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ADPI_034: Four Amazing Tax Advantages Of Real Estate

Oct 16, 2018


Episode Transcription:

Hey hey what's going on guys? Welcome to the active duty passive income podcast. Today I've got an awesome lesson for you. It is four tax advantages of real estate. Let’s dive in.

Hey hey freedom fighters welcome to the active duty passive income podcast. The only place where military members, veterans and their families learn how to build wealth through real estate investing. I'm your host Mike Foster and I'm here to show you how to stop wasting your benefits. Now get off your ass, step up to the firing line and make ready for today's lesson. Shooter stand by. 

What's going on guys welcome to the active duty passive income podcast. I'm really excited for today's lesson. Because it's on a topic that we don't really talk about that much right and the reason why I don't talk about it as much is because I'm not a tax professional. I don't claim to be and I'm actually learning a lot more about taxes as I progress in my own personal investing. But it's something that inspired me early on and I definitely want to do a justice. So I'm going to teach you four tax advantages of real estate investing. Because it is amazing okay and again before I go into this, I want to call it to really really reiterate here I am NOT a tax professional.

Okay I'm not a CPA, I do not know the nitty-gritty specifics of all these different things. But I do know enough to explain to you the magic and the reason behind it. So I'm going to do my best to try and relay all the awesome stuff that I have learned over my years of investing okay. Also real quick before we start I want to give a quick shout out to Cadena Mickelson. He posted on the Facebook group just the other day that he got an offer accepted and he is starting his journey towards financial freedom.

Hey best of luck buddy that's awesome news, you can do it. There are so many resources available to you and if you need any help, let us know we are here for you every step of the way. Alright so check this out all right. Number one, depreciation. What is that? It is amazing okay. It is the government telling you that your property will lose value over time because of the wear and tear over a long period of time and yes that kind of sounds counterintuitive. because when you think real estate right you think my property is going to appreciate in value over time and my property value will go up that when I'm looking to sell,  I will be able to sell for a higher price than when I bought it right theoretically is what we think.

Yes that is true right, your land appreciates over time. But the building right the structure that sits on that piece of land does not. It actually loses value over time and the government understands that. The longer you have a structure in place the more wear and tear it's going to have whether from the weather or from the tenants coming in and out right, its general use whatever right. Just like any business right they treat that as a depreciating asset and they will give you that back over time okay. Now I mentioned something here that I also probably should have clarified at the start here. Right the government treats your investments right or your assets as business assets.

Why is that important? you need to have your investments in some kind of a business to take advantage of most of these tax advantages that I'm going to talk about okay and the reason why that's important is because these tax advantages exist for entrepreneurs to not only create more jobs, but to create more housing. Right that's why real estate is amazing. That’s why a lot of the congressmen and men and women a lot of our officials invest in it. Because they understand that the benefits that you get from it are incredible okay. So depreciation is one of those things and one of those things that you'll only really get if you have it incorporated in some kind of entity whether it's an LLC, an S corporation, a C corporation whatever right. So you know you definitely want to make sure that you have your stuff incorporated and this is talking about rental real estate guy’s okay.  

All right so continuing on. Depreciation is absolutely amazing and not only that, not only are you able to depreciate your house; I'm sorry your rental property for an extended period of time. I believe it's like twenty seven point five years or something like that right. But they give you that money back from what you spent on it over that time. So let's say you held your property for thirty years. Well for twenty seven point five years you will begin to get a portion of what you spent on that property back in taxes every single year. That’s amazing right and not only that too, but you can depreciate more than just that that property right.

I mean you can depreciate different parts of the property and this goes into something called cost segregation. It’s something that's very very advanced, not something that I'm knowledgeable on. So I'm not going to go into it. But I'm going to briefly scratch this up scratch the surface and say that you can depreciate more than one part of the property at the same time right. Because while you're building right may only say okay over twenty

Seven and a half years; we'll give you this money back. there may be certain things that you put into your building like the granite countertops, like the flooring, like the roof right that maybe have a shorter lifespan and so those things depreciate in a much quicker rate and you'll get that money back a lot quicker than you would the overall purchase of the dwelling. Hope that makes any sense. Again I'm sure there's going to be some kind of person that I meet that I would love to deep dive the cost segregation topic a lot further.

So look forward to future episodes on that. I'm always looking out for folks. If you are listening to this and you are super knowledgeable in that aspect, please come talk to me and let's talk. Let’s see if we can schedule you know a podcast session to go out and educate folks a little further. I'm all about it okay.  

Next one business expenses. I love this topic guys. Because this right here is what inspires you to make investing fun. It’s not only great because you get a lot of deductions and things that you wouldn't otherwise normally think you could. But it's great because it allows you to build a lifestyle around investing and that is it's inspiring, it really is right. So when you think of business expenses as deductions from your taxes, you think what I need to do in order to operate my business, in order to promote growth and success for the company right.

Well let's just go down the basic list of operating expenses for our rental properties. Obviously you need property management right, obviously you need to pay insurance to get insured right. Obviously you have to pay interest on whatever loans that you have and then taxes of course you need to pay. All these items are deductible okay. Your standard operating costs for your property, those are deductible. But let's go a little further, let's dig a little deeper. Before we even get to the phase of buying a property and holding it, what do we have to do? We got to do a lot of research right. Okay so let's say your research is driving around your area. Well guess what? Some of the gas that you expend in your car is now deductible right. That’s amazing, that's amazing. Okay and I hope you see where I’m going with this.

Let’s say you're investing out of area, out of state and you want to go you know try things in another market. Well now guess what else is deductible? Your travel, maybe it's your flight to another state or if you drove it's your gas right? Maybe it's your hotel expenses that you incurred while you're out there right. All these things are amazing. Some of the food that you get while you're out there. I'm telling you guys like you can create a lifestyle around investing that allows you to deduct a lot more than what you think and it's incredible. Now understand that there are rules and guidelines that you want to follow when doing this okay.

You don't want to just go ahead and deduct everything that you're eating and everything that you're spending in terms of travel. Because you know oh well at some point I thought about investing here, so I just went and spent money. No that's not how it works. All right you need to actually have you know documented proof that you're doing business. So a good way to deduct a meal expense and this is something my wife and I do.

We'll go out, we'll eat and we'll talk about certain investments that we're looking to make whether it's throughout the year or within a specific time frame right and we'll actually you know talk about what we're looking to do to grow our family business and we'll document the minutes per se right all the key points that we talked about on the back of our receipt and then we'll take a picture of that receipt both sides and we keep it really file it in our records.

So that come tax time, we can prove that we used that meal right or that expense whatever it was to benefit our business right and now obviously you know we're not going to go out there and every single time we go out and we want to go for a little date night or a meal or whatever you know we'll go out and talk about business. No that's not always the case. But a lot of times it is and you'd be surprised right. When you and your spouse go out, if you guys find yourself talking about you know business and somewhere then you should definitely be documenting it. Because why not deduct something that. Even if it's only a little bit right. I mean that's great.

Every little bit adds up. Especially when you have a business account then that comes out of a different pot of money and you're left with more over in your personal lines. Which is great. But understand that you know in the case of audit you want to make sure that you have all your ducks in a row and everything kind of covered okay. That’s why we recommend that you document everything just so you keep everything nice and organized in case you need it.  

All right next one number three. Let’s talk about the 1031 exchange real quick okay. I know we have mentioned this briefly on a lot of other podcast episodes. I'm going to do a little deep dive here and I'm actually going to get a professional in on this to cover this a little bit more. Because this topic is so incredible. I want to make sure everyone understands it, like everything about it. just so that way in case you're faced with a situation where you might want to use it you can go ahead learn a little more on it and then implement it in action okay.

So 1031 exchange. basically with section 1031 of the US Internal Revenue Code, they allow you to sell your property and to wrap whatever gains that you received right any of that appreciation and interest that you received over the time that you had it right and when you sold it, anything you gain an interest you can wrap that into another purchase tax-free. You can wrap your perch, you're sold property into another purchase tax-free okay. I wanted to repeat that because it's incredible. Let’s say you bought a property in 2010 for $100,000 and in 2015 you sold that thing for $300,000, you can wrap the proceeds from your sale into the purchase of another property tax free.

It’s amazing okay. Alright so how does that work because obviously that's what we need to know right? What you need to do is you need to find what's called a qualified intermediary okay. That person is going to be someone that you sell your property to first and then that person sells the property to your buyer. The reason why there has to happen like this is because that money that you receive from the sale of your home cannot go in to your bank account. Let me repeat that, it cannot go into your bank account.

Once it does it is a taxable event and you will lose your qualification for this 1031 exchange okay. Now can you theoretically put the money into another person's account? Like a friend, do you have to find a qualified intermediary? Yes I think this is true however you run the risk of you know what happens if that person right it has a creditor that is out for them to kind of grab some of their money and they end up grabbing your cash. Well guess what? You lost it right. so in order to you know eliminate all the extra variables that comes out we do not recommend you just find a friend to have them hold your money and then you know give it back to you in order to put it into another investment okay. We don't recommend that.

Find a qualified professional right or in this case we're qualified intermediary that is knowledgeable and experienced with 1031 exchanges. Go do with a company that's been doing it for a few years okay and maybe make sure you shop around too. Because this could get a little expensive. But find someone that will hold your money from the sale and then put that money into the property that way doesn't ever touch your account and it is not taxed okay. That is important. Now there are some rules that you need to follow okay.

These are rules are set in stone okay, they're non-negotiable. so timeframes that are required from you, you have 45 days from the time you sell your property to identify another property that you want to buy, does that make sense? Okay so if you sell this property they'll give you 45 days to identify another property that you want to buy.

Now that is important. Because you have 180 days from again the points you sold your property right to close on that property that you've identified okay. Now it's very very important that you maintain these two timeframes okay. Because if it falls out of this time frame, then you lose the deal and your money is now taxable; does that make sense? Okay so it's kind of helps to have an understanding of a market. Like let's just be honest here. Helps I'll have an understanding of the market right before you go and you look to sell your property. If you want to do a 1031 exchange, at least know the market of the area you're looking to invest in and you can find a few different properties that will make sense for you okay.

Now there are a few rules with the amount of properties and how you buy these properties to that you need to understand. But once you have your market identified it's easier to go into that market and to find something to qualify within the time frame and you'll be good to go okay. Also make sure that you have financing in order. Because financing can be a huge thing that delays the timeline and can push you out of the window all right, just keep that in mind. Now let's talk about the rules for properties here. So the first rule is a three popery rule right. So if you identify three properties that you are looking to buy with your 1031 exchange, that's great.

Okay now the portfolio these three properties have to be equal or greater value from what you are selling okay. As a matter of fact to be honest with you it has to fit that across the board anyway. So let me just go ahead and blanket statement that. In order for the 1031 exchange to qualify you have to purchase something that's equal or greater in value to what you sold. Okay so again in that example if you bought a property for 100,000 and then you're selling it for 300,000, you have to buy something that's at least 300,000 or more in value.

Now again has to fit under these three rules okay. So keep this in mind. Now for the three property rule. Those three properties can be worth however much that you want it to be so long as it's again equal in value or greater okay. So now let's say in that example that we use if I identify three properties that were both worth well that were all worth three hundred thousand each right as in a total of nine hundred thousand, I can go ahead and buy that. Because it's three properties.

Let's say if I wanted to buy three properties that were two million each, now you are looking at six million; you can go ahead and buy that and you can invest that money in. its three properties can be however much you want it to be as long as three.  

Now here's another one. Okay the two percent rule alright. I'm sorry the two hundred percent rule; apologize. Two hundred percent rule means it can be more than three properties right but those three properties, I'm sorry those four or more properties cannot be more than two hundred percent of what you sold okay. So in that example right I sold a property for three hundred thousand, I cannot buy four or five properties more than that $600,000 value. Does that make sense? Okay now again this is just this rule.

I'd mentioned there are three. okay so the third rule is called the ninety five percent closing rule and it gets a little bit complicated and unless you're you know a Cash Money buyer with I'm sorry cash money, unless you're a cash buyer right and you're a very very experienced you know real estate professional you know this probably is not going to be something you would even have to worry about. But if you wanted to buy more than three properties and you wanted to buy more than that two hundred percent, you can buy an unlimited amount of properties. But here's the catch.

You have to close on ninety five percent of them right. So if I wanted to buy a clip of 100 properties and let's say each of they were 100,000 right okay, so I'm looking at ten thousand. I'm sorry ten thousand looking at ten million right; I can buy those 100 but I have to close on ninety five of them. Make sense? So again you can get convoluted and it's very very very important that you find a professional it's qualified in order to help you with this exchange. But those are the basics of it and if you end up in the situation where you want to sell your home and wrap the game that you have tax-free; you can do that. But you have to make sure that you follow these rules and get a qualified intermediary to hold your money.

Now real quick before I move on I want to cover your 1031 exchange does not apply to you if you are selling your primary residence okay. If you're selling your primary residence and you have lived in it, I think it's up to five years. I don't know don't quote me on that. but you can sell your home and automatically not have to pay taxes on it so long as your gain right what you've gained in value, it doesn't exceed two  hundred and fifty thousand as a single person or five hundred thousand as a married couple filing jointly okay. So keep that in mind. But outside of that if you're looking to sell any of your investment properties, 1031 exchange is the preferred way of investing. This isn't for everyone okay.

So understand that it's not for everyone in everyone's situation. Talk to your CPA, talk to a qualified professional. Make sure that you understand everything that's getting involved at the process and whether it's better for you or not. But hey this is something that can be a game-changer for you in the investing sphere okay.

All right next and the last one. Being a real estate professional, this is quite possibly one of the best things that you can do as an investor if you do not have a primary job that you're working anymore. Let’s say you're getting out of the military or let's say if your spouse right, if your spouse doesn't have a primary job maybe they're working from home or maybe they're just staying at home alright. Staying home mom, stay-at-home dad, taking care of the kids or just take care of the house alright. Stay-at-home spouse is cool.

You know this could be something that you should think about. because what you do is it allows you to take amazing tax benefits from just operating your business as a real estate professional as your full-time job if that makes sense right. So here are the rules. You must accumulate over 750 hours over the working year okay. That is a lot easier to do than you think it is okay and real estate must be your primary occupation. Now what does this mean? Let’s say you are a stay-at-home spouse and you are a realtor.

Because you got your Realtors license. Real estate is your primary profession that counts okay. Let’s say you are a contractor or a property manager right and that counts towards your 750 hours working in the real estate field okay. If real estate, if any aspect of real estate is your primary profession and you are managing your investments; you are allowed to take advantages, tax advantages

From all the losses you incur over that year. they will deduct that from your income and you can see a heck of a lot more money back at the end of tax year because of all the things you're able to take advantage of. Again gas, meals, right your expenses; all this stuff right. I mean all the stuff that I mentioned in the business expenses before above.

All right those are things that you can take advantage of and it's amazing. Because again real estate becomes your primary occupation and so the government will treat you as a real estate professional and therefore you are allowed tax advantages and deductions and write offs that you would otherwise normally get if you had a different occupation right. Just this one is geared towards a real estate. Now amazing guys, amazing stuff.

I hope that these four things have somewhat struck a chord inside you that gives you that motivation to go out and to learn more about these certain things, these topics, like legal like tax you know all these different things right. There’s an amazing book as a matter of fact there are two amazing books I'm going to recommend here. Both by the Rich Dad Poor Dad guys, Tom wheelwright right, he is the Robert Kiyosaki's tax advisor.

Came out with an amazing book called tax free wealth. You definitely need to make sure you read that. If you want to hear anything inspiring and motivating about our tax law and how real estate investors really use tax to boost and to jumpstart their investing careers; you definitely need to read that. Tax-free wealth by Tom Wheelwright. It’s in the show notes. Also the loopholes of real estate investing by Gary Sutton.

That one is another amazing book and both of these things will just transform your mind and really give you that structure that you need to get started. I'm telling you reading is amazing. because there are so many awesome real estate pros out there that are you know crushing it in the game and they pass on knowledge on you know how to do things right. Like a model okay.

Another great book I'm going to just throw it out there just because I mentioned models. It’s called the millionaire real estate investor by Gary Keller. All of these books will be in the show notes, I want you to go check them out. But understand that when you have a good model, a good system in place; it's so easy to duplicate and it's so easy to increase your success. Because you have those bare bones in place and it's like plug and play right.

So if you understand okay before I get started, I do want to have a good tax advisor, I want to have a good legal team in place right and even just those two things alone; you know that one you're not going to leave any money on the table. Because your tax advisor will be able to educate you on what expenses that you need to take account for and document. so that way when you come back to filing your returns at the end of the year; you can claim every little thing that you can to get the most value and to get the most money back at the end of the year okay.

So leave the money on the table is important. Also legal team to make sure that all your paperwork, your titles, all that stuff is in order so that saves you less headache okay. You also want to make sure that your incorporation setup right and everything is just kind of structured properly. So that way you're protected against you know lawsuits or claims or whatever alright and also that your entities are set up properly so your money can move through them without any repercussions from the IRS okay.

So amazing things that you need to have in place, amazing books that you need to go check out okay. Just go check them out all right. Make sure that you deep dive them you take notes all this stuff and then you know go out and invest. Guys I'm telling you all this knowledge means nothing if you don't take action all right. There are so many things out there for you to read and see and to learn and you're never going to stop learning okay.

You’re never going to stop learning. I don't care how long you let your analysis paralysis you know prevent you from taking action. You will never stop learning. What you need to do is you need to start somewhere okay. Even if you decide that you don't want to get an LLC for your first rental property. Okay it's not the end of the world right. Let’s hope that nothing bad happens to you and you end up getting setback. But you know a lot of people start out without one. I did okay. I did. I started out my rentals without LLC's and you know what I learned that I am at a lot of risk.

So I've put the things in place in order to you know to get things structured properly and put them in LLC. So that way I not only cover my butt just to make sure that you know nothing bad happens. But also so I can take advantage of these amazing tax benefits that otherwise are not offered to me, because I didn't have them in a business account okay. So I really hope that you guys take some of this right. I know I only scratched the surface. But I hope you take this and you run with it and look forward to hearing from some tax professionals that are going to come help us deep dive some of these complicated topics and to really dumb them down to make sure that you understand at the very least what questions to your tax advisor when you go for setting yourself up okay.

All right all right all right thanks so much for listening guys. I hope you've got a lot out of that lesson. Man I love love love the advantages of real estate investing. Because it shows you how to empower and change your life around it. Anyway thanks so much for tuning in guys. Be sure to catch future episodes on the podcast. We’ve got a few amazing interviews coming up, it's going to be great. Also check it out we've got a lot of things happening. We’ve got a book launching November 2nd. It is amazing.

Make sure you check it out. It’s our military house hacking 2.0 eBook. We’ve got amazing minds that came together to put that book together. It’s going to be amazing. hey also if you're in the Hampton Roads area, we've got another meet-up happening next week on the 23rd; it's going to be at Keegan's Irish pub again. It’s going to be a great time. Make sure you're there. Because we have a lot of awesome stuff that we're going to talk about. Can’t wait. Catch you guys over there, Mike out.




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