How to Choose, Buy and Sell Rental Property: Real Estate Investing for Retirement Income Explained

hello and welcome and thank you all for joining us for this real estate income webinar with Alan klopine CPA of pure financial advisors Ellen you have certainly had your plenty of personal experiences with the joys and the challenges of real estate investing right well first of all thank you for that great introduction Andy and uh so so right off the bat let me just say I've been a real estate investor for over 30 years I've had some big successes I've had some pretty big failures I'll try to weave in some stories here and there as time permits but I love real estate it's a great way to get a cash flow to build net worth but we're going to get into that quite a bit I'm going to spend a little time going over maybe three main things one is kind of Basics on how to think about properties maybe picking the right property how to do some financial analysis and then I think I'll pause and take a few questions then I want to get into taxes I'll pause and take a few questions then I will get into what happens if you want to sell a property how do you do that tax efficiently so we've got a lot to cover we probably won't get to every question on the webinar but rest assured I will answer this back when I get a chance so uh Andy I think this is a topic that's near and dear to my heart so I'm happy to be here I can't wait to hear the stories because I know we've talked about some of them on the podcast and they're just it's incredible that after all of the things that you've been through that you continue to to be such a an advocate for real estate investing um and I know that that'll be very entertaining for our viewers today okay so with that should I get started Danny yes please do okay awesome well okay real estate income a webinar so the very first thing I think you have to think about when it comes to real estate is what's your goal why are you doing this what are you trying to achieve and there's different answers for different people and that may determine what kind of property you're trying to buy so give you a few examples some people want they want a cash flow they want an income stream either while they're working or in retirement or allowing them to retire early because they've got a cash flow that's a great strategy great way to think about it another is sometimes people just want to build wealth they want to buy properties they're going to appreciate in value so that when they retire then they've got assets to have a cash to have a lifestyle that they want so that's that's a great way to go sometimes people in retirement they just want a second career right they they want something to do in retirement this can certainly provide that so I think right off the bat you need to think about what you're trying to accomplish because different properties can accomplish different things for you but with that let's hop right in okay today we're going to talk about real estate pros and cons we're going to get into picking the right property make sure you consider cash flow that might be the most important thing I'm going to go over today because if you have appropriate cash flows to weather various storms you can hold on to these properties and Good Times bad and then we'll get into cashing in your profits like okay now I've owned this property a while now what maybe just keep the property right get the mortgage paid off and you have great cash flow or maybe you want to sell it and have a lot of proceeds to do with whatever you want but you don't necessarily want to pay a lot of taxes so that's kind of what we'll get in today so first of all Pros let's see what are the pros creating uh steady cash flows I've done that it it I didn't do that in the early days I'll be honest I've always invested for the well not always mostly in Southern California I live in San Diego it was very hard to get cash flows even in the late 80s when I started investing but steady cash flows is is a great goal it can a property can appreciate in value I have seen that the properties can go down and make no mistake properties can go down dramatically I saw that in the Great Recession where properties I had some properties in Las Vegas that went down over 60 percent so be be aware properties can go up and they can go down but there's the opportunity for appreciation active investment control okay unlike a stock Bond mutual fund you have more control right if you own a property you own a condo you own a house you own an apartment building you own a commercial building whatever it may be you've got a measure of control over that investment and then finally tax advantages and there are quite a few that we'll get into okay now as far as cons it's time consuming if you've never done it rest assured it's time consuming so if you're doing this just because I you know I want to retire and this sounds kind of fun maybe I'll do a little it's it's it takes some effort and energy right it's a non-liquid investment meaning that you can't just cash out immediately you've got to put on the market and sell it but that's also an advantage because then it's harder to sell so you you tend not to sell as quickly which can be a good thing leverage effects can be negative okay what does that mean well you buy a property you use other people's money usually a bank right I'll use a real simple example property worth a hundred thousand dollars and I know there's no such thing but just follow the math right 100 000 property you put twenty thousand dollars down you have a loan for eighty thousand so you only invested twenty percent or twenty thousand dollars if the property goes up you get all that appreciation if the property goes down you have your responsibility is all that loss I just mentioned I had properties in Las Vegas that went down sixty percent and in all three cases their condos I had about 40 percent equity in other words total Value Loan to Total Value Loan was 60 Equity was forty percent properties went down sixty percent I was under water and if you have to sell quickly that can be rather Troublesome because you can't even afford to sell so when it comes to leverage it's your friend when properties go up but it's a double-edged sword so never forget that all right let's start by picking the right property now this particular webinar is going to focus a little bit more on residential but it's only one type of property you can invest in various types of commercial whether it be apartment buildings Office Buildings warehouses and the like most people when they invest start with residential because it's easier to understand there's a huge need for it so that's what I'm going to focus on in in this webinar so right off the bat where do you buy well number one I would say it's not that really cool home that has the ocean view that's not your best candidate for a rental property you're better off buying in a working class neighborhood suburbs places where people they work each day they go to work they come back they're living with their family these are the kinds of neighborhoods that generally work better because they have better cash flows right we call this bread and butter properties number two think about the the neighborhood itself is it upcoming is it improving is it declining well how do you know if it's upcoming maybe there's a New Home Depot or a Costco nearby right maybe there's some new development in the area maybe some older homes are being refurbished right these are signs that things are improving on the other hand if it's declining you generally see just the opposite so it's not too much of a mystery you'd rather buy an upcoming neighborhoods rather than those that are declining if you're going for appreciation which most of us that's at least part of this equation the condition of the property very important right I am not a a handyman by any means so when I see a property I see certain things but I always hire a home inspector when I make an offer on a property that's accepted to make sure I know exactly what I am buying right the home inspector will generally go through every single thing in the house find out problems and then you tell that to the seller those get either get fixed or you get a credit that's very important in some cases I have walked away from potential properties because of the home inspection report because I was buying someone else's problem let's talk briefly about cash flow I'll just give you a quick rule of thumb try to get the monthly rents as close to one percent of the value as possible very hard to do in Southern California in fact I would say probably impossible but get as close as you can so what does that mean so that means if your property is four hundred thousand dollars you want the monthly rent to be four thousand and you're saying that doesn't exist it's not available well it depends where you live there are certain markets uh in the in the in the south east that actually do have pretty good cash flow so it depends upon where you go this one though is is important is you want to get your cash flow as close to that one percent as possible because markets do turn markets do change and make sure that you have enough cash flow to be able to to cover what may come up here's another important point is buy for the cash flow not the flare so what does that mean if you're new to real estate investing maybe you've owned some homes and you like the one that has this kitchen and this View and this bathroom it's a great backyard I get it that's not necessarily the best criteria for a rental property you're going for the bread and butter homes they're not necessarily the homes that you are going to live in although they could be right but generally these are homes these are people that go to work every day that need a home to live they take care of the home generally because they've got families they've got jobs they're trying to they're trying to do the right thing so it's not when you walk in looking at the kitchen and saying I love this place that's not the best candidate for a rental property look at your cash flow cash flow cash flow cash flow right so buy something to collect cash flow and then think of it as an investor which is what you are you're investing in a property that's an investment any kind of investment you put in a certain amount of dollars and you have an expectation to get back a certain rate of return plus your Capital so you think of it the same exact way and I think one thing I want to mention on valuations properties versus rents this is kind of everything I'm going over is a generalization you could find exceptions to everything certainly but as a generalization the more expensive the property the harder it is to be a rental property and have a decent cash flow because as property values go up yes rents go up but not at the same rate right so when you're buying luxury homes maybe something in Rancho Santa Fe or Del Mar or wherever it may be those kinds of homes generally don't make the best rentals just because the valuation is too high relative to the rents that you're going to pay all right let's talk briefly about things to consider before you buy real estate it's like a business right and if you want a business if you're a business owner if you like having a business you probably like real estate if you don't want a business and you've never invested in real estate this may not be the best thing for you because there's a lot to it so first of all you got to pick the right property you got to do your own cash flow analysis figure out is this the right property in the right area then you need to find tenants and guess what tenants don't always pay right and so you may have to evict them you got to collect rent you got to be the handyman or you've got to hire people to do all this which is expensive so um anyway many people when they first start out they they're their own property manager their own maintenance person which I've done as well who I made several mistakes that way but uh anyway just just be aware that this there's a lot to this and there's a lot of ways to make mistakes be realistic about your your skills your time your money your budget right make sure that you can really afford this and what I would say is when you run your cash flow analysis which I'm going to show you how to do this in a second then make sure that you can weather storms in good markets and bad because there will be both as as we relate to the Future and then finally is if you're not going to do the work yourself then make sure you get a good team property manager maintenance people and so forth to be able to help you okay so that's a little bit on picking the right property let's go over cash flow and so what you want to think about is is something called Cash on cash I'm going to show you what that means and why that's important there's also cap rate I'm not going to talk about that today that's usually used for larger apartment buildings other kinds of commercial buildings cash on cash is what most investors use when they buy condos and single-family homes so here's what it is right calculate cash on cash and you take your net profits net profits and you divide that into your equity in the property to figure out what what kind of rate of return are you generating so go through example in a minute but it's really important to tell you City by city county by county state by state these are different ratios so just be aware different areas have different cash on cash so let me give you an example so I got a couple properties here okay so the first example is property number one has rental income at two thousand a month so that's 24 000 for the year and then you add up all the rental expenses right so what what's that well that would be your property taxes your your mortgage payment right it would be a property manager if you have one it would be maintenance it would be Insurance it would be cleaning fees on and on and on those are your expenses so you you take the net of those two 24 000 minus 19 000 of expenses gives you five thousand dollars of net cash flows you compare that to your Equity right in this case your Equity is a hundred thousand dollars again Equity is total value of the property minus the loan balance so Equity hundred thousand dollars cash on cash made five thousand dollars have a hundred thousand invested that's a five percent rate of return cash on cash that's pretty good in Southern California that's very difficult to find in fact almost impossible but there are places in the country where you can't property number two this might be a little bit more typical of Southern California rental income 30 000 Rel expenses twenty eight thousand so now you're two thousand dollars of net cash flows two hundred thousand is your Equity two thousand to two hundred thousand that's one percent cash on cash so that's not near as good but again it depends upon the area and if you are going for appreciation like let's just say which is often the strategy when you're in a high cost area then that's okay just understand that's what you're doing you're going more for appreciation than cash flow right but as long as you have enough cash flow to be able to weather storms then that's what you want to have and I'll give you another tip so these amounts the property rental amounts that's an annual amount so let's divide that by 12. what's the monthly amount two thousand dollars twenty five hundred dollars per month I want you to have three months rent in the bank just sitting there for every single property that you have as a safety net this is over and above your emergency cash okay two thousand dollars a month times three months that's six thousand dollars I want that to be sitting in an emergency account for this property here twenty five hundred dollars times three that's seventy five hundred dollars right I want you to have that set aside you may want to do more I'm giving you a minimum but in this way if you have that kind of cushion you might be um you might be able to weather storms a lot better okay now now that we've kind of gone through this let's sort of put it all together as to why why do people invest in real estate in the first place what are the numbers what's the benefit okay so this is property number one again okay so in this particular case let's say it was purchased for four hundred thousand and don't get hung up on these numbers these are just examples it's going to be different in your area of course so home value four hundred thousand loan amount three hundred thousand Equity is one hundred thousand like we saw in the last slide okay so what kind of rate of return are you actually getting on this property well the first thing is annual appreciation let's just say the property goes up five percent five percent of four hundred thousand is twenty thousand dollars you're the owner you get all of that right so that's pretty good this is one of the huge benefits of owning real estate secondly your cash flow we already saw that you had a five thousand dollar cash flow for the year and in that cash flow you're paying some principal payments on your loan so let's say that was a couple thousand dollars so we add those three together you get twenty seven thousand dollars is your total return now we take your total return divided by your home equity that's a that's 27 so can I make money in real estate uh the answer is yes a resounding yes now if this went down five percent okay what what kind of rate of return now we're negative 20 plus seven so now we're negative 13 000 right so now we basically lost 13 on our money so just that's why I talk about leverage leverage works both ways it really helps you when properties are going up it really can hurt you when properties go are going down and here's what happens happen to me too I read all the books I still made the mistake which is you have these properties they're going up you've got more and more Equity you refinance you pull out cash you buy more properties with them that works great as long as properties keep going up but when it turns you get stuck in this where you end up in some cases with negative equity I had several properties in 2008 2009 with negative equity I thought I did my homework they had good cash flows they had they had you know some cushion but what I didn't really fully anticipate was the Great Recession as big as it was as great as it was so now Natalie where my property's negative in terms of negative equity but the rents the rents I had to lowered drastically because people didn't have the money to pay the rent they were paying so I actually I'll just be real honest I lost three properties in a short sale in 2008 2009 this this is real life this happened so be aware of going too quickly make sure you have enough reserves to be able to handle it so with that we talked about some of the basics we talked about finding the right property how to compute your opportunity cash on cash Andy let's open it up for a few questions before you go to the next section all right well first I want to mention the fact that we did get uh more people asking whether or not today's webinar is being recorded the answer is yes you will receive an email when it's available for replay so that you can watch it on demand but now we're answering your questions if you have any questions about anything that Alan has just spoken about go ahead and type them into the Q a right now this is your opportunity to have him answer those questions live we do have a number of questions that relate to things that you're about to talk about we have some Advanced uh Real Estate Investors here but I will ask one that's a little bit off topic I don't think it's going to fit in anywhere else so I'll ask you uh now okay from Tim how can a parent help an adult child purchase a house or condo in the expensive San Diego area for example loan them say 300 000 out of a total 500 000 mortgage give them the money and how should title be held parent and child or child's name only that's a great question well first of all yeah all the above any of the above there's pros and cons on each certainly you can load money to your kids you have you have to have a Bonafide loan agreement they need to pay interest back to you and so forth in that scenario they probably are the owner right so they own it but you have a loan on the other hand you could jointly buy it with them maybe you co-sign on the Note in a lot of cases people don't want to co-say and I understand that but that is a way to go you can gift money you can gift the 300 000 you have to file a gift tax return I can't go too deep into it right now but anyway there are a lot a lot of considerations but anyway with that let's go on because maybe we have more advanced questions which is awesome okay let's talk about income taxes okay so when it comes to income taxes you got to understand how to calculate your income to know what you're paying tax on so we'll kind of go over that okay understanding depreciation uh what does that mean when you do an improvement on the property is it a pair repair is it capital repair you get to deduct right away if it's a capital expense you have to depreciate it and then you create a tax last but can you take it can you take the deduction not always so so we'll go over that so right off the bat let's talk about calculating your income okay so we kind of went through that one example of property number one right let's see if I can get that there quickly now twenty four thousand dollars of net income nineteen thousand dollars of rental expenses okay great five thousand dollars of profit and remember I said expenses would be things like like interest on your mortgage property taxes Insurance property management fee repairs cleaning pest control on and on and on things like that you end up with this net number and hopefully it's a positive number that's a positive cash flow if it's negative like let's say it's negative two thousand dollars now you've got a negative number you actually lost two thousand dollars not a cash on cash basis I have invested in properties that have negative cash flow and I'm okay doing that as long as the negative is not that bad and I and I feel really good on the prospects of career but in this case five thousand dollars is positive but remember we said this property costs four hundred thousand dollars right so now you get to depreciate it so four hundred thousand dollars you've got to allocate between land and building so land you don't get to depreciate building you do get to depreciate so let's just say accountant says 75 is the building so you get to depreciate three hundred thousand dollars in a residential property you get you get to depreciate it over 27 years 27 and a half years actually so you take the three hundred thousand you divide it by twenty seven and a half that that works out to be I don't know around eleven thousand dollars give or take so that's a deduction for you so now on paper on your tax return you don't have a five thousand dollar gain you get to subtract that depreciation against it eleven thousand so now you've got a six thousand dollar loss so this is one of the huge benefits of real estate is that you can take your income and you can depreciate it and in most cases what I've seen is is hopefully got a little positive cash flow but on the tax return it looks like you're losing money best of all worlds you're making money well on the tax return it looks like you're losing money right and when it comes to depreciation if you have other commercial property non-residential like like a business park or industrial that's 39 years right not 27 and a half years you have to take your your building part divided by 39 years there's something called the cost segregation study now I'm getting a little Advanced but if you've got a property that's big enough has enough value you're going to want to hire an engineering firm to come in and analyze what you bought it's not just landed building it's personal property and land improvements and you can get a lot more depreciation up front so just be aware of that but that's depreciation repair versus capitalization some things are obvious right so there's a there's something that needs to be fixed right or maybe you need to touch up paint well that's a repair well if you add on a bedroom well that's a capital item right that needs to be capitalized and appreciated over 27.5 years on residential right and then there's a whole Myriad of things in between which I don't have enough time to go into all of this but just be aware if you're a real estate investor make sure you get kind of clear on what's a repair versus Capital your accountant can do this but generally a repair is something that that go ahead and fixes something that you already have right in some cases accountants call Replacements repairs it just depends upon your accountant in other cases where you've added something right you've added a bathroom or you've added you you've substantially improved a kitchen that might be a capital Improvement as opposed to repairing what you already had there right so think about that and then qualifying for that tax deduction so if we think of our example I had a six thousand dollar tax deduction can I take it uh maybe so let's talk about that so to qualify for tax deduction I either have to have income that's low enough or I have to qualify as a real estate professional okay if I don't qualify for either of these two things that six thousand dollar loss it doesn't vanish it's on the tax return it gets captured as what's called a passive loss carryover so I will be able to use it later when I have positive income or I'll be able to use it when I sell the property but to take it currently on your tax return okay so the first rule is if your income is below 150 000 modified adjusted gross income okay which is basically your tax return adjusted gross income without regard to the real estate okay so that's uh you got to see what that is if it's below 150 000 you'll at least be able to deduct some of it if it's below a hundred thousand dollars you can deduct up to twenty five thousand dollars okay so in this example I had a six thousand dollar loss my income is below a hundred thousand dollars I will be able to deduct all six thousand dollars of loss because it's below twenty five thousand dollars my income is between 100 and 150 000 there's a phase out where I can either deduct all part but eventually by the time I get to 150 000 uh it's I can't take any so that's the one way that people get to take their deductions the second way a little more complicated real estate professional I think probably some of you know about this but as a as a review to be a real estate professional in the term in the eyes of the IRS it's not an IRS agent although it could be but no it's someone that works at least 750 hours a year on real estate Investments so if you have a number of properties you could qualify for that and it has to be over half of your professional time so let's just say you've got a full-time job you work 2 000 hours you would have to work 2001 hours to be able to qualify as a real estate professional right so you have to work more in another profession than you do in in real estate and finally the one that miss is missed all the time is you need to materially participate which means you have to be active in the property uh it can't just be a passive investor this one's tricky talk to your accountant there's a cup there's a few ways that you can you can pass this test generally if you're self-managing or even if you have a lot of properties and you have a property manager you can probably qualify for material participation but just be aware of that these are the hurdles you have to get past now if you get past all three of these then you can deduct your real estate losses dollar for dollar no matter what they are so let's take our six thousand dollars of loss let's add a zero to it sixty thousand let's add two zeros to it at the six hundred thousand these things are possible particularly when you have a large property and you do a cost segregation study you can generate some giant losses potentially on your tax return but in in most cases you'd have to qualify as a real estate professional to take those kinds of losses right so real estate professional 750 hours a year more than half of your time and you have to material you'll participate be aware that not all states uh go along with the real estate professional for example California does not recognize it so if you are a resident of California you're not going to be able to take the real estate professional against California maybe you get to deduct it on the federal but on the state it gets captured again it doesn't vanish it just gets captured carried forward to when you can actually use it later and my next topic is selling so okay we've got a number of questions there because I went through a lot quickly yeah um Raul asked is there any tax advantage when you have losses in investment properties uh yes as long as you qualify as a real estate professional right or your income is below a hundred thousand dollars you can take that twenty five thousand dollar uh deduction like let's say your real estate losses are 40 000 for example and you and you can qualify for that 25 so the first 25 000 you get to deduct dollar for dollar against any other income the extra fifteen thousand dollars gets carried over as passive blast into the following year right so that's how that works oh yeah we've got several Kelly would like to know is income that you discussed on qualifying for tax deductions based on rental income or your regular job income oh okay good question that's it's all everything I'm talking about right now is related to your property only except for how you compute your total income to figure out what your modified adjuster gross income to whether you can take that twenty five thousand dollar deduction but everything I'm talking about rental income rental expenses relating to the property that's how we come up with the property income minus depreciation that's how we got the six thousand dollar loss now you've got to add up all your income maybe that's the question all your income from all sources to figure out what you're up you know modified adjusted gross income is to see if you're below 100 you get the full twenty five thousand dollar deduction potentially over 150 you don't get anything or maybe you're somewhere halfway between and you get partial uh we also have another question would adding solar to a rental home be capitalization or repair uh great question solar solar would be uh capitalized uh you could get solar tax credits which could be a benefit those rules keep changing in terms of how much you can deduct but it's still it's still available so yeah that's a capital expense Ian says when you move property don't you get tax Ed on the amount that she aided throughout the years and if so then what's the benefit of depreciating oh great question I'm going to hold on that one because we're going to get to that but that's called depreciation recapture and I'm going to give you some strategies there the answer is yes yes you have to pay taxes on that all right and then we'll keep this one for later as well Charles wants to know what about using depreciation at the full disposition of an asset um okay and then another one what do you think about purchasing a house intended for personal use as a vacation property and then when it's vacant to have it as an Airbnb okay I like that I've done that so what what I've done is I have done a 1031 exchange from one property into a rental property in Hawaii that ultimately became a vacation rental property right so so in terms of how you go about doing that it's honestly it depends upon your accountant I mean the best thing to tell you is you sell your rental you buy a rental it's a straight rental right for a year or two and then you turn into a vacation rental does everyone do that no absolutely not and in some cases vacation rentals are highly profitable right so it hardly looks like it's a vacation rental and the truth is as long as you use it for 14 days or less it's still treated as a regular rental right once you use it more than 14 days now you've got all kinds of different rules and the vacation rental rules and all that sort of thing but I guess the point is when you do the exchange from one property to the other it needs to be rental property to rental property not a vacation rental Jeff says are condos or town homes a bad investment what's HOA to consider ah great question no condos can be great Investments it just depends right HOAs I've seen fifty dollars I've seen two thousand dollars oh I own one I own both of those properties my home my residence has a 50 HOA it's just for some shared Alonso stuff uh my Kauai property has a two thousand dollar a month uh homeowners is that excessive yeah seems like it but is that the most profitable property I've ever had yes right so it depends everything is relative right it depends upon your rental income versus your expenses and whether this is really going to pencil out great great question though I love condos they can be a fantastic investment a condo can generally allow you to get a property that maybe is a little bit nicer maybe than a single family home all things being equal right as a general rule Victor says what are your thoughts on the on the approach differences in in Penn rental at a time versus before buying another versus leveraging up and buying properties more frequently uh well it's a great question so the the buy the leveraging and buying more properties you you will grow your wealth quicker it's just more risky and I got caught in that trap myself with the Great Recession right safer safer to pay those properties down or at least have a lot of equity before you start doing that it's up to you it's it's personalized and I would say it this way for me I mean maybe think about this way if you're younger right and you want to grow your net worth you might be willing to take more chances if you've already got a nest egg you're close to retirement or in retirement I wouldn't be doing a lot of Leverage I would probably be doing some because that does increase your rate of return but I just be careful on that Kelly says my son is the one that's getting into buying and renting properties should he want it at this time he only has one rental right now uh good question uh the answer is probably yes although if your son is Savvy and excuse me knows how to use TurboTax that can be fine but I got to tell you the passive last rules that I sort of alluded to are pretty complicated so you might want to get some help there plus you your son may be missing some deductions that he might otherwise be entitled to so yeah I would say probably yes okay vivec has a number of questions which I know that you'll be able to answer after the webinar but one that he asked um is what if any tax planning opportunities or efficiencies exist for setting up a multi-member LLC with your spouse multi-member LLC with your spouse so multi-member LLC with only your spouse is still considered to be a single member LLC husband and wife are one in terms of LLCs so the reason why you do an LLC whether it's lots of people or one person or husband or wife is for liability protection it does not do a thing for saving taxes but it does give you liability protection and I'm not an attorney but this is my understanding and this is what I've done is you buy an LLC you put the property in the LLC something goes wrong with that property where you're negligent you've done something wrong you get sued you're limited to right the the person suing is limited to the value in that LLC not all of your assets now probably oversimplified it because there's ways to pierce that but that's the idea behind llc's is you isolate a property against your other properties or you isolate a property or two you can put multiple properties in LLC against other assets that you have Tom would like to know what is the best way to tap into the equity of an investment property in order to invest in another investment property great question so um refinance which we've already talked about so refinance is you get a higher loan than what you had before it's a little tricky right now because interest rates are higher than what we had been used to paying but for a number of years you could just refinance in some cases get a lower rate take a big pile of cash out buy another property with it that's a Surefire way to make money in real estate as long as long as properties go up which they don't always so just be aware of that I'm going to get into maybe that's a good segue into the next segment which is what happens when you sell right when you sell you rate a cash out right you you want to you're tired of the real estate and there's four main choices I would say one is you can do an outright sale and most people that own real estate already get that what an outright sale is right so an outright sale is you put the property on the market you sell it you end up paying taxes on the game simple as that and how much tax do you pay well you got to figure out what the gain is so the sales price I'll go a million dollars let's let's go into the million dollar range sell property for a million dollars let's say the closing costs are 10 I'm going high just to make this a simple example 10 closing costs hundred thousand dollars so you net nine hundred thousand that's what we call the net sales proceed so that's your starting point from the sales side from the cost side what did you pay for the property okay well I paid four hundred thousand dollars for it okay so nine hundred thousand minus four hundred thousand that sounds like a five hundred thousand dollar gain except you'd appreciated a hundred thousand dollars right so that depreciation has to be recaptured so that hundred so now it's not a five hundred thousand dollar gain it's a six hundred thousand dollar gain hundred thousand is depreciation or capture and 500 000 is the gain itself right so that's so you can do that you can sell a property just pay those taxes depreciation recapture is generally 25 that's the rate the capital gain rate could be zero right it could be fifteen percent could be twenty percent depending upon your bracket and you may be subject to the net investment income tax which is another three point eight percent something like that for those that are just trying to do a quick back of the envelope calculation what if I sell this property how much tax do I pay well try to calculate the net sales proceeds minus your basis and at least in California about a third of that is going to the government between the federal taxes and the state taxes now that's that's not exact it just gives you an idea if you've got a million dollars of gain you can probably expect to pay 330 000 plus or minus federal estate now you may live in a different state maybe different but that's kind of how I think about it but realize it's not just what you sold it for on a net base and you cost you also got to factor in that depreciation recapture do you still want to depreciate well first of all you have to depreciate it so it's not a choice if you don't appreciate it the IRS says we're going to pretend that you did and still tax you on it so that's not an option but secondly you always want a tax deduction early before right because time value money the tax deduction is more important today than it is tomorrow so you get a tax deduction now right and then you may pay it back later or you may not right you may not pay it back later because maybe you're going to do a 1031 exchange or a charitable remainder trust and you know what if you pass away with an asset like real estate it gets a full Step Up in basis for the Next Generation even your spouse right so you own that million dollar property it's got that six hundred thousand dollar gain in it you pass away your spouse now it's if they bought it for a million dollars so if you can take the depreciation now and never have to pay it back that's the best of all worlds I'm not suggesting that dying is a great strategy but I want you to know what the rules are because I get this question all the time you know my my mom is 85 she's got all these properties she wants to simplify before the assets go to the the kids the answer is no manage them yourself because you're going to get a step up in basis right anyway that's outright sale installment sale is it's the same idea except you're spreading it over time so installment sale generally means I have a free and clear property and instead of getting all my money at one time I'm going to pretend like I'm the bank right my million dollar property I'm gonna sell once you give me 200 000 or 300 000 cash and I I will loan you the rest at an interest rate blah blah blah so I'm only going to pay taxes on on the 300 000 that I actually got okay not the whole tax right so that's an installment sale that's tricky though installment sale if you pass away with an installment note there's no Step Up in basis number one and number two is you have very little control over it because if the person refinances with a bank for a better interest rate and they pay you it's all taxable in that year so you don't see a lot of people doing that but that is it is an option 1031 exchange this is much more common 1031 exchange is when you sell a property and you defer the gain into the next property right purchasing a replacement property okay so you have to find a like kind property you sell one property you buy another one okay like kind is pretty generous I can sell a condo and buy a house I can sell a house and buy an apartment I can sell an apartment and buy three single family homes right as long as it's a rental property rental property for rental property income property for income property that's what like kind is so I sell the property great and then I've got that starts the clock as soon as the close of escrow starts the clock I've got 45 days to identify the property that I want to buy and the IRS actually allows you to pick three properties in the identification process so you actually have to go to your exchange intermediary and tell them what three properties you've selected and exchange intermediary is a middle man middle woman middle person right that that basically is holding your money until you buy the replacement property and I'm not going to go any deeper than that it's more complicated than I want to get into right now but it's a third party that holds your money you have to tell them what what three properties that you want to potentially buy and then you have six months from close of escrow to actually buy one of those three properties okay so one of those three properties you need to buy if you don't if all those three properties fall through you have a balloon exchange you're going to pay the full tax on that so I've done three or four exchanges I guess in my career all of them were successful one was to the wire so um but at any rate it's it's very doable but you just have to be aware of the time frames and Andy before we get to our questions I got one more strategy and that is um what do I have here yeah this could be a charitable remainder trust we also call it a tax-exempt trust so this is where this is more complicated I'm just going to give you a little flavor here right you set up a charitable remainder trust you put your property into the trust so it's a contribution into the trust the trust sells it so this is you only do this when you want to sell a property the trust sells it and pays no tax whatsoever because it's a tax-exempt trust and you get a lifetime earnings stream from this trust and the way it's designed is not only do you get the income but you get 90 percent of the principal over your expected life or if you're married expected joint life so you get 90 percent of the money back right while you're didn't pay any taxes up front save a higher Investments to higher level Investments to be able to invest to where you get money back yourself and the balance of whatever's in that trust when you pass away goes to charity okay so in other words uh it's it's ultimately for charity that's why it's tax exempt but you're getting most of the assets back yourself you're not paying an upfront tax and because it's expected that 10 of the assets go to charity you get a 10 tax deduction in the year you do this so that million dollar property you get a hundred thousand dollar tax deduction on your return in that year so this can be a great strategy a little bit more complicated I couldn't dive too far into that um one more quick thing when you sell your home I think most of you know this 121 exclusion you get 250 000 exclusion per person if you're married five hundred thousand that means that you have gain that you don't have to pay tax on but you must live there and own for 24 months and so does your spouse to get the full 500 000 right I've had people say you know what I should I get married to get the full 500 000. well uh as if if you're if the person you want to marry has owned with you and lived in for two years you're fine but just the fact of marrying doesn't really do much of anything if you move uh or or unperceived circumstance happens you might be able to get a partial exclusion okay so I think I got a lot in in 44 minutes so uh what what other questions do we have Andy I know many people that are watching today still have a number of questions now is the time to schedule a free financial assessment with pure financial advisors right now to see how real estate income might fit into your plans for retirement I've just put a link into the chat so that you can click that link and schedule it for the time and date that works for you let an experienced Financial professional on big L's team at pure take a deep dive into your entire Financial picture you'll not only learn what part real estate can play in your retirement income plan but also how to choose a retirement distribution plan that's right for you how to legally reduce taxes now and in the future minimize is your risk maximize your return legally reduce taxes now and in retirement maximize your Social Security and you'll also learn how to protect yourself against Market volatility Rising inflation Rising health care costs there's no cost and there's no obligation it's a one-on-one comprehensive Financial assessment that's tailored specifically to you pure Financial is a fee only financial planning firm we don't sell any investment products or earn commissions and pure Financial is a fiduciary meaning that we are required by law to act in the best interests of our clients pure financial advisors has four offices in Southern California as well as offices in Denver Seattle Chicago but you can meet with any of our experienced Financial professionals online via Zoom just like this no matter where you are just click the link in the chat schedule your free financial assessment for the day and time that works best for you go ahead and click that link and schedule now now let's get back to those questions we did have a few on um 1031 exchange Christie said and I think you've already answered is there a time limit in reinvesting your 1031 exchange for example if I decide to sell and reinvest in a year is that allowed um yeah your time frame is six months unfortunately this is uh set in stone if you miss it by a day you're you're down right so you have 45 days to identify so in other words the three properties now there are exceptions to that I just said there's no exception here's one I guess there's exceptions to everything in some cases you want to buy more than three properties with the property you've sold and there are ways to go ahead and name more than three properties but for practical purposes almost everyone uses the three property rule which means you identify three properties right and then within the 45 days and you have to make sure that is closed escrow closed within six months of the close of your other escrow very very important I've done this like I said three or four times my best experience and this is what I recommend when you sell your property put another property in contract right away right so you have plenty of time if something goes wrong with that property you've got three more properties that you can name the 45 days so that's that would be my strong suggestion here's another suggestion is maybe you name two properties and maybe the third one you do like a DST Delaware statutory trust which qualifies for 1031 exchange status and there there's more flexibility like if the other two properties don't pan out maybe you can at least do that maybe it'd be long-term investment maybe short term but at least you've done your exchange you can always exchange out of that later depending upon what the time frames are for their that Delaware statutory Trust another 1031 exchange question people are excited about this concept um for a 1031 exchange can per a person sell the first property owned by me and use funds to partner with someone on a new Rental Purchase uh yes so in other words remember I said like kind needs to be like kind but you can sell one property and go into a fractional interest on another property which I think is what you're asking because you want a partner to come in bring their money you've got your money as long as your money it can't be in your hands here's another thing you can't touch it like if it comes to your bank account it's already a blown exchange it has to go to a qualified intermediary so that you don't have access to it and then the qualified intermediary sends it to your escrow you don't have to buy the whole property you could buy a fractional interest with your with your friend so just be aware of that and I guess it almost goes without saying but I'll say it anyway your qualified intermediary make sure they're bonded right because they're holding your money for up to six months so make sure that you can get your money back if need be not just the guy or gal down the street that just opened up a shop don't do that uh here's another one for 1031 exchanges uh sell a condo buy raw land for investment purpose to build a home and rent it out does that qualify for a 1031 exchange yeah sell rental buy a land for investment purposes that can work um and in fact there's different rules on construction which I won't get into now but it can work uh it's what what can blow this thing though is is like like for example if and people try to do this it's like they sell a property and then they buy another property and they build their own home on it so it in that particular scenario sell a rental property buy a land build a a structure on it rent it out rent it out for a couple years before you move in I don't care what you do after two years you can kick out the tenant and move in yourself and by the way this is what a lot of people do that have an expensive residence it's a hassle I shouldn't say a lot of people do some people do it they sell their expensive home they buy something that was 500 dollars cheaper than what they sold so 500 000 is the blown exchange if they're married but they get that for free right the section 121 exclusion you can take that but the rest of the proceeds they do in a 1031 exchange it almost May Boggle your mind but you can do the 500 000 residence exclusion and a 1031 exchange on the same property but the exchange part that may be your future residence but I don't want you living in that for two years you're going to have to have a tenant because I want you to sell a rental or a rental right Sylvia would like to know and I already know where this is going to go what do you think of holding properties in an IRA Big Al uh not a fan in fact that was something I was thinking about when I was much younger well this is where I have the money why not do it there and it's like well when you think about it I just took a I just took a piece of property that's highly tax advantage and I threw away every single tax advantage there is in an IRA so number one I can't there's no depreciation right number two there's no capital gain right so anything I get out of the IRA is taxed at ordinary income number three I pass away the kids get it there's no Step Up in basis right uh it's and furthermore I won't go into the reasons why but you can't really have debt inside of an IRA there are some exceptions but in most cases you can't have debt in an IRA so it kind of blows the ability to use other people's money so don't do it Roth IRA I'm okay with that regular Ira I do not recommend it all right these both of these questions are are very similarly related so I'll ask them both at once Jordan says I'm a first-time real estate investor where do you suggest that I go from here to expand on what was shared today and Kelly says are there any books out there that delvinch real estate investing that you would recommend ah great question um I would say yes there are great books out there I'm probably a little behind in the books that I read I would just Google it or talk to friends of yours that are more recent Real Estate Investors and find out what books they like focus on residential right don't don't worry about commercial or apartments you may graduate to that someday but focus on residential and depending upon where you where you live think about those neighborhoods that are kind of starter homes that are working class neighborhoods that's kind of where you want to focus on I'm not talking about neighborhoods where you don't really want to go at night right you don't have to you don't have to do that there is a there's a great market for that if you're willing to but no I'm just talking about that the bread and butter homes hard-working people that have families that's kind of neighborhoods that you want to focus on all right vivex Steve Steve tells everybody else that who has put in questions we're not going to have time to answer those today thank you all so much for joining us if you do have more questions go ahead and hit that link in the chat for your free assessment I've also put in the contact information so that you can call or email if you would like to have Big Al answer your questions via email you can go ahead and send them to info pureofinancial.com that is in the chat as well Big Al thank you so much for taking the time today to walk us through we didn't get a chance to hear the story about somebody um fixing their motorcycle in the living room of your apartment I was really looking forward to that one yeah well quick quick story when I was first a landlord and couldn't afford having a property manager and I didn't do the proper checks I ran it to this person turned out to be a complete dud I tried a victim I didn't even understand the process they knew more than I did but when I finally did evict them the new carpet that I bought they had parked their motorcycle in the living room I had grease spots everywhere I learned a lot I would say you probably learned more on your mistakes than you do your successes thank you so much everybody for joining us and we will see you again next time have a great day

Channel: Pure Financial

Views: 1,609

Keywords: real estate investing, rental property, investing in real estate, real estate, rental property investing, passive income, rental properties, how to invest in real estate, income property, real estate investing for beginners, Pure Financial, Pure Financial Advisors, purefinancial, pure advisors, pure fin, pure finance, pure financial advisers, pure finacial, peer financial, Certified Public Accountant, CPA, fiduciary, fee-only, financial planning, retirement planning

Id: KYnMq5xDUzs

Length: 57min 17sec (3437 seconds)

Published: Wed Jul 12 2023