How To Avoid Taxes (Legally) as a Real Estate Investor

this is the biggerpockets podcast show 569. so they're saying look if you invest in real estate we'll give you a better deal than if you invest in the stock market literally that is built into the law and so you know that just once we understand that now we have a choice and the goal here is the more education we have and this is why i love bigger pockets the more education we have the better our choices what's going on everyone it's david green your host of the bigger pockets podcast where we arm you with the information that you need to start building long-term wealth through real estate today if you're new here and you like today's show check out biggerpockets.com it's the website that hosts the podcast it's a free one-stop shop for all things real estate investing it'll help you save time and money avoid mistakes and tap into the wisdom of two million fellow members now on today's show we are joined by an awesome guest you are going to love this show if you've ever wondered how do the wealthy not pay taxes today we have tom will right now on episode 500 brandon turner and i interviewed robert kiyosaki the author of rich dad poor dad and tom is robert cpa and owns a cpa firm he's also a speaker and investor himself an author of several books one of them tax free wealth is sold very very well and is very well respected within the real estate investing community and tom comes on to tackle the question of how do people particularly wealthy people avoid paying taxes how can real estate help you the listener to do the same thing and what is actually happening behind the scenes that make this possible now i remember at one point when i heard people talk about elon musk doesn't pay taxes donald trump doesn't pay taxes i assumed it must be such a complicated concept that you need lawyers that graduated from harvard working on it that's not the case at all it's actually a handful of things that we talk about that will work for most people in most situations that will save you massive massive amounts of taxes and allow you to reinvest that capital into more real estate even more important it sort of forces you to develop healthy habits when it comes to managing your money so that you can take advantage of this that's personally why i love it because no one likes paying taxes but you can't just avoid paying them you have to actually do something different to do that and the steps you have to take to avoid paying taxes will make you a better investor a more disciplined person and an overall more prudent and safe investor and steward of your money now tom's awesome and i'd like to make sure that you listen all the way to the end of the show we went a little bit longer than we normally do specific because he was just dropping fire and i thought hey if this takes two listens to get through that's better than not getting information from tom will right that can save everybody a lot of money even if it's something that isn't going to save you money today as you grow in your investing journey this stuff will become very important if you can make it to the end tom actually breaks apart my businesses my tax situation how i'm structured it gives me some advice on how i could be doing things better safer and more prudently i'd love for you to be able to hear that i also want to make sure you guys learn the concepts we talk about today because they are not nearly as complicated as i originally thought probably not as scary as you there's a really good section where we talk about should i do an llc should i invest in my own name and what is the difference does an llc even help me and if so how and then tom shares some of his five steps for how you can get started also at the end so i love today's show i really think you're going to also please consider sharing this with anyone you know who's interested in saving in taxes make sure you follow us on biggerpockets youtube page so you can watch the interaction between us and then comment like and share with anyone that you care about alright today's quick tip is our podcast has a new landing page it's biggerpockets.com podcast this is where you can see all the shows that we're putting out across the entire bigger pockets network so make sure that you save that one in your browser or you save it in your phone so whenever you want a podcast to listen to or you feel like you want to be able to make some money and build some wealth you know exactly where to go all right thanks to our sponsors as always after you listen to this one if you're curious for a little more background on this topic please check out episode 500 of the bigger pockets real estate podcast where brandon and i interview robert kiyosaki which is how we ended up getting here with tom himself hope you enjoy it mr tom wheelwright welcome to the biggerpockets podcast it's great to have you it's great to be here thanks for having me now tom you've written a very impressive book that many real estate investors have read and loved and that was tax free wealth which is just a great name for a book who doesn't want tax free wealth and my understanding is you have another book coming out can you tell me a little bit about this up-and-coming book i do very excited it's called incentives seven investments the government will pay you to make so i'm very excited about talking about the role of taxes and getting done what the government wants done so much of life is perspective that we take and looking at it like you did these are things the government will pay you to do to grow your wealth is a great way of looking at especially because so many other people benefit if you do it as opposed to looking at it as a way that greedy shady people can hide from their responsibility to pay their own fair share now uh we recently interviewed one of your partners robert kiyosaki and he mentioned you on the show we're going to talk about that in a minute but before we get into that i want to play a clip from my interview with robert and then we're going to get your feedback on that so let's go ahead and start with that ray kroc founder of mcdonald's and my my friend who was at the european university of texas he was talking to ray kroc and he said something about you know ray what business are you in i mean ray says what business is written mcdonald's in and everybody says hamburgers and ray said no mcdonald's is a real estate company and today i think they own more real estate than the catholic church and so back in the 70s when i was trying to figure my life out my rich dad said the same thing it says the purpose of a business is to buy real estate now if you understand that your brain will shift but it's not about starting a business to make money the purpose of a business is to acquire real estate so you can use massive amounts of debt and pay no taxes i mean that's why i do it all right so as you saw robert talked about that the purpose of a business is to buy real estate and you can use massive amounts of debt and not pay taxes and that's why he actually does it this is obviously a hot button topic because the minute that some multi-millionaire says i don't pay taxes it upsets people i'd love it if you could give your perspective on what that actually means and how it plays out in real life so let's do this uh let me share my screen here and you can let's actually look at robert's cash flow quadrant here and if you look at this cash flow quadrant you see well really there's four ways that people make money they make it as an employee we've all been employees at some point self-employed as a big business or as a professional investor what's interesting is that how much tax you pay depends largely on how you make your money so if you make your money as an employee you're typically going to pay a tax at around 40 if you make a good income you get more um education you become a doctor lawyer etc now you get to pay 60 if you're a big business owner you tend to pay around 20 which is by the way why warren buffett said that he pays less tax than a secretary because he's paying a 20 rate she's paying at a 40 rate and if you're a professional investor you can pay zero so what robert does is and this is what everybody who knows how the tax law works does is he takes his money let's say goes out and speaks and makes money speaking he puts it into investing he combines it with debt buys an investment or if he makes money as business he puts it combines it with debt and puts it in to an investment and the investment he likes is real estate now it doesn't have to be real estate could be agriculture could be energy could be a business but this is what this is how the tax law by the way in every country it's not just the u.s every country works this way okay and the reason is because look what does the government want they want tax dollars but they also want certain things to happen they want energy they want housing and up here they want jobs and then they want food okay so they are saying look if you do if you take the risk you're the entrepreneur and you put your money where we want it we'll encourage you to do that by giving you tax incentives now that's it's really that simple i want to jump in briefly to highlight what you said because that's the part that doesn't come up when we talk about i pay no taxes when we look at this quadrant that you've drawn out for us and we're in the e area the employee their taxes are high but their risk is low employees don't contribute capital to their own company when you become self-employed your taxes are high but your risk is lower there is absolutely a relationship between the risk you take and the tax benefits that you get it isn't free that's true and that's what i wanted to highlight is the government is incentivizing you to do this because no one likes risk risk is inherently expensive you have to put that on a sheet somewhere to uh to account for the risk you're taking and how you could lose something and what we're actually talking about is investing is a way of sort of like writing this wave of risk and reward and there's some skill that every like just every surfer needs to understand is that similar to how you see it or do you think that there's a more nuanced perspective yeah no no for sure and it's it's actually even simpler than that the government actually makes money on it it's it's not just that the government wants housing and they want energy and they want food and they want jobs obviously but the government actually makes more money when you have entrepreneurs for example let's take an entrepreneur who starts a business well literally you can start a business and the government will pay you for all of the costs of starting that business and i actually show you that in my new book and okay well what does the government get out of it well they get a share of the income for the rest of your life and you can never get out of that partnership so the reality is we're all partners with the government the question is are we active partners are we silent partners and employees are silent partners right most small business owners are silent partners but the big business owners the professional investors are active partners we're actively saying look we'll do what you want done and we'll and you'll share basically in the capital it takes to start it and then we'll share in the profits once we get them it works and frankly they make so much money and i i show this in my new book but they make so much money in this that you go why would they not do this it's kind of like take amazon when amazon was going to set up shop in new york and politicians said we don't want you because we don't want to give you the tax benefits i'm going but they weren't giving tax benefits they weren't giving the amazon money they were just saying amazon you won't have to pay as much taxes you would otherwise have to pay so the government still would have gotten money from that you know when amazon moved and choose chose another location that other location said we'll take it because we'd rather have half the money we were going to get than have none of the money we were going to get and and that's essentially what they're saying we'd rather have we we'd rather make an investment the government is saying this we would rather make an investment and then and we'll take the risk you may not make a profit and then we'll see nothing but we'll take that risk because we know that we'll actually make more money if you're successful and if we can contribute to that success great i think part of the problem is when we focus on amazon as a corporation and we say well they're getting tax benefits why are they getting all these these loopholes so they don't have to pay and we don't think about all the employees that amazon is bringing along that are paying taxes we don't think about all the houses are going to have to be built for all these people to live in where property taxes we don't think about all the times they're going to go eat at restaurants or buy things and all of the sales taxes i mean there's more than just income tax that should be accounted for right well and actually when you look at it the the incentives amazon was going to get there in new york for example it's not income tax incentives these are property tax and lower property taxes than they would otherwise pay these are sales taxes that they would uh that without amazon there they're not going to pay but with amazon there they'll pay they just pay less or they defer the taxes so this is not a it's it's not like we're taking money that we already have it's not not new york saying we're gonna take money we already have and give it to amazon no no this is we're gonna share in the profits down the road so if amazon would normally pay a billion dollars in taxes down the road we're going to split that we say amazon you pay 600 million dollars in taxes and we won't collect the other 400 million because 600 million is better than zero which is not uncommon for everyone else in life to do the same thing if someone comes to me and says david i want you to sell my house and i say okay here's our commission you say great what if you're bringing me 10 houses every single month wouldn't you expect to have some form of discount on that commission and it would be sort of misleading for me to say tom is trying to steal money from me because he doesn't want to pay the commission i pay right like you're actually giving me quite a bit of money well or or better yet david let's say that we go into um a business still together we're going to go develop real estate i say david so i'm only going to do this if you'll do it for free i want all the i want all the profits you're going why would i do that you know where you say well look what are we always doing we're competing with other partners and saying we'll give we'll give you a better deal and that's all the states are doing the states are just saying we'll give you a better deal well the federal government is already built into the law yes so they're saying look if you invest in real estate we'll give you a better deal than if you've invested in the stock market literally that is built into the law and so you know that just once we understand that now we have a choice and the goal here is the more education we have and this is why i love bigger pockets the more education we have the better our choices you know this will be a bit of a caveat i won't go too far down that road but i see sort of this happening in the opposite sense what you're talking about are incentives to bring business to an area so we see that happening in states like florida where or texas where they're saying bring your business here we'll give you a reduction because we want all the revenue that's going to have well the state i live in california is constantly talking about raising in state income tax like they're now trying to push it upwards of 18 percent right that's called a disincentive there you go and here is what i just want to highlight for the people who hear that think well what's wrong with that we're going to get more revenue we need it it would be another five or six percent you're not getting an extra five or six percent by raising taxes if people leave you are actually losing the 13 that you were getting and it goes somewhere else and so there is a point of diminishing returns where if you ask for too much from a business owner or a resident and they leave you hurt yourself you end up getting nothing yeah to that point actually um you know i've been in this business for a very long time and uh 40 percent tax rate is the magic number um when you get over 40 federal tax rate it starts being a disincentive that's why 40 is that magic number and it's that magic number in most countries that's wonderful i love that you know that that's why i'm so glad that you're here right now so when we interviewed robert at around 16 minutes he actually gave you a shout out he referred to your book tax free wealth and he basically explained that taxes are incentives from the government to do what the government wants done not loopholes would you mind sharing your perspective on how we should look at this and then maybe giving some examples of the most common uh incentives that people can take advantage of yeah sure let me give you a uh first of all definition of loophole loophole is an unintended consequence so uh for example last year there was a loophole in cryptocurrency that if you sold it a loss you can immediately buy the crypto back and you could recognize that loss that's a loophole they they actually closed that loophole um in the infrastructure bill okay so that would be a loophole an incentive is something they they've actually thought about going what do we want to have happen and let me give you a simple example that everybody will relate to your home mortgage interest deduction okay now i will tell you that not all countries give a deduction for home mortgage interest um they do for rental properties but not for your personal residence well what's the policy there the policy is simply well we we think we have a more stable population if we incentivize home ownership and so there's incentives for home ownership and because if you if you pay rent you don't get a deduction for rent but if you pay on a mortgage again go to your risk standpoint right no risk with rent there's risk with a mortgage because now you own the asset all right if i take that risk and i do and and i i'm going to get a deduction for that interest and that's uh that's the most common sense nobody would turn that down nobody would call that a loophole well you're also incentivizing people to save money to invest that money smarter to buy real estate so that more home builders build more homes it's to me it sounds exactly like what the parent would do where they say if you get all a's or if you get a grade point average i will give you a raise in your allowance it's that is a natural way that human beings understand things yeah it's interesting this actually uh really got going under president kennedy right a democrat and uh he he very much uh looked at tax incentives and that's where we got the investment tax credit was under uh john f kennedy so this is this is something that all countries do um in in my new book we actually look at 15 different countries and um you know you you look at that and you go wow this can't be a loophole in every single country right i mean we we didn't get the same lobbying from the same people in every single country what we got instead was what does the government want done let's incentivize it let's take some of the risk off and then we'll take some of the rewards this is what's so important about education because if most people will do what they watch everyone around them doing so if you just see people working 40 hour a week w-2 jobs and you are accustomed to zero risk being normal then any risk seems risky i mean i'm probably not articulating that well but it feels wrong like why would i want to take risk if normal is to have none but if you grew up in the world 400 years ago or so where you didn't have all these labor laws and you didn't have a guaranteed job that you could just fall into something like what we have right now you didn't have an education was provided for you subsidized by the government risk was a normal part of life all the time and so um you didn't need to be educated on your options it was sort of right there in front of you well in today's episode i'm so excited that people are going to have a pack painted for them that when you hear us say you cannot pay taxes as a real estate investor or a investor of any type this is exactly what you're doing in order to make that happen it will sort of come alive as if you were living 400 years ago and you were looking at it everywhere that you turned yeah i think it's also interesting as you get more education you understand what is risk you kind of change your mind on what's risking what isn't for example i i i went years ago i went to work as the in-house tax advisor for a fortune 1000 company and my very first task was to lay off half of my department we're doing a company wide layout and i'm going so let me get this straight if you're an employee you have one customer and you're at risk even if you do a good job you know and then i look at what if i start my own firm okay let's say i have 200 clients well if one client fires me so okay but i still have 199 clients and i just go get another client but if if i only had one client think about this if you went to a bank you're a business owner you went to a bank and you had a single client would they lend to you probably not probably not they'll lend to if you're an employee but not if you have a single customer as a business owner which is really interesting it's just a different assessment of risk yeah that's a very good point i also think about if you really wanted to decrease your risk in the world in general you would build as many skills as you could right like we don't you don't know what's going to happen what if our power grid goes out that's when you're going to find out who has survival skills and who doesn't and the same happens in sort of the workforce in a capitalistic country the more skills you have the less you worry about losing that job and part of the in my mind the risk i see in the person who just shows up and does the same thing every single freaking day for 30 years is they stop building new skills and they're very they become dependent on that employer and maybe even that specific company not just that industry that they work in versus someone like you that has several different businesses that is an investor and a business owner you are forced to build skills all the time and so you don't live in fear of change you're not worried about if the tax code changes or the economy changes we frequently say here if we have a recession that's horrible for the most of the country but we're going to be good we will know how to adapt and take advantage and so another reason i just want to encourage everybody to really listen intently to this show is to understand this will help you build skills which will ultimately reduce your your exposure to risk in life right on top of that right the more education you have the less risk you have yes right by definition and that's true in the tax world too uh the better you understand the tax law people people ask me are you aggressive or conservative and say well let's define that okay i think aggressive is somebody who does something that's outside their education level that's aggressive but if i do something within my education level and i just have a lot more education i'm conservative so i like to think that i'm the most conservative accountant in the world or i would like to be because i just want to understand the tax law so well that there's nothing i'm going to do that i'm going to feel is outside my comfort zone yeah that's the secret to being good at something in life isn't it is you get so good at doing it that you can be aggressive in that area and you're not actually increasing your risk right okay so let's talk about sort of what you think are some of the biggest areas where somebody can decrease their taxes the first one to me um i'll and i'll defer to your expertise here but it's probably like where you get the most bang for your bucket possible it's the full-time real estate professional status if you want to jump off there and then walk us through your list that'd be great yeah so so first of all so i i would get even one step backwards and robert talks about this all the time it's debt right so if if i invest in real estate but i put all my own money into it then my deduction ratio is one to one but if the bank puts in four dollars and i put in one dollar my deduction ratio is five to one so i'm literally in all of the banks money i get tax benefits for all of the bank's money on in addition to my money and that's why debt and taxes go together and robert's always saying debt and taxes will make you rich that's it is that combination i know robert talked about that in his interview it is that combination of debt and taxes um because by itself um frankly uh you don't you're not you're not going to need to be a real estate professional if you're using your own equity for all your real estate because you're never going to have a loss from your real estate unless it's an economic loss you're never going to have a tax loss that is what we call a phantom loss um so that's that's the first thing i would say uh david is is that that debt piece is actually a pretty important piece um but then the the big issue is uh back in 1986 uh when i was in washington dc actually uh with the national tax office of ernst young uh we had this big reagan tax bill and part of that tax bill were these passive loss rules and basically all the passive loss rule said was prior to 1986 if you were a doctor you were in the er s you could invest in any kind of investment and if it created losses you'd get those losses whether you didn't have any active participation in that business or that investment or that real estate whatever that's what changed in 1986 is all of a sudden it became okay if you're a passive investor you can only offset passive law losses passive losses can only offset passive income can you give us a brief example of what passive losses or passive income would be in practice i mean it's actually pretty well defined um what the the term that the internal revenue service uses is material participation so the general rule is that if you spend more than 500 hours in a business activity you're active if you spend less than 500 you're not active now there's six other rules that we won't get into but that's the primary rule there's there are two exceptions to that the first exception is a negative exception and that's real estate rental and real estate rental is as a general rule always passive real estate rental is always past it doesn't matter if you work 500 hours it's always passive oil and gas investment is always active whether you work in it or not okay as long as you structure it right it's always active so those are the two primary exceptions well real estate active real estate professionals didn't like this idea so they started lobbying and in 1993 the lobbyists which included a fellow by the name of donald trump by the way just a little tax history there were able to change the law and said well look if if you're really a real estate professional you shouldn't be subject to these passive loss limitations even on rental property and so they made up these rules and the rules are really simple so to be a real estate professional you have to spend more than 750 150 hours in real estate and it's defined what real estate is there's seven categories and you have to spend more time in real estate than all your other business activities combined including your your day job okay so for example there was uh an example where a nurse who was a full-time nurse was actually able to prove that she worked more time in real estate than she did she actually worked 2 300 hours in real estate and 2 200 hours as a nurse and i'm going oh my heavens what a i sounds terrible to me but what's now what's interesting is she lost the case and the reason is is because you really have two rules the first rule is remember real estate rental is by definition passive unless you're real estate professional but once you meet that rule you still have to meet the material participation rule so and that is a by per activity so she had like she had like 25 different properties well she couldn't meet 500 hours for each property so she she didn't qualify to be non-passive in that real estate even though she was a real estate professional gotcha so real estate expression's just first test so what you have to do is there's actually an election you make that you combine all of your real estate activities into a single activity and it's literally it's a section 469 c7 election you probably want to write that down section 469 c7 and you elect to combine all your rental real estate into a single activity and then if all your work is on the rental real estate you're going to meet more of that 500 hours because by definition if you hit 750 hours you hit 500 hours so you do have to meet both tests and that's actually a that's a pretty big distinction that people forget that if you don't make that election or let's say for example you you're a full-time real estate agent well that's a real estate professional does that mean you worked 500 hours in your rental properties nope you still have to work 500 hours in your rental properties so you still have to meet the general rule even though you met the specific role for real estate professional now i want to make sure i understand this concept so i'm going to give you an example in layman's terms and you can correct me if i have it wrong when we talk about passive losses what that basically means is i imagine a rental property like its own standalone business and you can take losses like depreciation and other losses against the income that that one business makes meaning the rent that that property generates but if you have more depreciation than you can actually use it doesn't help you now when you're talking about being a full-time real estate professional the the lobbying that was done by donald trump and others said hey if you're taking a loss in this area you should be able to count it against income that you made in another area because it's more or less all real estate do i have the do i have that right yeah that that's the general rule so um and just a couple of fine points on this first of all you don't lose the loss just because you're passive doesn't mean you lose the loss you can use only use the loss against real against passive income which means you can use it next year the year after it carries forward forever okay and then once you sell the property it frees up and you get to use it all so it's a temporary it's just a deferral of the loss basically it's just postponing the law so that's the first thing to remember um you're not losing you're not losing the deduction you're just getting it later in time what we want to do of course though everybody's in real estate knows that it's all about having capital and employing that capital so the less tax we pay the more capital we have and more capital we can deploy and the more debt we can get and it's it's a it's a wonderful vicious cycle because we actually buy more real estate we pay less tax we pay more real estate we pay less tax and literally you can actually triple your benefit in a single year just because you know you're going to take all that tax money redeploy it so you just have more money and you have more access to debt now i want to slow you down for one second have you unpacked something because the minute that you say taking on more debt means you have less risk that the dave ramsey folks bells are exploding in their head whistles are going off sirens are alarming and they're like heretic okay can you take a minute to explain how debt is actually reducing your own risk yeah let me kind of walk you through so i love walking through financial statements if you've read rich dad poor dad robert's book you know the whole book is full of financial statements it's really a book on on accounting and if you look at you have income expense assets and liabilities so the first question is what's the purpose of each of these so if you have income what's the purpose of the income well the person the income is to create cash flow right so if you have somebody owe you money that doesn't do you any good until they pay you so purpose of income is to create cash flow what's the purpose of an expense well the purpose of an expense is actually to increase your income if you're in a business and you're spending money and it's not creating income you should stop spending the money it's that simple right right an asset what's the purpose of an asset to two purposes one is it's either to create income or reduce an expense that's what an asset does what's the purpose of a liability the purpose of liabilities to buy an asset so here's what i would say to everyone who has that when it comes to debt if you're afraid of debt it's not really the debt that you're afraid of it's the asset if you're if you're if you're secure and the asset is going to produce income why wouldn't you want to take on the debt it's really a function of the asset not the debt when we're afraid of debt what we're actually afraid of is the asset not covering the debt service that's correct we're afraid that the asset won't actually produce the income we think it's going to produce i would go a step further why are you willing to risk your money and not the bank's money so that was a point you made when you said the bank's putting in four dollars you're putting in one versus if you put in all five of your own money that's a 80 reduction of your own risk because you're not putting your capital into this investment you're putting money in from somebody else right now obviously if you're if it's a recourse liability so you're on the hook for it you're going okay well eventually i'm going to be on the hook for that but here's the reality you know what do you cover your capital first you cover the debt first you cover your debt first so as long as your rent can cover your debt yeah you're not making the income on your capital but you're still covering you know the debt payments you're covering the debt service but it really is a function of do you trust the asset and that's why education like bigger pockets is so important because the more education we get the more comfortable we get with the asset and the more comfortable we are with the asset then we can leverage that asset and we can actually go after the bank money banks money and not just risk ours and that's why we say that not all debt is good debt or bad debt like when we talk about good debt what we're generally referring to is buying something an asset with that money that will produce income to pay back your debt service and hopefully some extra and hopefully will appreciate bad debt is using that money to buy something that will not pay you back that's the motorcycle the rv the home that doesn't generate income the timeshare whatever it is that you're spending that money on that doesn't it's not an asset in the sense that it's not actually creating income it is an asset on a balance sheet as in it has value and it can be sold but according to robert's definition of like what's an asset is it something that pays you to own it is that accurate no absolutely and so if you want more assets the easiest way to do that is to borrow but you only want to do that if the asset actually does put money in your pocket there we go and that's why people that are becoming financially educated listening to something like this shouldn't be afraid of the word debt people who are not who are just out there like ah let me just buy something and see what happens those are the ones that need to be listening to dave ramsey very very seriously and not taking on some of that okay so what about the seven day rule okay so let's talk about this real so real estate professional remember it applies to real estate rental we only care about it when it comes to real estate rental if you are rent if you have a property that rents for seven days or less it's not under the tax law definition it's not a rental it's a business so you don't have the re you don't have the real estate rental issue you don't have to be a real estate professional now it's still real estate don't get me wrong and so you can become a real estate professional for purposes of your rental property with your short-term rentals but the short-term rental itself is not subject to the real estate rental rules because it's by definition not rental it's it's just it's just a business what that means is that now it's the 500-hour test it's not the summer 50 hour test and you're just looking at okay do i materially participate in my short-term rental or not well you have to do that in your long-term rental too now one thing we can't do you can't aggregate in other words you can't combine your short-term rentals with your long-term rentals because again short-term rentals are not rentals for tax purposes long-term rentals are so we can't combine unlike properties or unlike businesses so the the the great thing about short-term rentals and a lot of people do this and and they're they're total professionals at i've stayed in airbnbs i'm sure you have too and uh there's some great properties out there and they do a great service and guess what they just have to meet the regular rules they don't have to meet the real estate professional rules they still get depreciation but they don't have to worry about the passive loss rules as long as they're active in their business i'm curious i never asked this earlier what if you use a property manager to manage your rental does that actually hurt you from making that 500 hour rule sure absolutely um it will certainly reduce the number of hours you have so it's very important that if you're going to take the real estate professional um if you're if you're going to go that down that that route which is not the only route to using the losses right now but it is the easiest route then what you have to make sure of is that combined of all of your rental properties that you i mean you're going to have to work 500 hours realistically in in those properties that you have on a combined basis okay thank you let's talk about how we generate losses shall we in real estate um this is what i call in chapter seven of tax free wealth i call the magic of depreciation um the very first time um so i met robert back in 2001 and the first time he put me on stage i was at his one of his three day events and it was november of 2003 i remember very clearly we didn't know each other very well um we just kind of gotten to know each other a little bit and he pulled me up on stage i mean that is one brave guide guy um robert because he had no idea if i even knew how to speak english and he pulls me up on stage says so tell us about depreciation i said well it's magic he looks at me goes what i said well here's what it is you get a deduction for an asset that's going up in value you get a deduction for an asset that's going up in value where else do you get that you get a deduction for oil and gas it's the minute you drill it's going down in value because you're depleting that asset right you you get it you know you spend money on your business that that that expense is gone right now hopefully it's going to create income but that expense is gone so this is the one place real estate is really the one place where you get this deduction for an appreciating asset so it's it's pretty cool here's but here's what makes it even better so a lot of people have heard that we have what's called bonus depreciation bonus depreciation means that rather than taking it over the whole let's say useful life of the building we actually get to take it faster than that and you know certainly there are some things when we buy a property uh think about this when you buy a property typically you're buying four things you're buying the land you're buying the building you're buying the land improvements which includes um all of the you know the the sidewalks the driveway the the landscaping all that kind of stuff and you're buying the contents of the building like the window coverings and the floor coverings and all that kind of stuff cabinets etc okay so we all know that carpets wear out faster than buildings right landscaping actually wears out okay it wears out faster for some of us who are brown thumbs than others who are green thumbs but it wears out and so what we do is we we appreciate those at a faster rate so we're building for example a residential property we might depreciate the building over 27.5 years which is about three and a half percent a year um depreciating the carpet will probably depreciate at 20 percent a year yes except when it comes to bonus depreciation which we have this year and for the next couple of years in a decreasing amount the land improvements and the contents which typically amount to 20 to 30 percent of your purchase price if you do a cost segregation um those are deductible the year you buy the property and put it in the service so you might have say a million dollar building you buy a million dollar building and you might get a 200 300 000 deduction in year one on that million dollar building okay let's break this down to make sure that that i understand it i've always when you talk about depreciation as magic and real estate there's a few things i want to highlight for our listeners that are inexperienced with the tax code when you hear depreciation that does not mean the value of the asset going down it's not the opposite of appreciation which is what it sounds like it's an accounting term that is used to describe the fact that when you buy something an asset for your business it will fall apart over time so i've if you understand that owning real estate is owning a business you can compare it to a different business so let's say you have a company that a landscaping company that cuts grass where you're going to have to buy a truck to drive all your stuff around you need that as an expense to create income because like you said earlier tom that's the purpose of an expense that truck the minute you start using it depreciates in value it's it or maybe not in value but it falls apart the tires start to get worn out it needs to have the oil change the windshield wipers are going to go bad the the truck gets worn down and we all understand if you're in a restaurant you buy a dishwasher it's not going to last forever so they let you take off of your income this concept of depreciation to pay you back for the fact that when you buy these assets to run your business they fall apart now the reason it's magic in real estate is because even though the buildings are falling apart and the stuff inside them is falling apart the value of the thing is going up real estate goes up over time trucks typically don't i mean during the last couple years of supply chain issues we've seen that's a little different but in general nobody's paying more for a dishwasher that's 30 years old and they're going to pay for the one that that's right now this this accounting concept of depreciation is fair the business owner should be compensated for the fact that the things are buying or falling apart it just so happens to work in our favor in a massive way when you're buying real estate because the value of the asset is going up now ideally they would have let us just write off the full value of the property in year one so if you buy a four hundred thousand dollar house you're covered for four hundred thousand dollars of income but they realize yeah that's not really no one would ever pay a tax so instead like you mentioned they write it off over 27 and a half years for residential i believe it's 38 years for commercial property if i'm not mistaken and you get that three and a half percent every year so if you buy a property um you have a number in my like 400 000 house would probably get you around what like twelve thousand a year or something am i off there well so so so remember we also we're buying land okay land does not wear out even the irs knows that so uh you don't get a deduction for the land and land somewhere typically is going to be anywhere from 10 to 40 percent of the value so if you buy a 500 000 property for example you may have 400 000 that is not land so 100 000 land and then there's a good point so that that's what's depreciated over 27 and a half years and whatever that number is you can write off against the income that that actual property or business made fair correct okay and what you're explaining in this in this uh concept is that with certain things like carpet like plumbing the infrastructure of the home the cabinets they're not going to last for a full 27 and a half years so the tax code allows you to accelerate how quickly you take the depreciation on those specific assets right correct and and the normal rule is somewhere between five to seven years for those and about 15 years for the land improvements the true magic comes from the 2017 uh tax cuts and jobs act what we like to call the trump tax act where we now get those those two items land improvements and the contents we get to deduct a hundred percent the first year we don't have to wait five years seven years fifteen years uh to take the deduction we can take it all in the first year wonderful okay and then there's and that is typically done through cost segregation studies is that right right so that means you hire an engineer and an accountant they go out they actually do a a study on what are the different cost elements of the property and that does cost money so this isn't free right like i think i paid for two i mean you have to pay for the services yeah it was like six grand per property and then i had a big one that i did that one was much more expensive so it typically isn't something you want to do if it's a really small property it'll be a very small tax benefit so it it you know again what i would suggest always though david is to run the numbers so i've seen cost segregations for small properties be as little as thousand dollars and say fifteen thousand dollars and that's on it less than two hundred thousand dollar property so it also depends on what you're gonna do with the money so if you can deploy that tax savings you can use the tax savings so either real estate professional or you have other techniques like we use to use that that tax loss against other income and you can take that tax money you would have sent to the government and combine that with debt and buy more property that's the magic formula that's the magic okay what are some of the drawbacks of using accelerated depreciation so i hear a lot of people talk about drawbacks i don't think there are drawbacks okay okay um and here's why because people say well what about recapture well let's talk let's talk briefly about this concept of recapture which is a hugely misconstrued concept so basically what happens is that when you sell an asset like real estate that the amount of gain or loss that you recognize for tax purposes is the difference between your basis and your sales price well your basis is your original cost less depreciation so effectively when you sell it you're bringing that depreciation back into income okay now here's where the misconception happens people go well wait a minute if i got a 40 deduction today and three years from now i have to pick up 40 in income is it really worth the three years well for those of us who are having real estate investors yes okay but let's say you're not is it still worth it well here's why it is because you're gonna save money at that 40 percent but you're going to pay tax at the most to 25 so there's a differential we call that a conversion so we're actually converting ordinary income to capital gain income and so even though yes there is technically recapture really the highest it should be is 25 now um the the part that's the contents of the building if you sell within five years you're gonna have some actual forty percent recapture but we don't look at i mean you know i i don't look at three or three three-year deals right i'm typically looking at five years or more and so you know the question is am i going to a do i want do i need the capital can i deploy the capital and b if i can't deploy the capital immediately do i have a rate differential in that capital gain versus ordinary income now what about the fact that if you normally were going to get depreciation over 27 and a half years and you took a lot of it up front that would mean that the period of time you can take that depreciation is is shortened right could be shortened in one year and what that means is is that it creates a positive addiction so it means that we actually literally have to become addicted to buying more property and building more wealth so i i call it a positive addiction because i think an addiction of building more wealth is not such a bad idea that's a great point so that's what i wanted to highlight is because you're taking it in year one or maybe in the first couple years you have to buy more real estate in order to be able to offset the additional income which forces you to make prudent decisions to save your money to invest it in something to delay gratification not to say i just made a bunch of money i'm gonna go be frivolous and spend it everywhere if you wanna save in taxes you have to be disciplined and prudent and that's why i believe you're calling it a uh what was the word you used for it uh healthy and a positive addiction positive addiction right correct okay um i think i have another question i was asking you one of the main questions we get here on bigger pockets i know this is probably very similar to you with your cpa firm is should i start an llc to buy a property or should i buy it in my own name and it's very hard to get people to take any form of action until they get the answer can can we try to lay that to rest once and for all now what is the difference between owning an llc why would you want to do it and when would you not okay so first of all let me tell you what there's there's something that's not a difference and that is your tax treatment okay whether the property is an llc or whether it's in your own name you get the same tax treatment this is a big this is a big issue that i hear because i'll actually hear advisors say well you need to be in a corporation first of all please don't ever put rental real estate into a corporation that's a no-no okay every good real estate tax professional like myself knows that you don't do that okay there's a lot of bad things that can happen and nothing good happens so instead what we do is do we use an llc maybe um the reason for an llc is simply asset protection now here's the kind of what we might call the fallacy of the lc and that is that if you have an lc nobody's ever going to see you yeah that's not true right or if you have an llc they can never get your assets also not true here's the way i look at it david if you and i go out camping in the woods and uh we come across a mama bear and she's char starts chasing us do i need to outrun the bear or do i need to outrun you right right i need to outrun you and that's the idea of the llc the llc is you're going to outrun your neighbor who doesn't have an llc so is it better than not having lc absolutely do we always do it pretty much pretty much always do it there are some states where it's a little more challenging like tennessee but we we pretty much always want to have some kind of either an llc or a limited partnership that we use for our real estate because we do want to protect our assets and we want to make it more difficult like putting a lock on your door will it keep the thief out of your house no but will make it harder for them to get in might they go to the the the house next to you doesn't have the door locked yes and that's kind of the ideas we're we're just trying to reduce um the liability but the reality is is that let's say you buy the house and a month later you put it into an llc well what that means is that you have that risk for one month that's it after that you don't have the risk so my understanding of llcs was this idea and i think most people probably share it that it's a corporation that if you put something in there and you get sued and lose they can only take what is inside of that llc and they can't get after any of your personal assets and therefore an llc is way safer and the trade-off is the convenience it's kind of a pain to get financing can you clear up some of the fallacies behind the fact that they can't get into anything that's outside of the llc as well as what an llc even really is yeah first of all it's not a corporation it is a limited liability company and it's actually more like a limited partnership than it is like a corporation the only difference between really the only difference between an llc and a limited partnership is that you don't have to have a general partner it's really like a limited partnership where everybody's a limited partner right um and so that's really what it's like the the real key to the llc is that it's actually if they so it's not that they can't get the asset and they can always let's say you have a tenant that slips and falls are they gonna still be getting able to get the asset in there yes is it harder for them to get through that llc and get your personal assets yeah it is if you treat it right if you set it up right particularly if you have multiple owners it's going to be way more difficult to get to your personal assets but let me tell you the other thing i've i've got clients been through lawsuits i've been through lawsuits the attorneys are always going to sue you too so they're not just going to sue the llc they're going to see you too so can you will it help you no question i think llc's are extraordinarily valuable will it is it is it impenetrable no do you have to absolutely maintain every single detailed and and do it right all the time yes okay so the uh they're a bit of a trap sometimes because people think oh well if i have an llc i just have to have the llc and then i'm done no you have to maintain books and records you have to have annual meeting meeting minutes you have to file the tax return you have to do all those things so there are expenses to the llc and there are requirements of the llc and if you don't follow those the judge is just going to look at that and say well and so will the irs by the way they'll look at it and they'll say well you didn't respect the form of the llc so i'm not going to you know i want to get your perspective on this thought that i've often had from a practical standpoint it seems like if you had six paid off properties in an llc and they were worth two million dollars that would be way riskier from the perspective of being sued than if you had six properties in there and you had leverage on 80 of it and there was way less actual equity in the deal yeah for sure i mean that's the other thing that gives you you know you talk about risk um you know now instead of having two million dollars in that llc you have 20 percent you have 400 000 in that llc the other thing you can do of course is you can form multiple llc's you can have holding company structures all of these things when we do a tax strategy with a client we look at all of that we set it all up that's wonderful yeah that's another area where i i had several paid off properties and i'm a victim of fraud where people are basically stealing them they've taken title from those properties through fraudulent activity through a title company and they were paid off had they not been paid off if there was a ton of equity the person would not have been able to get them and then try to sell them to someone else and so it's just another thing you don't hear when you hear people say the path to freedom is to pay off all your debt own it free and clear and you're good to go i was literally this big fat target sitting there with these paid off properties that drew somebody in yeah yeah for sure i mean let's take an airbnb our short-term rental okay you've got you have uh you know 150 people going through your house every year 150 potential lawsuits going through your house every year um so if you own that free and clear that's all at risk that's a great point now one of the ways that you can reduce that risk is instead of just thinking of an llc is actually taking out insurance in your name on the property is that is that a sort of a more prudent decision if you're going to hold it in your own name if i had to choose between insurance typically an umbrella policy by the gyms being to insurance and llc i would choose insurance now fortunately we don't have to choose we can do both the reason the reason insurance is so important actually we think about oh well if i get sued then the insurance will pay off maybe what's the most important thing is that the insurance company will use their attorney and they will take care of it let's go and i actually think i've had that situation i had a rental property up in utah and uh the the renter lost their job and next thing i know they're saying that they slipped and fell right so maybe a coincidence i don't know but what happened was property manager contacted the uh insurance company actually i heard i spent five minutes on the phone with the insurance adjuster and that's the last i heard of it they handled everything so i you know my mother taught all of us a long time ago she said two the two most important people in your life are a good cpa and a good insurance agent that's some good education you had i've always looked at it like having a big brother on your side their attorneys know what they're doing they're paid to save that company money you've now aligned yourself with this big powerful expert in that field it's very similar to when you're buying commercial property and you're getting a loan from a bank their underwriters are looking at that deal because they're putting 80 percent of the money and they're more exposed than you are it's another set of eyes that is an expert in doing that that can kind of verify what you're doing that's one of the reasons why you just want to have the right people on your team when you're buying real estate it's not about learning it yourself 100 agree so tell me about the system that you've created how does one go about starting out on the right foot when they want to get into sort of an investing system that can be repeated yeah so so here's what i've learned over the years and i i've got i've had a lot of clients that are very successful uh real estate investors i've i've it's really been my specialty for 40 years and a lot of developers a lot of people a lot of investors and here's what i found is that there's something in common with all of them and that is that they do all have a system and they have a set of criteria they use so we call it the three-minute investment decision you know so for example what kind of a cap rate are you looking at what location are you looking at what kind of uh what size of property are you looking at how what kind of a loan are you looking at all of these are criteria for investing and what happens is two things are going to happen the first of all is you only have to make one decision you're just going to apply that decision multiple times so the professional investor makes a single decision applies it over and over and over again the amateur investor makes a new decision on every single property okay so that that's really to me that's the key because i don't have a lot of time i'm doing i have four different businesses besides all the investments and so i want to make sure that i'm not looking at a property unless it meets my criteria right and so i'll take for example ken mcilroy who's a big real estate investor a lot of people know can a good friend of mine we've taught all over the world together and i've listened to ken on stage after stage after stage in moscow i've listened to him in in uh in australia literally new zealand everywhere and what i found was is he always does the same thing you know he's in a certain type of market in a certain type of property um with a certain type of tenant right in a certain cap rate et cetera he's looking for the same thing and so what it does it makes the investment decision much less risky and it makes it much easier the other thing that's pretty interesting though is actually makes you um it actually gets you a lot more opportunities and now if i can i'll just share why i say this and it's what i call the blue honda rule it's like you decide you're going to buy a car and you do all your research to go well what i want reliability and i want to resell value et cetera and i want it to be blue okay so you go into the honda dealer and they say great we've uh we've got that coming in in three weeks so what car do you see on the road for the next three weeks blue honda right that's how our brains work consider let's say you've got those same criteria for investing you've got the same criteria what do you see what kind of investments do you see those are the ones you see that's a great point and a lot of other people will pass them by because they never see them but you'll see them and so i i think it's just it brings you uh you know deal flow is a big issue for a lot of investors and you want deal flow you need to set your criteria and really have a system for investing but the good news is not only is there can you create a system for investing you can also create a system for reducing your taxes so you make sure that every single thing you do reduces your taxes as long as you follow the system for reducing taxes we call that the crystal clear criteria here at bigger pockets that you have to be very clear an idea popped in my head as you were speaking about so my real estate team spends a lot of time helping people with what we call house hacking so that's where we buy a house as a primary residence we rent out a part of the home to someone else to reduce eliminate or even give you positive cash flow at some point one of the trickiest things to accomplish in the bay area is to find a floor plan that will work for that because like a track house is very hard to do that with and then have enough parking like no one ever thinks about the fact that there needs to be enough parking i've noticed that whenever a deal crosses my path if it has parking immediately i start to pay attention to that thing it's like i've been programmed to look for that because to me that's very valuable and then when i see it i know exactly what i'm looking for what's the floor plan how many bathrooms does it have if those three things are there i'm digging into it deeper so that is absolutely true that's what i love about when you know what you're looking for you make these decisions in three minutes and they're not risky or they're not any more risky than they would have been the first time you did it they're way less risky because again you trust your asset because you made that decision multiple times and it's worked for you and so now you can trust that asset and now you can think about bringing on debt because guess what you know that's gonna you know it's gonna work yes you know i'm just starting to think about like professional athletes when they're new in the nba or the nfl that player doesn't really know what shot he can get in the nba when he's new he's trying to figure out how is his game going to work that quarterback isn't quite sure if that pass will work or not and then doing it enough times they get really clear and recognizing that's open or that's not this is good for me and then what you see is confidence and quick decisions can be made like it's such a great point that you're highlighting that this is what successful people do is they start broad they narrow down and then they just look for that thing and they do the same thing over and over and over until it's boring but awesome that's right okay was there anything else you that you think that we should cover as far as misconceptions on the tax code or things that people can do to save money on their taxes through real estate yeah one one more thing so we i hear people focus all the time in this real estate professional and people go well i can't be a real estate professional let me let me give an example my wife and i my wife and i are never going to be real estate professionals my wife has her own cpa firm i have not only a cpa firm i also have a network of 60 cpa firms that i train in fact i'm middle of a training program right now you know i have i have a software company and i have a and i have a real estate business i'm not going to spend more time in real estate than i do everything else and my wife isn't either okay she she loves it so how do we get how do we get to use those losses here's the key got to go back to this idea that passive losses just because passive doesn't mean it's not deductible passive loss means it's not deductible except against passive income so the goal with the real estate professional is turn a passive loss into an active loss the other side of that is if you could turn active income into passive income you could accomplish exactly the same result okay well what makes something active versus passive it's the owner spends 500 hours in that business well what if you have owners that don't spend 500 hours for example the the trust for your three-year-old three-year-old's not going to spend 500 hours you're not going to be the trustee because if you are you're not ass protected with that trust so you have nobody who's nobody who's active if the if the three-year-old owns part of your business and owns part of your real estate now they have passive income from your business it's active to you passive to them and they have passive losses from the real estate so we can match these up we can create literally create passive income simply by converting active income to passive income and we can still maintain control over we can still have you know what we want with it i mean the most important thing that any asset protection attorney will tell you um and i'm not an attorney but my but i have a lot of several buddies who are they'll say look the important thing about ass protection is you want to control everything and own nothing okay well listen if i can control that asset why do i care i mean it's eventually going to go to my kids anyway why not have them have it now and reduce my tax liability so if i hear what you're saying correctly one thing you have to be careful of is you put enough hours into something like real estate rentals but another way to accomplish the same purpose would be to spend less hours on what used to be active income sure um i'll give you a simple example i started a brand new cpa firm a couple years ago the first year i was active second year i was active third year not active i spend far less than 500 hours in my cpa firm well guess what that's passive income which means you can use depreciation for rental properties means i can use depreciation from my rental properties you know what's beautiful about this is that actually creates another positive addiction where you have to leverage yourself out of active income right so every time you start a new business it's a race to how quickly can i get other people running the business for me enjoying the fruits of it making more money so i can get out of it because then i get the tax benefit well even better is so in the early years when you're active that business is creating a loss right probably as soon as that as soon as it starts turning income now you become passive because you've got the team in place and the systems in place you become passive and now you can offset that income with passive losses from your real estate beautiful okay this is awesome i'm really glad you brought that up i don't think i ever was told that before which is why i'm glad we have the man himself to explain this in this next segment of the show tom is actually going to break down my personal situation with some of the ways that i have income coming into businesses i own and give me some advice on what i could do to limit my own tax liability so this is a little bit of like a a consultation that we're going to be having as i come to you that we're doing in front of everyone here so what questions do you need to start with to be able to get the information you need to help me yeah so the first thing i need to know is what you own okay what do you have now so i need i need two things i want to know what do you have right now and what are your plans for the future so in other words what do you want to have um because all tax all taxes are based on your current facts and circumstances we always say if you want to change your tax you have to change your facts so i need to understand not only what you have now but i understand how are you investing for the future and what are your plans for the future because how you make your money just like i showed in cash flow quadrant right at the beginning how you make your money has a an enormous impact on how much tax you pay and that includes what asset classes what types of assets what type of real estate whatever it is what type of business and what so we need to understand what you have now and what your plans are for the future very good okay so this is actually a great time to bring this up my uh i haven't really made it public yet but one of my huge goals for 2022 is to raise money to buy more real estate with so i have a website set up investmentdavidgreen.com where people can go if they want to invest with me and we have a system set up where we look to see if they're an accredited investor or not and then my plans are to buy some very expensive residential real estate and likely use it as a short-term rental or possible like corporate housing situations as well as multi-family real estate those are the two things that i'm going to start off focusing on in the areas that i think like the population is moving towards where we're expected to see both rent growth and price growth i have a couple corporations set up where i run a real estate sales team a mortgage company there's an insurance company that will be coming soon a couple other ways that i create revenue and then i have money coming in that is currently in my personal name that i'm probably going to be changing where i have book royalties from stuff with bigger pockets and um other ways that i get paid like speaking at different events stuff like that okay so what i need to know now now i have to start drilling down a little bit right so when you say i have corporations explain that you have you have c corporations s corporations llc's taxes partnerships i have a c corporation i have an s corporation and then i have probably six or seven llcs where i own um somewhere between 45 and 50 residential properties between them and and those are taxed as partnerships yes okay and this is a point i'd like to make here is that um llcs can be taxed any way we want so we can choose to tax an llc as a corporation we can choose tax and llc as a partnership we can actually choose tax and llc as a sole proprietorship so we have all these choices so um that's why i i i'm always going to go back to is it is it a partnership for tax purposes is it a nas corporation c corporation partnerships and as corporations that income flows through and so that income so the income from an s corporation theoretically can be offset with the losses from a partnership okay because those both flow through to your personal tax return so what we want to look at is um first question i'm going to ask you is and we've had this discussion so do you qualify as a real estate professional by my understanding yes okay so we we've got that so what we're going to do is we're going to make sure we make an election to aggregate all your properties we're going to do that on your tax return and we're so so you're going to be able to use those losses we don't have to worry about anything else we're just we're do you spend more than 500 hours when you take all your properties together you spend more than 500 hours absolutely okay so we're good there we've met that passive loss rule that passive loss test so now active losses active income so now what we have is we have the losses from the real estate can offset the income from the s corporation what it can't do is offset the income from the c corporation so tell me about the c corporation that's where the majority of the money uh that i make i would say that's the biggest bucket and i use that money i lend it to other companies to earn additional income so i would lend myself money from that to flip houses to buy assets with in the other corporations make investments like that and then um there's the corporate tax rate that i'm paying on that but i also can pay myself a salary from that c corporation that would be offset by the deductions that we talked about just like the s corp so we should probably talk about that for a minute so we have a new rule uh beginning in 2021 and the new rule is called the business loss limitation rule and what it says is is that business losses including real estate losses can only offset business income plus an additional five hundred thousand dollars so as long as that salary is not more than 500 000 and you don't have interest income dividends retirement etc that would push you over that 500 000 you are absolutely correct you can offset all of that when once you get over that 500 000 though you're not going to be able to use those losses anymore and that will just carry over so we have to be a little careful with that and that's brand new brand new 20 would there be a downside to shifting the way that income is taxed from a c corp into an s corp and making that a pass-through right so we may want to do that so so that is one thing we would want to look at right off the bat is um are you going to invest so this is where the future matters right are you going to invest so much in real estate that it will offset all of the income from the c corporation the c corporation great thing is 21 tax rate right that's the good news about the c corporation federal tax rate of 21 but if we can get below that because we got all these losses from real estate why would we want to get it stuck at 21 especially knowing that eventually that money is going to come out and be taxed as a dividend so when i made that decision to set up the c corp i was not buying real estate i had other things going on and so i could reduce my taxes since then i've started not only buying real estate but ramping it up significantly and i've learned more about a lot of what you're talking about the the bonus depreciation accelerated depreciation cost segregation study so now what i basically do is i have my cpa tell me hey david you you're on track to make x amount of money you need to buy x amount of real estate and that becomes the minimum goal that i'm gonna be shooting for there you go and that and that's why that's that's why another part of the the whole system here is that you meet with your cpi on a regular basis and you're constantly looking at what your income is and what your cash flow is and and you know do i have cash flow to buy that and then and then we also have to know those criteria because we need to know okay so how much debt are you going to get and how are you going to go about getting that debt because we all know that you know if we go through normal channels we're limited that way so how are we going to increase the amount of debt we can get and those are all decisions that's actually all part of what i consider to be wealth and tax strategies you've got to look at both sides of it you can't just look at the tax side i think what i love about what i've heard so far well first off is your approach to this it's like you said it's not just saving in taxes that's defense but you also got to play offense it's also how you build wealth and debt is a huge piece of that as well as education right we're not saying just go buy anything out there it's buying the right stuff but i only have to know enough of these concepts to feel comfortable trusting someone like you who's going to tell me what to go do right i don't need to be an expert in all of this part of the reason that we're sharing this information is it's good to understand what your cpa is doing so that you know that it's legal and the advice they give you makes sense but someone like you like you just said is gonna say we need to switch this up we need to change that and this is what i want you to go out there and buy and i don't have to understand it all you you don't you you do have to understand the concepts which is why i wrote tax reward frankly so everybody could understand the concepts because here's the here's the challenge i can't reduce your taxes you're the only one who can reduce your taxes what you need me for is to tell you how to redistribute what you need to do to reduce taxes right what facts do you have to change to reduce that tax and so it's very much a team effort it's very much a partnership and we look at that that's how we look at all of our relationships with our clients to the point where we don't even charge um we don't even charge a separate fee for a tax return we charge a basically flat monthly fee to our clients and that is how we charge because we want to make sure that nobody's hesitating picking up the phone calling us nobody's hesitating with um okay i i need to talk about this boy am i gonna get dinged for that 15 minutes like you do with an attorney oh boy that's exactly how it goes to you know i should probably highlight you and i have to understand these concepts because we're responsible for teaching people but the person listening doesn't have to understand them all i'd like if you don't mind to wrap this up with you sharing your five steps to eliminate income taxes from real estate deals i think it's very practical i think everybody can get started and it's a it's a it's a great uh concept to understand if you want to start to take action on some of the stuff we talked about today okay so so number one is you've got to develop that strategy right you've got to develop that plan of action and typically we find that's going to take anywhere from three to six months just developing the plan if you've ever played robert's cash flow game i would encourage anybody who's played it to try playing it by developing a strategy first before you start playing the game and what you'll find is you'll make far fewer mistakes you'll get out of the rat race a lot faster so you've got to start by developing the plan but you need a team so part of developing that plan is who's on your team who's your tax advisor who's your who's your uh legal advisor who's you know who's going to find the real estate for you if you're not going to do it who's going to manage the real estate if you're not going to do it you know use your insurance i mean all of these people are part of that and um you know then the second part is really long term so remember that you you talked a little bit about you know flipping properties that's great that's a business okay i want to be really clear that's not an investment that's a business you are actively managing flipping properties you're more like a developer than you are like a uh a a landlord right because you're not just leasing these out so i love the long term rentals which is what robert likes likes because you a you get the depreciation which you don't get when you flip b you get lower tax rates because you get capital gains rates when you sell unlike flipping which is ordinary income rates and um and and you've got an asset that's producing cash flow for a very long period of time so i love that um fixing flips are great if that's the business you want to be in but just treat it more like a business understand that you're not in the i segment of the cash flow quadrant you're an s okay you're an s you're not an i thank you that's a good way to put it make sure that you're doing cost segregation and bonus depreciation on your properties that is just critical i hear a lot of naysayers about cost segregation oh it's too expensive seriously i mean i've seen cost segregation save people millions of dollars and there's even some online tools that you can do for pretty inexpensively uh cost segregation on a single family home so there are some tools that you can use that are that are um kind of a quasi-do-it-yourself the other is uh next is you either need to look at becoming a real estate professional or your spouse become a real estate professional don't have to be both of you just one of you or or you've got to look at the alternatives which is how do i create passive income so i either need to take the passive loss make it active or i need to take my active income and make it passive so that would be number four and then finally is part of really it's part of number one and it's part number four number number five which is the team uh investing is a team sport that's what that's one of the very first things i learned from uh robert kiyosaki is investing as a team sport and business is a team sport i mean i right now right literally i'm right now teaching a class of 60 tax professionals well my team is right the reason i can do this podcast because i have a team that i trust and they can do that and they can do that while i'm while i've stepped out to do this podcast and teach you guys so i just can't emphasize that enough well the rich advisors actually wrote um a book called more important than money and it's all about developing that team so i definitely recommend that book as well that's awesome now here's what's even more awesome is people like you and i can help with step five that's literally what we're here to do is to help people build wealth through real estate so that they don't have to figure it all out themselves that's where most of the businesses i have were built for that purpose is you're going to need a loan to get property commercial and residential you're going to need loans for certain properties that you won't be able to qualify for based on your own income you're going to need a representative to help you buy it you're going to need someone to manage it you're going to need a way to keep the books of the income coming in and you're going to need a way to make sure you're getting a tax deduction there so we've kind of i mean would you agree we both committed our life to helping people to do this for sure the reason we have a network it's called the weltability network is actually because we had a cpa firm and we could really only handle the high-end clients and we couldn't handle the beginners okay we can have people just starting out because you can't pay somebody differently you can't pay a tax professional differently for handling a a a beginner than you do on an hourly rate than you do for somebody who makes millions of dollars a year so what we did was create a network and now we have 60 cpa firms across the country and now we can handle people at all stages and that that's really just like you um david we are here to serve the entrepreneur and we certainly include real estate investors as a key part of that entrepreneurship group man it feels good to have big brother having your back when it comes to that so tom for the people that want to reach out find out more about what you can do to help them or just kind of follow up with you where's a good place for them to go best way is just go to wealthability.com it's exactly spelled exactly how it sounds wealth ability all one word dot com and uh just contact us we're happy for example we'll do a free free look at your tax return we'll look at say you know is there some way we can help if there isn't we will tell you if there is we will tell you if you um have a cpa that you go boy my cpa i love my cpa they just don't understand the stuff have your cpa go to wealthability.com and have suggest they become a member all almost all of our members have come from their clients and that's because you know entrepreneurs hear what we have to say entrepreneurs want to know what their choices are and they might like their cpa but their cpa needs to learn this if alternatively you go i hate my cpa um first of all sorry to hear that and second of all just go to weltability.com and we'll help find you there are certain pieces of this puzzle that you rarely ever find a human being that says i love this person in it like property management's one of them you just don't hear people say i love my property manager cpa is another one of those things and it's just because it's so hard there's so many questions it's a lot of the people who have the most questions are able to pay the least and so it's hard to like pay a professional to be able to answer those questions if there's not enough revenue coming in and frankly most cpas will just tell you just like most lawyers yeah just don't do it because that will get them in trouble right what you're looking for is a person who says you're if you're gonna do it here is the way to do it and that's invaluable yeah let me give you the the question to ask instead of asking is this deductible so um is this is this marker deductible the better question is how do i make it deductible in life that is the weight right way to think how do i make it how do i do what i want to do that's what entrepreneurs want to know i would also share i do have uh the wealth ability show which is my podcast and uh and and basically and david i'd love to have you on you got it man by the way absolutely and uh we um we talk we we talk to a lot of very interesting people about all aspects of finance and tax i'd love to do that i believe it was in rich dad poor dad where robert said um the rich don't ask can i afford it they ask how can i afford it does that sound familiar it does actually yep um robert cam had a uh rule throughout um they've had a rule throughout their their marriage which is they never say you you can't buy this you just have to say okay tell me where the tell me where the cash flow is coming from what asset are you buying in order to pay for that expense oh that's such a great point like i miss brandon turner my former co-host because he would come up with these cool names for everything that we talk about but there's this concept that i live by where i basically have all my income coming in from the different businesses then that's all invested into real estate and then an amount is set aside in reserves and whatever is left over from that cash flow is what i consider the money that i actually make i don't even look at the money that businesses make and if i want to buy anything it like you said it comes from that and if you live that way you never run out of money you can buy anything you want as long as you invested before which is why these positive addictions are so important because they keep you buying real estate they keep you saving and investing your money uh what was the other example that we brought up about a positive addiction oh getting out of your business right like don't just follow the temptation to do all the work yourself because it's easier train hire delegate grow become a leader create opportunity for others and then you get it to take advantage of all it makes you a better person when you're trying to save in taxes i think that's what i really like about it oh for sure you know and look to your team i mean you know i've had people say well i'm gonna i'm gonna do my own taxes i'm going really that's how little your you value your time you can't do something that's more productive than learning what it's taking me 40 years to learn i just think it's crazy why wouldn't you always hire somebody who knows it better than you do and really can do it for a much better rate than for you to have to go in and learn it all then go do it yourself i i think do it yourself three most expensive words in the english language and i've learned that lesson the hard way i started off just like people and now that i'm a real estate agent i see it too people say i'm just going to sell the house myself save the commission you have no idea i have no idea how much money you're losing especially in a market like this and unfortunately like i want you guys to listen and not make that same mistake uh you could do anything yourself you need surgery you could learn how to do surgery you could do it on yourself you're uh in court you could represent yourself as a lawyer anything can be learned it doesn't mean a smart use of your time to do that way you let the professionals uh handle the stuff that they're better at handling and then you focus on the vision that you have and executing that absolutely 100 percent agree well i want to thank you tom this has been fantastic i really appreciate your time we've been wanting to get a tax professional on here because this is one of those things that nobody values it until they need it and then all of a sudden it's an emergency i need to talk to someone right now they've already made the decision and they go to you and they say how do you fix what i did how do you build me out of this instead of like you said step number one was come up with a plan to work it is there anything that you want to say before we get out of here now i just wanted to say thank you because i think when you talk about education and how important education is i don't i don't think you can you know if you want to spend if you want to invest money at a really high rate of return then invest in yourself and invest in your education that's what i would say that's way more that's going to be way more productive frankly than investing in any singular piece of real estate wonderful well thank you very much for your time your expertise your knowledge and your heart tom really appreciate you and we'll uh i'll go to your podcast i was also on ken mcelroy's if anyone wants to listen to that just google what was it your nine to five just isn't worth it anymore with ken mcelroy and david green and we kind of talk about some of the same stuff that's awesome great thank you david you got it [Music] you

Channel: BiggerPockets

Views: 457,580

Keywords: biggerpockets, real estate, real estate investing, investing, rentals, rental property, investing in real estate, income property, bigger pockets, passive income, how to avoid taxes, how to avoid taxes legally, avoid taxes, how to not pay taxes, how to not pay taxes legally, real estate investor, robert kiyosaki, robert kiyosaki taxes, tax loopholes, tax incentives, rich dad poor dad, rich dad, rich dad robert kiyosaki, real estate taxes, how the rich avoid paying taxes

Id: MdFae0JoPIE

Length: 88min 39sec (5319 seconds)

Published: Thu Feb 10 2022