Successful Multifamily Tax Strategies

Full Transcript Below

Intro
Hi, my name is Rod Khleif, and I’m the host of “The Lifetime Cash Flow Through Real Estate Investing” podcasts. And every week, I interview Multifamily Rock Stars and we talk about how they built incredible wealth for themselves and their families through multifamily properties. So hit the “Like” and “Subscribe” buttons to get notified every Monday when a new episode comes out. Let’s get to it.

Rod
Welcome to another edition of How to Build Lifetime Cash Flow Through Real Estate Investing. I’m Rod Khleif, and I’m thrilled you’re here. And I know you’re going to get very valuable information from the gentleman I’m interviewing today. His name is Thomas Castelli, and Thomas is with Hall CPA Firm. And I’ve actually been on his podcast. He’s got a podcast and he’s a tax strategist and CPA, and we’re actually considering using him ourselves. Welcome to the show, brother.

Thomas
Thank you for having me on, Rod. It’s an honor to be here.

Rod
Well, thank you for saying that. Well, I know, you know, you’re also a sponsor on a deal in Jacksonville. Is that where you guys are located? I can’t remember.

Thomas
Yeah. So we’re a virtual firm, so we’re all over the United States.

Rod
Okay.

Thomas
But, yeah, I did a deal back in Jacksonville back in 2017, in which I was on the sponsorship team.

Rod
Nice. Well, that market has gone crazy. I looked at an asset out there recently, and it’s just insane what’s happened rent-wise. Well, so, you know, why don’t you maybe introduce yourself a little better than I did, talk about, you know, your story a little bit, maybe even, then, you know, let’s get into–yeah, just real briefly, but then we’ll get into, you know, some of these tax strategies that you listening may or may not be aware of.

Thomas
Absolutely. So, kind of quick background on me. I went to college for accounting, and when I was in college, I kind of realized that you know, the whole nine to five thing wasn’t going to get me to where I wanted to go. So I started reading books, you know, the “Rich Dad Poor Dad”, that entire thing. Rod, I think your book came up in there somewhere at some point. I was like, okay, you know, real estate is going to be something that I need to focus on. So I ended up going on a three-day weekend after I graduated from college and learned all about syndication. Really fell in love with that business model. Started attending meetings, networking, and all that. And invested as a Limited Partner in a handful of deals. And then someone who basically became like a mentor to me said, hey, look, if you ever find a deal, we’ll syndicate it and we’ll make it happen. So I ended up, you know, banging the phones all that down in Jacksonville, and I did find an 82-unit apartment complex that we did end up syndicating back in 2017. And that was very exciting. And then we ended up exiting that deal back in– during the pandemic, which is also an interesting situation. And so that was kind of how I got my start on the investing side. And then around the same time that deal actually happened, I ended up meeting Brandon Hall, who is the founder of the firm that I’m currently working for. And I found him on LinkedIn. He was always posting about real estate investing and taxes and stuff. And I’m like, hey, you know, I’m investing in real estate. I’m a CPA. Would love to see if there are some synergies. So next thing you know, I’m at the firm. I’m a tax strategist. I’m working with clients, consulting with them on how to minimize taxes, which is also very exciting. And, you know, today, I’m a partner at the firm and I have an advisory team that works with clients to help them minimize taxes. So it’s definitely been an exciting trip.

Rod
Nice. Well, you know what? Let’s just get right into–I mean, again, some of you are listening are aware of the fact that real estate is probably the most tax advantage vehicle you can possibly get involved with. There’s a reason 90% of the millionaires out there either did it through real estate or invest in real estate for tax reasons. But let’s talk about some of the benefits. So why don’t you take it away and I’ll just interject.

Thomas
Right. Okay. So I’m going to start just by breaking down kind of how real estate tax works and why it’s so beneficial. Right. So, way back in the 80s, there was a Tax Reform Act of 1986. And what that did is it made rental real estate passive by default. So that means that all the losses that you get from rental real estate can only offset your other passive income, which is typically for many people, going to be rental income. And these losses are generated by this non-cash expense called depreciation. And the best part about depreciation is, is it reduces your taxable income, but it does not reduce your actual cash flow. So I always give an example. Let’s say you had $100,000 of rental income, right? And you had $60,000 of hard expenses. This is repairs, maintenance, property management fees, utilities, property taxes, and so on and so forth. Now, you’re left with $40,000 of cash flow. Well, that would also be taxable income. But now we have this depreciation expense that comes in, and it often completely offsets that taxable income. So let’s just follow the example. You had $100,000 of rental income. Now you have $60,000 of hard expenses. Let’s say you have a $50,000 depreciation expense, which is not even too far-fetched. And now all of a sudden, you have a loss of $10,000. So this answers the first benefit of investing in real estate is the cash flow is tax advantage. So you just pocketed $40,000 of cash flow into your pocket, but you’re paying no taxes on it. And that’s the first benefit. Now–

Rod
Let’s stop there for one second. Yeah, you know, I’m going to tell you personally, I haven’t paid taxes in two decades, maybe? Maybe longer. You know, when I have businesses that are profitable, then I pay taxes on those businesses sometimes, but never in the real estate. And, you know, in fact, if you love him or hate him, Trump, you know, they wanted to see his tax returns. And he owns tons of real estate, so you know damn well he hasn’t paid taxes. You’d be an idiot to pay taxes. I mean, why wouldn’t he take advantage of the tax laws? And so, you know, that’s why we love this business, guys. So this is–you know, besides the cash flow probably one of the biggest benefits associated with real estate. So keep going.

Thomas
So that’s the first aspect of it, right? And I’m going to get into how you can use that gain in a second. But then also, not only is the cash flow tax advantage but so is the exit, right? There are so many different ways you can exit a property in a tax advantage manner that you can really reduce or eliminate the capital gains tax. And obviously, the first one that everybody always thinks of is the 1031 Exchange, if you do a 1031 Exchange, you can kick the can down the road by buying another asset, putting the sales proceeds in it, and you just basically buy a bigger asset and not have to pay taxes, at least not now.

Rod
Right.

Thomas
So that’s one of the benefits. Another benefit of it is real estate tends to appreciate over time. And with that, you can do, you know, cash-out refinances or get HELOCs. So instead of saying selling a property, which is going to be a taxable event, unless you use like a 1031 exchange or another strategy, then basically when you get the HELOC, the cash proceeds from that, the debt proceeds are not taxable. So as the value of your real estate increases, you pull money out through cash-out refinances, and you’re not paying tax on that income.

Rod
Let me elaborate on that one now. So, you know, that’s our model. We actually have two deals under contract right now. In fact, if you’re an accredited investor, text the word “partner” to “72345”. I’ve only bought one deal with my partner in the last year in San Antonio, Texas, 296 units because we’re super conservative. And that thing broke even day one at 59% occupied, it’s even better now. You know, and now we have two under contract. I mean, that’s the effect of the recession already, is we’re finding deals, phenomenal deals, and we’re placing long-term fixed-rate debt on them. So, you know, super solid projected returns on this thing, on both of them, actually, one in Nashville and one in Hot Springs, Arkansas. So if you’re accredited, again, text the word “partner” and talk to us about it. But anyway, the other piece of this– I lost my train of thought for a second, but let’s dig into–oh, I’m sorry, you were continuing. So you just talk about– oh, refi. That’s where I was going with that. The reason I brought that up. So what we do in our assets, for example, is our goal is always to refi in you know, say, three to five years, because we’ve, you know, done a value add, increase the NOI and increase the value. We’re able to refi and get our investors, you know, the goal is to get them all or most of their money back, and then, you know, it’s infinity returns, right? You don’t have any money in a deal and you’re getting cash flow. Still, its infinity returns. And that is a huge benefit of real estate. And, you know, the smaller assets, they call it the BRRRR Method. You know, BiggerPockets coined a method called the BRRRR method. You buy it, you repair it, you refinance it, and you repeat. Rinse and repeat. And so, you know, that’s a fantastic strategy in all asset classes. So anyway, I just wanted to elaborate on that real quick. So please continue.

Thomas
Yeah, absolutely. So the cash-out refinance is one way that the income you can get as a tax advantage because you pull it out tax-free.

Rod
Right.

Thomas
Now, the question always becomes okay, well, what happens to this loss? Remember, I mentioned the loss before? You have a $10,000 loss. Well, the loss can be used in a handful of ways. For most investors, the loss will either be used to offset future income, so the loss can be suspended and carried forward in the future years. When you do have passive income, you know, presumably for rental real estate, it could also be used to offset the gain on sale of the property. So what a lot of investors actually do these days is they actually don’t use a 1031 Exchange. What they’ll do is they’ll buy a new property or invest in a new syndicate within the same year they sell another property. And then the new property, they’ll run across segregation study on it. That will push up the depreciation expense. We get more into the details there. But it will push up the depreciation expense on it generating a loss. And then that loss from the new property can offset the gain on sale of the original or the property you sold.

Rod
Right. And sometimes that’s just as tax advantage, as advantaged as a 1031. Especially with, you know, what we’ve had, you know, these last year or so, is the bonus depreciation that they put out there, which, as we discussed, is, you know, phasing out right now. But, why don’t you– let’s drill down on cost segregation a little bit. Talk about what that means.

Thomas
Right. So when you buy a property, if you’re buying residential property, like multifamily, the property is typically going to be depreciated over 27 and a half years. So roughly speaking, you know, 127.5 is just deducted every year. But what Cost Segregation study does, it’s an engineering study where an engineer comes down to your property and they’re going to break down the components of your property because the property you buy is not just the building. You have appliances, you have fixtures, you have carpeting, you have windows, all these different components. And what ends up happening is they’re going to break it down into five, seven, 15, and 27 and a half years. So you’re going to have basically four different categories of–

Rod
So what he’s talking about is the remaining life on each one of these things. Okay, just to be clear. Right. Okay.

Thomas
Right. So what happens is when they break, they’re going to break this all down and give you a report, and that five, seven, and 15-year property can all be depreciated using bonus depreciation in the first year, 100%. So basically, long story short, if you buy a property, placed in the service between 2018 and 2022, at the end of this year, when this is being recorded, you can fully depreciate the amount of the five, seven, and 15-year property all in one year. So that’s extremely powerful. And, you know, generally, from our experience, anywhere between 20% to 30% on average. It could go a little higher. It could go a little lower depending on the asset can be reallocated to these class lives and eligible for bonus depreciation. So to kind of give an example of how powerful this can be, just take a million-dollar asset. I know people are buying much more expensive properties out there, but million dollars, and let’s just say you get 25% reallocated to 100% bonus depreciation. Well, now you have a $250,000 deduction, a non-cash deduction. So if you had that $100,000 rental income I mentioned before, and then you had a $250,000 deduction, thanks to bonus depreciation, you’re going to have a negative– and combine it with all your other expenses, of course, but keep things simple here. If that was your only expense, you’re at a negative $150,000 loss, and that means you didn’t pay the tax on your rental income. And now you have this $150,000 loss that you can use to offset income in future years or offset the gain on sale of other properties that you may have. Or, you know, if we can get into a little bit, if you’re on the active side, it could perhaps offset some of your other income.

Rod
Yeah, we’ll talk about that in just a second. But before we move to that, how is the phase-out structured for bonus? Could you speak to that a little bit? You’ll be educating me on this one.

Thomas
Right. So if you place an asset, you buy your place in service by the end of 2022, then you’ll have 100% bonus depreciation.

Rod
Right.

Thomas
In 2023, it’s going to be an 80% bonus depreciation.

Rod
Okay.

Thomas
In 2024, it’s going to be 60, in 2025, it’s going to be 40. 2026, it’s going to be 20. And then 2027, as it stands today, it is gone. There’s zero. Whether or not they renew it has yet–

Rod
Who threw the phase-out in? Was it the Dems or was it a Republican thing?

Thomas
Yeah, so I don’t remember–

Rod
Okay. Just curious. If it was politically driven, I’m just curious because who knows, there could be a change here, and maybe it’ll come back. But still, you’ve still got a couple of decent years. Even 60% is better than a stick in the eye. So–right. So, talk now about–and guys, again, just so you fully understand it, an engineer will go out and they’ll look at the light fixtures, the carpet, the doors, how much remaining life is in each of them, and they’ll categorize them in those buckets. And it’s very powerful. I mean, I’ve saved hundreds of thousands of dollars literally through Cost Seg. Even on single-family. Believe it or not. I had a package of single-family at Cost Seg and was about a $600,000 loss. It was phenomenal. Stuff I’d own for decades. But, okay, so talk about a real estate professional and what that means and how that is even more enhanced?

Thomas
Right. So you’re kind of going back to the Tax Reform Act of 1986 when they made all the losses passive. What that meant was you cannot take the losses that you have from real estate against your active income, you know, “active income”. So income from a W-2 job or from an active trade or business that you might be running. But with the real estate professional status allows you to do, if you’re working more than 750 hours and more than half of your total working time in a real property trader business, then you can qualify as real estate professional status. And then that will take the losses that you’re generating and make them what’s known as non-passive. So “non-passive” and basically, what that means is that they can offset pretty much any source of income that you have. So if you’re a real estate professional and you have a spouse who is generating, you know, a substantial amount of income from another job or another business, you can use these losses. Like, let’s talk about the 150K loss that we just mentioned before to offset their income. And that can be, you know, even– not only did you not pay taxes on your rental income now, but now you’re reducing the tax that you’re going to pay on your other sources of income, which, you know, if you can qualify as a real estate professional, if your spouse can qualify as a real estate professional, then, you know, you’re going to be able to significantly reduce taxes on your other source of income or [inaudible]

Rod
Or eliminate. In my case, it was eliminate. So, I mean, it’s freaking awesome, guys. I mean, that’s why we love this business. But, yeah, so let’s talk about strategies that–I mean, maybe you’ve already covered them all that relate to just investing passively. Have you already covered all of them?

Thomas
Right. So, yeah. When you’re investing passively, when you’re say a “Limited Partner” in a deal, the main strategy with the game becomes– for you is going to be making sure that you’re a, sheltering your passive income. So you might be involved in all different types of syndicates or funds. Some of them might be generating more income or cash flow than others. So you want to make sure that you have enough losses from your other syndicate interests basically, to offset any passive income that you might have, any rental income. And then also when the sponsor tells you, by the way, we’re going to be selling the deal this year, you’re going to want to go look at– this is going to be a form on your tax return called Form 8582. This is where your passive losses are stored, for lack of a better word. And if you have enough passive losses on your Form 8582 from the prior year to offset the gain or expected gain on sale from this syndicate that’s going to be sold, then you’re in the clear. You don’t have to do anything. But if you don’t, then what you could do is you could go ahead and reinvest in another syndicate or just invest in another syndicate in general. And assuming that the sponsorship team, they’re going to have a Cost Segregation study run, which most do, but you always want to confirm that.

Rod
Right.

Thomas
The loss from this next deal that you’re investing in can offset the gain on sale of the syndicate that has been sold.

Rod
Right.

Thomas
So that really just becomes a game of monitoring how much passive losses you have on your tax return and then taking steps if you don’t have enough to offset the gain, taking steps to make sure you get losses in that same year syndicate sales so that you could, you know, keep playing and kicking the can down the road.

Rod
Nice. Well, guys, so it’s Hall CPA, and if you’ve got additional questions on tax strategy–what did–did we– is there any topic we didn’t cover? I think we may have covered them all as far as real estate tax strategy. Was there anything we missed?

Thomas
Yeah, no, I don’t think we missed. I think we hit everything.

Rod
Yeah. Awesome. Well, Thomas, I appreciate you coming on, brother. It’s great to see you again. And I think we’ll be talking soon. And guys, have a great day. Those are listening and watching. Take care.

Outro
Rod, I know a lot of our listeners are wanting to take their multifamily investing business to the next level. Now, I know you’ve been hard at work helping our Warrior students do just that using our “ACT” methodology, which is Awareness, Close, and Transform. Can you explain to the listeners how they can get our help?

Rod
You bet. Guys, we’ve been going non-stop for three years building an amazing community of like-minded people, and our coaching students which we call our Warriors have had extraordinary results. They’ve purchased thousands and thousands of units, and last year we did over 1000 units with our students. And we’re looking to grow this group and take it to the next level. We’re looking for people who want to follow a proven framework that’s really step by step and then leverage our systems and network to raise equity, to find and close deals, and to build partnerships nationwide. Now, our Warrior community is finding success in any market cycle. So if you’re interested in finding out more about how you can become more of our incredible network and take advantage of the incredible opportunities that are coming very soon, apply to work with us at “MentorWithRod.com” or text “CRUSH” to “72345” and we’ll set up a call so you can check us out and we can check you out. That’s “MentorWithRod.com” or text “CRUSH” to “72345”.