Episode Transcript
[00:00:00] Speaker A: I'm always getting these tax questions from folks.
[00:00:03] Speaker B: As a lawyer, being an investor is the way to go because that entitles you to more deductions and more write offs.
[00:00:13] Speaker A: Should I go ahead and bite the bullet and do the S Corp LLC, or does it make sense, or do I wait till I'm making more money?
[00:00:23] Speaker B: You're making under 100k when you're making under 80k in income, whether you're an investor or not, whether if you're just a business owner, you may not need an S corp. People think, oh, having an LLC is going to help you attack automatically. Yeah, and people think that, but it's more of a liability protection, equity protection, things like that.
[00:00:42] Speaker A: As you know, before you start doing those things, think and talk to a CPA before you just shift your business model. Yes, because there may be things you need to do to get in a position to do that the right way.
Some tax strategies and tactics. We had Assad Ahmad of Fitbiz CPAs, great real estate investing focused CPA firm based out of central Florida. But they do business all over the country, like a lot of CPA firms do.
Welcome, Asad. I'm glad to have you here today.
[00:01:22] Speaker B: Thank you, Joe. Appreciate the welcome and the podcast.
[00:01:25] Speaker A: Thank you. If you guys ever have any questions about Assad's background, feel free to go over to our master series studio. You can see him over there, you'll hear his whole background story. We're also gonna have links, of course, to the firm down in the show notes. But today we're gonna focus on just some quick strategies and tactics. Questions rapid fire here for Assad to go through, especially folks that small business owners with even more focused on real estate entrepreneurs. Investor entrepreneurs. So, first off aside, can you explain the key tax deductions that small business owners and real estate investors should be aware of?
[00:02:04] Speaker B: Absolutely. So real estate has some amazing tax deductions, especially if you're an investor. So there's a difference between it being an investor and being a simply, simply a business owner. So if you're a business owner, you have different deductions, but as a real estate investor, you're entitled to certain deductions that will help you reduce your taxes, especially if you're a w two. Now, for example, once most of our clients are, one of the spouses is a, is a, you know, a w two earner and the other spouse runs a real estate rental property portfolio. And let's say that portfolio has a short term rental portfolio. Now, generally, the way to get the most deductions is through something called the real estate professional status election. But that requires 750 hours and material participation rules to be met. Those are tough to meet if you are not a real estate agent or a property manager. There are certain categories of real estate that you, if you fall under, you're automatically a real estate professional. But to get the reps, the reps is very hard. But there's a loophole. The loophole is short term rental. So when you are a short term rental loophole qualified individual, you can do something you can take advantage of depreciation. And depreciation is one of the biggest tax benefits that real estate professionals who qualify under 750 take advantage of. For example, let me, let me tell you a little bit about deductions wise. So, general depreciation is done over 27 and a half years. That means if you have a $27,000 property, you depreciate it over 27 and a half years and you get 1000 per year. But with bonus depreciation, which is the biggest tax deduction for investors, what you can do is you can categorize or reclassify certain items or components within your property, whether it be appliances, h vac, flooring, roofing, lightning, cabinetry, into five year, ten year property, and then take 100% bonus depreciation, meaning write it off completely on your tax return.
What that'll do is you'll take that, let's say that $50,000 tax, bonus depreciation, or 50 or $70,000 tax loss against your w two income. You can't write this off unless you are qualified under a short term rental loophole or reps. But once you take that $70,000 tax loss, let's say you were making 202,000, but now your income is 130,000. Right. You're in a lower tax bracket. So instead of paying 30% in taxes or 32 being in the 24 or 30% tax bracket, you're now in the 12% tax bracket, right? You're in a much lower tax bracket. And thus, if you've paid 50, 60 grand in taxes in the, during the year, you're not getting, you're now getting a 35 $40,000 tax refund. This is a very complicated deduction for investors. So it's key to meet with your CPA and consult with them on whether your rental property qualifies for realist for cost segregation, and if you qualify under reps or short term rental loopholes.
[00:05:54] Speaker A: Cool. Cool.
So, short term rentals is a way of accelerating depreciation.
[00:06:01] Speaker B: It is. It is the biggest and the most advantageous way. If you don't qualify for real estate professional, because not, not everybody can. Because that's why we recommend short term rentals. Airbnbs. The rules are a little bit complicated because you do have to do a certain period of stays to qualify under that. You can't just do, hey, 30 days or 100 days, because then that becomes a midterm rental. And midterm rentals don't qualify for real estate professional status. It's the short term rental. Seven days or less.
[00:06:38] Speaker A: Yeah, we're starting to see a lot of people move from short term rentals into midterm rentals with pad split and things like that. Would midterm rentals also.
[00:06:48] Speaker B: They don't, they don't, they don't. It has to be either you, you have 750 hours in reps, or you're doing average of seven days or less. Now that add that. That means you can have more than seven days, but overall period, overall stay during the year has to be seven days or less.
[00:07:07] Speaker A: Wow. Okay. I did not learn something new today. Okay, cool.
What are some common tax mistakes that small business owners and real estate investors make, and how can they avoid making those mistakes?
[00:07:20] Speaker B: Some of the common mistakes that we see are doing different kinds of real estate investments with the wrong entity structure.
You know, people think that just because they have an attorney that made an LLC for them, that they're all good to go, but that's not always the case. For example, we had a flipper who was doing rental, who was doing a flipper client of ours.
[00:07:48] Speaker A: I know where this is heading.
[00:07:50] Speaker B: I'm sure you do. He was working with an accountant who was not real estate specialized. And the entity was a schedule c. All right? It was on their 1040 return.
And you know what that means when you're doing a flip? That means you're actively participating. It's active income. That means it's subject to not only the federal income taxes, but then self employment taxes, 15 and a half percent. 15.3%. And then you're paying, you ended up paying about 35, almost 30% in taxes on just one deal.
And you're making, and he was making about 100. And he just came to us last year, he was making 120 or 140 in flips, ended up paying like over 40 grand in taxes with his old CPA.
[00:08:37] Speaker A: So how did you handle it? What do you end up doing?
[00:08:40] Speaker B: We had to, we had to do some amendments. We did some amendments. We did help put in deductions. And then we changed this entity structure from all c to an s corp, because the S Corp will 100% eliminate that. You know, half the taxes, you get a k one. You take that when you're 1040, and that's what you're taxed on. You take the rest, you know, tax free. But he didn't know that. He didn't know that you could do an s corp for flips. And that would be the best structure, entity structure.
[00:09:12] Speaker A: That's a big question I get as a lawyer. A lot of people come to me and they go, hey, my other lawyer told me that I need five or six llcs and this and that. And I'm going, well, what are you doing? And that's my first question.
[00:09:24] Speaker B: Exactly.
[00:09:24] Speaker A: What are you doing with real estate? Before we determine how many you need and then what types you need, what do most, starting out, then mid level, then high level real estate investors need what type?
[00:09:38] Speaker B: And I would say if it's just a small investor, they don't really need an LLC, especially in Florida, a land trust is fine. If they're a beginning investor, land trust is fine. It's easy. It's simple. Llcs. You've got filing requirements. You've got annual reports, you've got tax reports. You've got other stuff you got to upkeep. It's a little bit more costly. And if you're a first new investor, just do a land trust. Simple. In Florida. In other states, maybe not, but in Florida, because land trusts have certain protections.
[00:10:11] Speaker A: Right.
[00:10:11] Speaker B: It's best to do it at that. If you're a mid level investor, then think about maybe doing, still having land trusts, but also maybe having an LLC, maybe having a holding company, maybe having an operating company and a holding company, maybe having a member manager, member managed LLC in Florida or any state where they're in, and having an LLC in Delaware or Wyoming or one of those states. This is for a mid level investor. Now, this is just, I'm speaking from my personal experience. What I recommend could be different from other scenarios. But, you know, just, you don't have to have five llcs. You don't need. It depends on, again, the equity you have in your portfolio. If you're holding 500,000 in equity versus 5 million, it's a different ballgame altogether. Right.
[00:11:04] Speaker A: So one of the questions often get is, how much money? Does it make sense to say, I'm making $20,000 a year in real estate investing? Do I, should I go ahead and bite the bullet and do the S corp. LLC, or do I, should I, does it make sense? Or do I wait till I'm making more money. What is that?
[00:11:29] Speaker B: It always depends on the type of investment they're doing. So if they're holding long term rentals or short term rentals, keep it in a simple LLC. Don't try to do any s corp partnership elections. Don't do a k one that's not recommended.
If you're gonna do flips again, do an S corp that'll help eliminate your taxes when you're doing, when you're not, you know, when you're making under 100k, when you're making under 80k in income, whether you're investor or not, whether, if you're just a business owner, you may not need an s corp because your deductions on your schedule c are going to be high enough to kind of offset the effects of us doing another s corp return for you. So. Right. I mean, we could. We could tell them, hey, I do an s corp, and we could make money off of them, but I'm not going to tell somebody who's making 60k or 80k that go ahead and do an s corp. Sure, it's good to lay the foundation, but it depends on what kind of investments you're doing, what kind of business you have, and it all depends. That's the key.
[00:12:30] Speaker A: Well, and that's. I think that's. That is the key. Everything always is, and everybody hates lawyers and cpas because we always go, well, it depends.
But that's why you go see them and talk to them. And I'm always getting these tax questions from folks as a lawyer, and they say, what do you think?
[00:12:49] Speaker B: This?
[00:12:50] Speaker A: And if I do that, and I go, you need to talk to your CPA who is familiar with your business.
[00:12:57] Speaker B: Yes.
[00:12:58] Speaker A: And your situation, because they have the history of your tax returns sitting in there in their computer, and they'll know whether we need to do x or Y, and then they'll call me and they'll say, hey, do this, llc or do this, Lanchester, whatever, you know, they're not gonna. And I often have many, I've heard it for 30, almost 30 years now from cpas.
Yeah, but if we do this, they're going to have to file an 1120s or a 1065 or this or that, and the cost they're going to spend on doing that return is not going to be worth it. So that's why I always ask that question.
[00:13:40] Speaker B: Yeah, exactly. Sometimes it's not worth doing the election if it's. If you have all. If you don't have income. Right. Deductions don't help. Deductions don't mean anything. Bonus depreciation.
You have to have w two income to help to help offset your, you know, get tax refunds, right. You can't just get a refund by having zero income and just be doing cost x and paying 910 thousand dollars for a cost seg, right. You got to have income to offset, you know, for the losses to offset income you got to have income. So.
[00:14:13] Speaker A: Yeah, yeah. Because when all this, all these things cost money and it's like you got to think about is it worth the money I'm going to spend, that I'm going to get back on it.
What are the best tax strategies for small business owners looking to grow their business or invest in real estate?
[00:14:30] Speaker B: One of the well known, or not so known tax strategy for a business owner is, you know, when they're early on and maybe they have kids and they, they have young children and they're starting a business, whether it's a shopify, whether it's any of those, you know, online businesses and they're making good money, they're making 150,000 or 200,000, whatever it is, and they have kids under the age of 18. They can put those kids on their payroll, on a payroll under the LLC. You don't need an S corp. A lot of people think you need an S corp to put your kids on payroll. You need to do a w two for them. Absolutely not.
For kids.
There is no, there is no federal income withholdings. There's none of, you don't have to pay taxes as a kid, right? You, you just do a simple, you have a simple LLC. Let's say it's magic global travel or something, something funny. You just 1099 them through that LLC. Give them the 1099, give them $6,000, $5,000, $10,000, whatever it is, give them that 1099.
Not only do you get a deduction for that in the year, you issue that 1099, but you can also fund their HSA, their IRA, their uh, five ESA, cover Dell college savings accounts. Boom. That is. It is a completely under the radar, amazing strategy.
[00:16:02] Speaker A: I know a lot of people always think, well, my kids are dependent, so I get to take them off, you know, my taxes as a dependent, but they don't think of. But here's another way I can reduce my income and still save for my, while saving for my child. Because you're going to be saving for your kids future anyway.
[00:16:17] Speaker B: Anyway. Exactly.
[00:16:18] Speaker A: So why not do it in a way that you're, you're reducing your, your income there.
[00:16:23] Speaker B: Yes, that is one strategy. There are other strategies as well with tax planning. You know, throughout the year we look at your, some people like to do the whole, you know, do the S corp, do the payroll throughout the year where you can, you know, let's say you're making hundred, hundred thousand, 120,000 and you pay yourself a salary of you, you know, let's say 1500 bucks bi weekly. So 3000 a month. So you're essentially only liable for 36 grand for taxes, tax purposes, and the rest of it is pretty much a distribution like a dividend, very tax free. So that is one thing that people look at when they're new starting out. Well, as you get old, as you get more in business, business, you know, more well versed in business world of business, there's more in depth things you can do, especially with llcs and, you know, certain structures to set up llcs and, but tax wise it is, it's, you know, I tell them, listen, give us everything, right. We'll take a look at your home office, we'll take a look at your bills, we'll take a look at your electricity, you'll take a look at your phone, Internet. A lot of it can be written off. Not everything, but a lot of it, if it falls under the criteria, certain percentage can be written off.
[00:17:44] Speaker A: A big question I get are, what are some red flags that the IR's, it's going to be like, well, you're probably going to get, there's a high probability you could be audited if you do this or that. Are there certain things out there that you just go, yeah, don't bother.
[00:17:59] Speaker B: Speaking from an investor perspective, we've had certain clients in the past and that we, that tried to be, you know, they think they know everything. Clients know everything, guys. Clients are the best. The w two earners, both husband and, husband and wife, and they invested in a multifamily syndication. These are w two earners, right. And, you know, with multifamily syndications, you get a k one, you get a depreciation loss, pass through to your k one, and then you write that off or not, you take it to your 1040. If it's income, you get taxed on it. But if it's a loss, depreciation, you're not going to write that off against your w two income. So there is no tax benefit from that k one that you're receiving from your investment activity. This is what people understand. You have to be real estate professional status to take advantage of that. K. One.
Another problem, another issue that comes up, another red flag is with 1030 ones and flips, people think they can do a 1031 with flips. You do that, that's a one way ticket to the IR's office.
Oh, yeah. Avoid flips and 1031 exchanges.
[00:19:16] Speaker A: Yeah. You don't meet the holding requirement on a flip. You have to hold the property for investment and flipping it within a month or two after buying it, that's not holding it for investment.
[00:19:27] Speaker B: Yeah.
[00:19:27] Speaker A: That's a big one that I've always warned people about over the years. What about being, there's, is there a hard and fast royalty IR's? Have they ever come with a hard and fast rule of what is a dealer versus just not a dealer when it comes to real estate, flipping, investing?
[00:19:47] Speaker B: Yeah.
So again, with dealers and investors, there's specific elections that you can make that'll help you, you know, get more.
Being an investor is the way to go because that entitles you to more deductions and more write offs versus just being a dealer. So let's, for example, when we're talking about flips, when we have flips going on, again, there are certain rules with, hey, you gotta, you gotta follow through on the flip and you gotta make sure that you qualify.
But with flips, again, it depends on the activity you're doing. So you could do long term rental, short term rental. You can be just a passive investor, land, lot, flipper, whatever, whatever you're doing, you have to make sure that you qualify under the investor status because that, that investor status then gives you that, hey, we can use active income.
We can write off active income because these are active losses.
With the IR's, you know, they, they don't audit clients as much, especially if they're not huge, really big clients. So the general rule of thumb is that if, you know, if, unless you're doing big multifamily building deals and you're hiding money or anything like that. So, you know, unless you're doing that, then you get audited. But unless, if you're just a small time investor, you're not going to get any kind of red flags from the IR's. And, you know, with our team, we're bulletproof. With the IR's, clients come to us with notices, we help them resolve those issues.
But overall, I'd say it's, it's best to be an investor rather than just be classified as a dealer. Because then you get the other tax implications.
[00:21:50] Speaker A: Yeah, I've always had that problem. I have clients who come and and they start telling me what they do and they go, well, I'm buying and flipping and I'm wholesaling and I'm, and I've got some long term rentals that I'm buying and holding and for, you know, really long time. And I go, are you doing them all in your name or all in one company? And that, that's a big issue. And I think maybe, maybe explain why that's a big issue for those folks.
[00:22:18] Speaker B: Yeah, because the reason why it's a big issue is because that commingles different activities and different tax implications. So, for example, you know, you're not going to hold a long term rental in an S corp because if you do, then again, and something happens and it becomes a taxable event, and then you're stuck with a tax liability tax bill. So segregate that from doing it in an S corp. Don't do it. Do it in an LLC. Same thing with flips. Don't do it under your s corp or so. Don't do it in your LLC. Do it in your s corp.
Short term rentals. You know, don't do it in an s corp. Same thing. It's gonna. You're gonna have a issue. Right. So what sounds right to some people, because they're doing certain activities may not be the right solution for somebody else. Making sure the entity structure is proper and there's bookkeeping. Right. Record keeping is so important. That's one thing we help our clients with as well. We have, we tell them that if you're doing these flips or midterm rentals or projects, you got to have class accounting in quickbooks. That'll help categorize expenses, income, and you'll be able to bulletproof yourself. I mean, record keeping is the number one way to protect yourself against the IR's.
And that's what we do. We take on clients who do their books, do their taxes, but then, you know, we tell them, hey, are you working with an attorney? Have you made your LLC? Do you have a land trust? We always ask them that because of protection. And, you know, it's not, it's not tax beneficial. People think, oh, having an LLC is going to help you with tax automatically. Yeah, and people think that, but it's more of a liability protection, equity protection, things like that, as you know.
[00:24:04] Speaker A: So the biggest point I got out of that, too, was if you're wholesaling and now you go, oh, wait, now I'm going to buy something. I decided we'll hold it. Before you start doing those things. Think and talk to a CPA before you just shift your business model.
[00:24:22] Speaker B: Yes.
[00:24:23] Speaker A: Because there may be things you need to do to get in a position to do that the right way.
[00:24:28] Speaker B: Exactly. You need a professional team. And our team. Our director, one of my, he's got over 30 years experience. He's worked on s corpse partnerships myself. I've seen so many k one s, so many partnership returns with rental properties and with different kinds of situations where it's. It's, you know, it's case by case. So one thing works for somebody, another thing may not work for somebody else.
[00:24:53] Speaker A: That's so important for people to pay attention to. I mean, everybody goes, well, my buddy does this, and I think I could do the same thing when maybe, maybe not. So, again, that's why you want to talk to your CPA and your lawyer and not go with whatever your buddies or friends are doing.
[00:25:09] Speaker B: Right.
[00:25:10] Speaker A: So, yeah.
Is there anything else that you think is just absolutely. That real estate investors need to know about taxes before they. Before this tax season ends coming up in a few days?
[00:25:25] Speaker B: Yeah, there are a couple of. Couple of main important piece, pieces of information that I think real estate investors need to know. Number one, obviously, the Corporate Transparency act. That is. That is, you know, it's, it's, it's. If you have an LLC that was formed before 2023 or 2022, then you have some time to get that filing done. You got to get it done. If you have. If you're a newer LLC, you've got to. You have a tight deadline. You should have either gotten it done or you're in. You got to get it done as soon as possible.
The second thing is the bonus depreciation piece. So that bonus depreciation that I mentioned early on, that is going to get phased out. So last year it was 80%. This year it's going to be 60%, and then 2026, 2025 it'll be 40, 26, it'll be. 2027 will be gone. So if you are somebody who holds rental properties, doesn't matter if the value of the property is 300,000, 400,000, 500,000 does not matter, you need to do a cost seg study. We work with a lot of engineering based firms who do cost segs.
We know that it's always better to do it on something that's worth over 500k. But residential properties are still eligible for cost segregation, bonus depreciation, and it's important to take advantage of that this year. So you can get at least 80% or 60% done. The deadline is April 15 to get it done for 23. So if you're running up against the deadline for 23, you're going to get stuck with 60%, unfortunately, in 2024. So that is one thing that, and Congress is always changing the rules and the laws, so there might be some opportunities for it may come back maybe 100% again in the future. Tax cuts and jobs acts expires pretty soon, so hopefully it'll stay. But if it doesn't, then take advantage of it right now, guys, 2024.
[00:27:29] Speaker A: Yeah. Cost segregation analysis is, to me, it's a new thing. I just heard about it this year and I said, you can do what? Really? That's cool.
But yeah, it's a big thing. And I'm so glad you came. Day, I know you got to run. It's tax season. You got to get, you got to get doing some taxes. So I'm going to let you go today. But thank you again so much. Again. Fitbiz cpas, check them out. We'll have the information down in the show notes. And with that, see you guys. Have a great rest of your week. Thanks for listening to this edition of Trust this if you got something out of it, please press like and subscribe and give us a five star review to help us reach others who can benefit from this series. Until next time, keep aspiring to a better life.
