two, um, I’m kind of in the camp that, that you should DIY it and, and I’ve got two reasons for that.

Brandon:
One, when you DIY, it, uh, assuming again that the risk profile is, is manageable, okay? ’cause if you’ve got a hundred unit apartment complex or five partners or whatever, um, making a mistake is a lot more costly at that point. So you gotta be careful. But I I, I like DIY because you learn the ins and outs of how your taxes work, right? You learn about Schedule E, you learn about depreciation, you learn about cost basis. You learn how to book all the acquisition costs. You learn how to book rents and everything that goes into Schedule E. But then you also learn how it flows to schedule one and how that gets offset with other income and losses on schedule one. And then how that ultimately flows to your 10 40. ’cause the tax returns are just this like huge maze. You know, it, all the forms say you’ve got the number here, now go put it over here, and now that it’s here, go put it over here.

Brandon:
So learning that maze, I think is actually really beneficial for investors. Uh, so that’s my first reason. My second reason is when, when new investors buy, uh, by their first couple rentals, they look to offload taxes because taxes are un, are overwhelming, understandably so. Uh, but the mistake that they make is they’ll the higher tax pros that will charge ’em like 800 bucks for a tax return or something. And, and this isn’t like to say that tax pros that do that are bad. There are great tax pros that charge 800 bucks for tax returns and a thousand bucks for tax returns. But the reality is, is that if you think about the economics of tax preparation, uh, the, the preparer has to make enough money to eat. Now, if you were in business yourself, how much money would you want to make to justify being in business yourself?

Brandon:
All the additional administrative headaches, all the people management, the risk that you’re taking on, you probably wanna make at least 150 to $200,000, right? So if somebody’s gonna charge you 800 or a thousand dollars for your tax return, how many tax returns do they need to prepare to get to their number, uh, of, of net income that they need? And this is net income, right? So this is after expenses. We’re probably talking to clear 200 as a sole tax preparer, maybe 300 K in total total revenue. So how many tax returns to get to 300 K total revenue? And then what does that mean for you specifically as their client in terms of client experience and in terms of quality output? Because tax prep is, is condensed, right? We have nine months essentially to prepare or to do 12 months worth of work. So it’s very condensed.

Brandon:
It’s around deadlines. Uh, things happen very quickly between April 1st and April 15th. And, uh, and mistakes get made, especially when there’s more volume. So because of those two things on, if, if I’m, if I’ve just bought my first or second rental, I’m probably of the mind that you should DIY it now, you know your own skillset, you know, you know your attention to detail levels. So if that’s just like way beyond you, then for sure offload it. But, um, you know, I I mean there, there’s a lot of sophisticated people that are highly analytical that are buying, buying rentals. Uh, and I think that those folks, you can try to DIY it, there’s no harm in trying.

Dave:
That’s really good advice and two points that I’ve never heard before, but it’s sort of similar to house hacking or doing self-management as a landlord, because you learn how to do it yourself. And that doesn’t mean you have to do it yourself forever. But then when you go to hire a tax pro, or using my analogy, you go to hire a property manager, you at least know to look what to look for because you’ve done this before and you know, the intricacies of what’s involved and some of the pitfalls. Uh, so that, that’s great advice. That being said, when you started talking about Schedule Z and all that stuff, and I was like, thank God I have a tax professional <laugh> because I am a highly analytical person and to be honest, I have no interest in doing it myself.

Brandon:
Uh, but here’s a question for you. How do you know if they’re doing a good job?

Dave:
Honestly, that’s a great question. I don’t really, I just guess I’ve been outsourcing it long enough for 14 years now Sure. That I’ve fired two <laugh> and now know that my third is better than the first two.

Brandon:
Yeah. And this is a question that I think about a lot. I mean, we, we have attorneys that we work with, right? And I’m always like, I have no idea if my attorney’s doing a good job or a bad job. And unfortunately you don’t find out until it’s too late. Um, so it, it’s just one of those things with professional services and, and that’s why I say like if you can, uh, DIY especially if you’re on the smaller scale, as you grow and as you do move to that outsourcing of just saving time and it’s, it is getting too complex, you’ll be able to have more sophisticated conversations. You’ll be able to kind of fact check. It’s really difficult to fact check if you don’t have any experience like doing the thing that you’re outsourcing. That’s just how I’ve, how I kind of believe in running my own business as well, much to the chagrin of, uh, some other folks that I work with that are all about the who, not how the, the who should we hire to all source this rather than how do we get it done. So, yeah,

Dave:
But it, it totally makes sense. You need to sort of get to a baseline understanding of any topic before you can start critically evaluating whether or not someone is good at something. That’s probably true of, you know, a lot of different professional services and different vendors that you need to work with as a real estate investor. Yeah. Well, Brendan, I, I appreciate this, uh, non-biased perspective. ’cause I’m sure as a tax professional you could just say that everyone should use them. So thank you for sharing the, uh, your opinion on when people should DIY it, but obviously you believe in tax professional. So tell us when people should consider using a tax professional.

Brandon:
So, so there’s two, there’s two reasons to use a tax professional. One is to get high quality compliance work completed on a con on an ongoing basis. Uh, so basically tax preparation, right? And the second reason is to get some strategic planning done. Um, I think that if you are, if you have the ability to scale fast, meaning that I have access to a large amount of capital, even if I purchased no rentals yet, but my plan over the next 12 months is to blow my portfolio up, um, I think that you should get strategic planning done from a tax professional a hundred percent. Uh, should you get your returns done pro depends on what else you have going on. But until you actually buy some rental properties, you’ll probably, again find DIYing it. But at least from the strategic planning perspective, educating yourself on the fundamentals of tax might change how you acquire properties.

Brandon:
Uh, and it will definitely change how you sell properties later on. So any sort of like planning there that like, like it’s really good to work with a tax pro who can sit down with you and understand your goals, where you’re trying to go over what period of time, and then help you understand what types of assets to buy and why. So that piece is important. But back to the compliance piece, when should you, I mean, there’s no bright line test. Uh, the, the way that I talk to people that are interviewing our firm is how big of a pain point is this for you? Um, you just used the person charging you a thousand bucks and you said that you found a couple mistakes, but a thousand bucks is relatively inexpensive for what you’ve got going on Mr. Prospect or Mrs. Prospect. Um, so are you sure you’re ready to make the switch?

Brandon:
Like, why would you wanna make that switch today? And I think that just evaluating that yourself, like with some self-reflection is important. Typically, it’s peace of mind. I just wanna make sure that it’s being done right. Uh, and then it’s, it’s also just saving me time. I don’t have to worry about preparing my taxes myself or reviewing my taxes, uh, like on April 15th when everything’s crazy. Um, so if you’re kind of at the point where it’s just, it’s over your head and you’re feeling uncomfortable, I would say that’s the time to offload your taxes. And then it, then, then the next question is just how much do you need to be part of that process? And that depends on the, the quality level probably that you’re gonna get.

Dave:
Alright, now that Brandon has walked us through the basics, let’s get into the benefits. Brandon talks about how investors can set their portfolios up for the best tax advantages in the long run, plus the latest on bonus depreciation right after the break. Welcome back to the BiggerPockets Real Estate podcast. I’m here with Tax Professional Brandon Hall. Let’s pick up where we left off. I know for myself the time that it, it really started making sense to have a good quality CPA and to invest in it was that ongoing tax strategy because as a real estate investor, there is so much to tax strategy that I think people who invest in the stock market or don’t invest much don’t really understand with real estate, there’s just so many different avenues you can go, so many different things that you can do. Can you tell us Brandon, a little bit more about why real estate investors have so much opportunity to think strategically in terms of tax planning and preparation?

Brandon:
Yeah, well, uh, I mean, the simple answer is that real estate is, in my opinion, the most tax advantageous asset class. So you want to make sure that you’re fully optimized per your situation when you’re buying rental real estate, right? If I buy rental real estate, I’m gonna create net operating income that is ideally tax deferred. I’m also gonna create tax losses that ideally I can claim. Um, and learning how to structure that is very important for that optimization. And so a lot of the planning that we do will be around repairs versus improvements. When should you make those repairs and improvements? Do you do it year one? Do you do it before you place it in the service? Do you do it year two or year three? There’s different considerations there. So if you’re somebody that’s like, I’m gonna be a value add investor, well, you could just go buy property and just start the value add process immediately.

Brandon:
Or once you talk to a tax professional, you might change your tune a little bit if you’re trying to optimize under taxes as well. It just kind of depends on your situation. There’s differences between buying a single family home and a four unit property and a 20 unit property. There’s differences between a long-term rental and a short-term rental. The passive activity loss rules, you have to educate yourself on or get some strategic planning around. So the, the thing the challenge is, I’m gonna buy rental real estate. I want to build wealth ideally over the long term. That’s another big like planning point that we have with our clients. Everybody wants a tax refund today. But what we like to help our clients understand is, yeah, but if you keep doing this thing over 20 years, you won’t have to jump through all these hoops. You’ll just have the portfolio that offsets itself and now you’re rich dad poured out on steroids, right?

Brandon:
So it’s just helping people understand everything that’s available to them, and then also what should they actually do. I can’t tell you how many times we get people that come to me and they’re like, Hey, uh, my newborn baby, I wanna pay them $13,000 because I just saw on TikTok that like, I could make them a model, right? And, and so part of what we do is we’re like, well, you could do that, but you’re also now at risk for audit. Uh, it’s unlikely that you would be able to substantiate paying a baby $13,000 for modeling for your rental properties ’cause your tenants don’t care. Um, so you’re, you would be at risk of losing the audit. And the question is just, is all that worth the hassle? Or should we just kinda get the tax optimization on autopilot? And, and those are too. So it’s just, it’s a huge, huge task to navigate every aspect of this. But it’s really important to work with, uh, professionals who aren’t necessarily sitting there telling you, we’re gonna get you every dollar back. They, they’re balancing, we’re gonna get you as much as we can with how much time does this take? And how much risk are you taking on in terms of that audit piece.

Dave:
That’s a fantastic point of view branded, because I do think, and I I see people saying like, I wanna minimize taxes today, but often, at least in my limited experience, you see that if you develop sort of a longer term portfolio level approach where you’re not just thinking about like, how do I maximize this one property, but how are all of my properties, how’s my W2 income, how are all these different components of my income working together to create the most tax advantaged and risk free, um, solution for, for yourself? Now, I imagine for people listening to this who still work at W2 job, they might not fully understand some of the things that you can do with real estate to offset your income or to create a better tax situation for yourself. So can you tell us just a couple of the common approaches real estate investors use?

Brandon:
Yeah, so the, the first thing to understand is that depreciation, uh, which we’ve talked about before on some prior episodes, it’s a non-cash expense. Uh, and you get to claim that every single year. So depreciation is a calculation based on the purchase price, less the cost of land divided by 27 and a half years. So I get to claim that expense every single year. Um, and, and that’s a, it’s called a non-cash expense because I pay for all this upfront. So that annual expense that I get to claim per that calculation, it doesn’t change if I buy the property all cash, if I finance the property a hundred percent, if I’ve got 70% debt, 30% equity doesn’t change. So the depreciation expense is the same every single year. So if I have a, if I have $10,000 in rent and, uh, $8,000 in expenses, I’ve got $2,000 in net operating income.

Brandon:
But if my depreciation expense is three k, I get to tell the IRSI have a thousand dollars tax loss. So I get to tell the IRSI lost money even though I made money. And that’s, that’s the beauty of depreciation. It shelters our cashflow today. So that’s one thing. The second thing though is that extra a thousand dollars tax loss, what do we do with that? And the answer is we have to understand the passive activity loss rules. And that’s when we get into like, like pretty sophisticated strategic planning because there’s real estate professional status, there’s material participation, there’s short term rentals, there’s self rentals, there’s, I’m a physician and I’ve, I’m renting to my own condo and how do I group all that in? So that can get, uh, pretty gnarly pretty fast. But the third thing that I see investors, uh, not do, which I wish that they did more of is something called partial asset dispositions.

Brandon:
So if you buy, let’s just say you buy a a hundred thousand dollars single family home, I, I don’t know where you’d be able to do that these days, but, uh, a hundred thousand dollars single family home, whether or not you get a cost segregation study, which is the act of like identifying all the components inside the property and assigning value to them. Even if you don’t do that, it’s true that like the roof still has value. So a hundred thousand property, the roof might have $7,000 in value if I replace the roof two or three years later and I don’t write off the cost of the roof that no longer exists. Now I’m depreciating two roofs basically, right? Even though I only have one roof. So I bought, I bought the house a hundred k, the roof that was there had seven K of value assigned to it. I replace it two or three years later with a new roof, but this old roof doesn’t exist anymore. So if I don’t write off that remaining cost, now I’m depreciating two roofs essentially. So a partial asset disposition is the, is the practice of writing off the cost of the asset that you literally ripped out of the home that no longer exists. Very few people are doing that, very few investors are doing that.

Dave:
Can I just summarize that to make sure I understand this? Sure. ’cause I’ve, I’ve never heard of this so clearly I’m not doing it <laugh>. It’s

Brandon:
Great for anybody that’s rehabbing <laugh>.

Dave:
So the way depreciation works is like over time, I think it’s specifically 27 and a half years for residential real estate that the value of your property, uh, is going down. And so you can, uh, depreciate 1 27 and a half of the value of your structure every single year. And that includes stuff. Uh, and there’s also, you could depreciate your roof like the example that you gave, but if you replace that roof before those 27 and a half years, that basically means that you have this opportunity to write it off because you haven’t fully depreciated it. Is that right?

Brandon:
Yeah, yeah, yeah. So, so let’s make it really simple. Let’s say that the roof was worth $27,000, uh, and you’re depreciating $27,000 over 27 and a half years, we’ll just call it 27 to make it simple. So a thousand dollars a year, so after two years, your roof is worth $25,000, but then you’re putting a new roof on for maybe $30,000, right? So if you don’t write off the cost, that $25,000 of roof that no longer exists. If you don’t write that off, then your balance sheet now shows 25 cave old roof plus 30 k of new roof. So really you’re depreciating 50 5K of total roof, even though you only have 30 k of roof on your property. So the idea with a partial asset disposition is to recognize that discrepancy and say, Hey, that roof doesn’t exist anymore. We, we removed it, therefore the value assigned to it should also be removed. And when you remove it, it’s an immediate write off. Uh, and whenever you go to sell the property later, you don’t have depreciation recapture because the doesn’t exist. So you get, you get to optimize two times.

Dave:
Ah, okay. That makes sense. ’cause if, I can imagine that people listening are thinking, oh, wouldn’t I want to depreciate two roofs because that would offset the maximum amount of income. But I’m guessing that most times, uh, that would be, you know, using this example, uh, it might be more than your cashflow or your income in a given year. Yeah, but also to your point, depreciation is just a tax deferral. It is not an elimination of the tax. So you would have to recapture that at sale, and that would basically just mean that your tax burden upon sale would go up. Uh, if you don’t do this write off.

Brandon:
Correct. Correct. You, you still get the benefit via depreciation up until that point. But yeah, you would have to pay that benefit back via depreciation recapture. So that’s why it’s such a nice tool because you’re literally removing that asset from the books.

Dave:
Got it. Okay. That is super helpful.

Brandon:
Yeah. And this by the way, is like where, where that, that we were asking, earlier, you were asking earlier about when should somebody hire a CPA? Well, if you’re doing any sort of major rehab, and you gotta really, you gotta think about this, right? Because if I’ve got a hundred thousand property and I replaced one roof for seven k, I don’t think that’s worth like a strategic conversation with your CPA, but if I’m doing that 10 times a year or or to the scale of 10 x, then uh, then that becomes some real money that I’m potentially leaving on the table, right? So you gotta have, you have to judge it. But, but these are the little nuances that a strategic tax, uh, strategist or just any, any sort of tax planner, CPA EA or regular tax pro will be able to help you navigate. So the, these are, these rules are all in the 2013 tangible property regulations. That’s also where you get that $2,500 di minimus safe harbor, the betterment adaptation restoration test, which are another beautiful thing to explore. Um, so you’re

Dave:
Just saying things, I I don’t even know if these are real words that you’re

Brandon:
Saying, <laugh>. I I’m actually just making it all up and hoping nobody fact check. I’m just kidding. <laugh>. Yeah, but no, it’s, it’s, these are all the things that like we know as tax bros and, and we don’t expect clients to know. Um, but if you’re, if you’re DIYing it, you’re probably gonna miss these things. If you’re using, uh, inexpensive tax preparers, you’re probably gonna miss these things. ’cause again, it’s a volume shop. They have, they have less time to spend optimizing.

Dave:
Okay, we have to take one more short break, but we’ve got Brandon’s tips you can use as an investor today right after this. Welcome back investors. Let’s jump back in. All right, while we’re on the topic of depreciation, I wanna talk a little bit about bonus depreciation. And we actually had you on a episode recently where we talked all about this fascinating conversation. And to everyone listening, yes, tax conversations can be fascinating. I challenge you to go listen to this episode. We will put a link to it in the show notes. I don’t know the number off the top of my head, but we’ll put a link in the show notes to go listen to it. But can you just give us a real brief, you know, rundown of what bonus depreciation is and why it’s been in the news the last couple months?

Brandon:
Sure. So let’s go back to that a hundred k example. So I buy a property for a hundred k, let’s say land is worth the $10,000. So the improvements are worth $90,000. Now, we just kind of talked about how depreciation’s calculated $90,000 divided by 27 and a half years gives me my annual expense that I get the claim. That’s called straight line depreciation. But there’s a concept called bonus depreciation. And bonus depreciation allows you to expense to a much higher degree any component with a useful life of less than 20 years. So if I, if, if I buy a property and I have, and I do a cost segregation study, uh, a cost segregation study is the practice of saying, Hey, you got 90 k of building of improvements. But the reality is that, that your building is made up of a lot of components, right?

Brandon:
It’s not just structure. There’s windows, there’s carpeting, there’s appliances, there’s fixtures, there’s all these things that go into the building. So cost segregation study is the practice of identifying all of those components and assigning value to them. After a cost segregation study, you will have components with a useful life of five years, seven years, 15 years, and also that building whatever’s left in that bucket of 27 and a half years. So bonus appreciation enables you to expense everything identified in a cost study that’s five, seven, and 15 year property. And you know, on single family homes that could be 15% of the purchase price, multifamily homes like 25, 30% of the purchase price. So the point is, is that you can allocate a lot of, of value to bonus eligible property. So prior to 2023, bonus depreciation is a hundred percent meaning that if I bought a $1 million multifamily home, I could probably via a cost segregation study, allocate 250 to 300 k of value to components with 5, 7 15 year lives.

Brandon:
And then I could immediately expense that 250 to, to 300 k. So the first year that I buy this multifamily property, I’m getting a 250 to $300,000 tax deduction. Um, and that’s, that’s amazing, right? Starting in 2023, it’s 80%, 20, 24, 60%, 20, 25, uh, 40%, and then it just keeps going down 20% until it phases out to zero. The reason that it’s all been in the news recently is there’s a bill going through Congress. It has passed the house, it’s currently stuck in the Senate still. We were hoping that we would have a yes or a no by this point because we’re sitting on a ton of tax returns. <laugh>, we, I would recommend not filing your return until we get some sort of clarity on this, especially if you’ve bought property and you’ve placed it into service and you’re going to use bonus depreciation because this bill will make the 80% in 2023, it’ll, it’ll make it a hundred percent.

Brandon:
So it’s retroactive to 2023, bumps it from 80 to a hundred percent, it’s a hundred percent 20, 24. And then I believe it’s also a hundred percent in 2025. And the phase out starts in 2026. So 2026 would be 80%, 27 would be 60%, and so on and so forth until it phases down to zero. That’s currently sitting in the Senate. Uh, and it’s stuck in con or the senate’s been on recess a couple times and they keep saying they’re gonna look at it and then not look at it. And there’s some infighting. It’s a very popular bill though. So there’s, there’s pressure to, uh, to get something done, but at this point we have no idea when it’s gonna get done. And that leaves all these tax returns in limbo because, you know, if you file your return with 80% and then they pass this and make it a hundred percent bonus appreciation, retroactively, you’ve just lost out on some value. So whatcha gonna do, you’re gonna go to amend your tax return. It’s extra compliance costs, extra hassle. Uh, so it’s just kind of a nightmare

Dave:
<laugh>. So it sounds like you’re recommending to your clients to file for an extension.

Brandon:
Yeah. Yeah. All of our partnership clients that, that are like syndicating deals or running funds, it’s extending everything. Uh, all of our individual clients and business clients that have bought property in 2023 and placed it into service, uh, we’re recommending that they extend as well until we get clarity on is 2023 gonna be 80% bonus depreciation or a hundred percent bonus depreciation? ’cause it makes, makes a huge difference.

Dave:
Well, that’s some great tactical advice here. For anyone who’s listening, haven’t, hasn’t yet filed their returns and plans to use some sort of bonus depreciation, you may wanna file an extension and wait and see what happens with this bill. Brandon, do you have any other last thoughts on tactics that people can use here for their 2023 returns?

Brandon:
Um, my last thought is there are typically two areas where taxpayers, landlords, real estate investors, uh, take on risks that I don’t think they’re fully aware of. Um, and I just wanna make everybody aware of these risks. So if you are, if you’ve heard of qualifying as a real estate professional or if you’ve heard of the short-term rental loophole, um, what happens with these two, these two strategies, these two are, these two strategies are amazing strategies, okay? They’re totally legit, uh, and they can save you a ton of money in taxes. But the problem is when we get into like group groups of, of other real estate investors, we tend to get group think, we tend to get some fomo. We hear one person’s do Bob’s doing it, so I want to do it too <laugh>, you know, and, and, but your situation might not, might not actually be able to support whatever Bob’s doing.

Brandon:
Um, we see a lot of, of people claiming real estate professional status when they cannot possibly qualify. Uh, we also see people claiming the short-term rental loophole when they haven’t rented their short-term rentals out at all. So there’s no way to even prove that it’s a short-term rental because it hasn’t been rented. Um, the people doing those two things are taking on a substantial amount of risk. Uh, if you qualify as real estate professional or if you, if you can, uh, do the short-term rental loophole, then you can use large tax losses to offset your regular income. That’s why it’s attractive, right? I could go buy a million dollar property, do the cost segregation study, get the bonus depreciation, and that million dollar property in the year of acquisition could very easily give me a $250,000 tax loss that I could use to offset my CPA firm income.

Brandon:
But I have to make sure that I really understand the passive activity loss rules, and I have to make sure that I un that I’m working with a pro A CPA EA Tax Pro that isn’t going to, uh, just tell me what I want to hear. And that’s the biggest risk is that I’ll go to my CPA and say, well, I want to be a real estate professional, and if you can’t do that, I don’t wanna work with you. And man, that is the wrong approach with this type of stuff. You, you have to, you have to lean on their professional guidance. Um, I mean, they need to know what they’re talking about too, but you, you really need to lean on the professional guidance there because we’ve seen a lot of situations where, uh, you know, people claim real estate professional status and they’re working full-time jobs.

Brandon:
There’s no way you can substantiate that. Uh, they’re claiming short-term rental loophole, and they, they haven’t materially participated, they haven’t rented the property out. You get audited for this stuff, and these audits happen a lot. We get called in on these audits, uh, relatively frequently at this point. Uh, it’s a losing battle. Um, you’re, you’re immediately kind of going to the table and figuring out how can you settle with the IRS rather than be able to substantiate your position. So just be careful. Just be careful. It’s very tempting, especially when you’re, if you’re using tax software, you know, it’s just, it’s checking a box in a lot of cases, and then your refund goes from, you know, owing 5K to $40,000. And that’s a, uh, that’s a very tempting thing to just say, yeah, yeah, this sounds right, but you gotta understand the rules and you gotta understand, understand the risks.

Dave:
That’s, that’s super helpful. And I do think that, uh, it’s important to call out some of the risks of being aggressive with some of these strategies if you’re not familiar with, uh, real estate professional status and the loophole. Let me just try and summarize here, Brandon, correct me if I’m wrong, but basically all the stuff we’ve been talking about here with depreciation, what you can use that to right off your income from passive investments like your rental property. So you have a passive loss for your passive income, yes. But for ordinary people, you cannot take the losses from your rental property and apply it to your ordinary income. So we can use me as an example, because I still work full time. I am not a real estate professional, even though I work in tangentially in the real estate industry because I don’t meet this very specific qualifications that the IRS has outlined.

Dave:
What a quote unquote real estate professional is. I cannot take the depreciation from my rental properties and apply them to my salary here at BiggerPockets. I wish I could, but I can’t. That is just not possible. The short term rental quote unquote loophole is a loophole because it is one way that you can apply some passive losses for short-term rentals that are operated in a very specific way, as Brandon said, that you can take, that you can apply some passive losses to active income, but again, it’s gotta be super specific. So Brandon, how’d I do there?

Brandon:
You did, you did a phenomenal job. Yeah, <laugh>.

Dave:
Okay. Thank you. Yeah,

Brandon:
That was great. That was great. And, and just to put some numbers to it, again, like, like let’s say that I buy a million dollar beach home and, and the rents are, uh, 180 K, the operating expenses are a hundred K, my net operating income is $80,000. Then I do a cost segregation study and bonus depreciation gives me depreciation expense of, uh, $280,000. My net loss, my tax loss, even though I made 80 k, my tax loss that I get to report is $200,000. And so that’s a negative 200 K that I get to claim hopefully against my regular income if I’m materially participating in that short-term rental. Um, or if I’m a real estate professional and, and I’m buying like multifamily property or something like that. So it’s, it’s very, it’s very attractive and it’s very appealing. Um, but there are very specific quantitative and qualitative tests that you have to adhere to.

Brandon:
And the, that’s where the whole, is it worth the hassle thing comes in and, and do you understand the risks that you’re taking on this stuff is heavily litigated. Um, so it’s not, it’s not something that I would ever, uh, just kind of do haphazardly. Uh, but yeah, it, it’s, it’s, it’s important to get it right, but if you can get it right, man, you, you can, you can save a lot of money in taxes. You can be fully optimized. Or what some of our, our clients do is they’re just like, Hey, I, I wanna be in this game for 15 years. Can you help me reduce my effective tax rate by five points over 10 to 15 years? It’s like, yeah, yeah, we could definitely do that. And then it’s just strategically how do you add passive income and utilize your passive losses created from these rental properties?

Dave:
Got it. Well, that’s phenomenal advice, Brandon. I think that you’ve got the right idea there. Just thinking long term, not trying to do anything that is not legal or unethical or anything like that, but there are perfectly legal great ways to reduce your tax liabilities by working with a tax professional. Well, Brandon, thank you so much for joining us. As always, you somehow make taxes very interesting and helpful. And as a real estate investor, I really appreciate it because there is so much to learn and it is such an enormous benefit to your portfolio to do it

Brandon:
Right. Thanks, Dave. I appreciate you having me on. If I keep coming back one day, you’re gonna be teaching me, that was a really good <laugh>, really good real estate professional status, short term rental explanation that you

Dave:
Have. Thank you. I always just, uh, say that taxes is the weakest part of my real estate game, but I’ve, I think I’ve interviewed you like three or four times now, so slowly I’m learning <laugh>.

Brandon:
Yeah, you’re doing a great job, and I appreciate you having

Dave:
Me on. Thanks, Brandon. Thanks again to Brandon for joining us and sharing all of his extensive knowledge about taxes and real estate with us. If you are looking for a tax professional to help you with your portfolio, don’t forget to go to biggerpockets.com/taxpro. It’s a completely free tool to match you with tax pros who understand real estate, who understand real estate investing, and could help you set the long term strategy that Brandon was talking about. Thank you all so much for listening. I’m Dave Meyer and I’ll see you all again soon.

 

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