Tired of feeling anxious around tax season every year? Us too!
That’s why we we're excited to have Brandon Hall, CEO at The Real Estate CPA, join us on the podcast to share the two best tools available at your fingertips to simplify your tax life in 2021 and beyond.
The Real Estate CPA helps high net worth individuals, real estate investment companies, syndicates, and private equity funds save thousands in taxes, streamline their accounting process, and grow their companies with outsourced CFO services.
Learn More About The Real Estate CPA At:
therealestatecpa.com
If you'd like to learn more about how ReAllocate + Mariner Wealth Advisors can help you build a roadmap for your real estate investments head to — BuildMyRoadmap.com.
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Adam Hooper:
Hello and Welcome I’m RealCrowd CEO, Adam Hooper and this is the Real Estate Investing For Your Future Podcast where we explore the latest commercial real estate trends, insights, and investment strategies passive investors can use to build portfolios that last.
[Disclaimer]
Adam Hooper:
Our guest today is Brandon Hall, CEO at the Real Estate CPA.
Brandon’s mission is to help real estate investors save money on taxes. In today’s conversation we discuss simple steps you can take to make your tax life easier in 2021.
Hope you enjoy this conversation with Brandon Hall.
Adam Hooper:
Brandon, thank you so much for coming back on the show. We were just talking, it's been a little while since we've had you on here, but we appreciate you spending some time with us today and checking in with what's new in the tax world.
Brandon Hall:
Yeah. Appreciate the invite back.
Adam Hooper:
So why don't you give us just a quick background of maybe what's changed since we spoke last year. What's new, what's on your radar and then we can dig into a little bit more.
Brandon Hall:
Yeah, well, a lot has changed with 2020. We had the CARES Act, we had multiple acts that tweaked the tax code added the PPP funding changed the QIP Qualified Improvement Property provisions. Now they're eligible for 100%. We've got 100% meal deductions now rather than 50% in 2021 and 2022, which is a nice boon to business owners. And then things are definitely going to be changing with the Biden administration. I expect quite a few changes coming down the pipe into 2021 and into 2022. So definitely something to watch out for there.
Adam Hooper:
Okay. For listeners that maybe haven't heard our prior episodes with you, maybe give a little bit of background how you got into the real estate space, what you focus on currently, and maybe fill in a little bit of background on what you do on the day to day.
Brandon Hall:
Sure. Yeah. Happy to my name is Brandon Hall. I'm a CPA. I run the real estate CPA. We have about 21 staff, a team of 21 people, myself included at this point, I've got three partners. And most of us invest in real estate. Most of our staff invest in real estate. We have about 300 units between all 21 of us. We service real estate investors. So we provide tax planning, tax compliance, like preparation and accounting services to small midsize and really large real estate investors. We have about 600 clients across the United States, our largest clients as a gentleman that owns about a billion dollars in assets and a real estate fund that manages about half a billion, about $500 million. And we're their outsource CFO to manage everything top to bottom on the finance side. But we also work with really small landlords too. I think our smallest is a woman who has a condo in Florida and that's it.
Brandon Hall:
So we've seen it all. We've seen a lot and, and I think that our bread and butter is the tax planning piece. Being able to help people, being able to break down complex topics, tax topics, to help you understand what you need to be doing on an ongoing basis to mitigate tax as you grow your real estate portfolio.
Adam Hooper:
Yeah. And we've talked in prior shows about building that team, having a stable of experts that you can rely on. A lot of our listeners are limited, minority investors in syndicated deals. Do you guys work with clients like that? Is there a value that people that are investing through a platform like ours or others out there as a syndicated investor, should they be talking with a tax professional? When does it get to the stage where they should be engaging services of more official tax advice?
Brandon Hall:
So if you're going to place money into a syndication deal or a fund as a limited partner, you should be talking with your CPA about the tax implications of doing so whether or not you talk to us, that depends on what else you have going on. So if you have like a W2 job and you've got one or two syndication investments where you're an LP and you're not really participating, you just put some money in. There's probably not a whole lot that we are going to be able to do to help you out. So we typically look for clients that have a lot more going on either they have their own rentals, they're running their own business, or they've got like five to 10 LP investments. Because at that point we can help them think about the timing of different investments they're going to make and the implications that are going to come out of that. So yeah, so even if you're making one investment, you should definitely talk to a CPA.
Adam Hooper:
And then just depends on the scale of what that operation is, how central that is to the overall strategies, maybe engaging someone that's a little bit more of a real estate specialist once you get to a certain scale.
Brandon Hall:
Yeah, exactly. With our clients, we're looking to add a lot of value and we know that if you have one or two LP investments and that's all you have going on, aside from like a W2 job, we just know that we can't add the value that we we want to add for our clients. So you've got to have more things going on for us to say, "Yeah, let's do this."
Adam Hooper:
So you mentioned some of the changes that were made with prior acts and in the prior administration, obviously now here early 2021, still trying to get her feet under what the new administration's position is going to be towards tax. I think it's going to be fairly different than what we'd seen historically at least the last four years. So why don't we just talk about a little bit, what is currently in place that's maybe new since we last spoke and then what some of those changes are? Obviously the big one that that's been talked about, I don't think we've ever seen official confirmation yet, but the 1031 exchange, maybe there's going to be some limitations or restrictions for earners over 400,000 annual income. You're going, I haven't seen anything official on that yet, but let's maybe take stock of where we're at today. And some of the things that you guys are paying attention to as it comes down the line for a potential new changes from the current administration.
Brandon Hall:
Sure. So 2020 gave us quite a few tax changes. The big one was the PPP loan, not necessarily a tax change, but for anybody that has a PPP loan, when you originally got the PPP loan, you obtained it under the premise that that was going to be tax-free, but the IRS came out later and they said, "Hey, if you took a PPP loan, we're not going to tax you on the funds that are forgiven, but we're not going to allow you to deduct any expenses that you use the PPP loan for which effectively makes the funds taxable." If you can't reduce the net operating income then the funds that you've received are effectively taxable, but Congress later came out December of 2020 and passed as part of the Act that they passed formalized that you could indeed deduct expenses related to the PPP loan.
Brandon Hall:
So you can receive the funds tax-free, they're forgiven they're tax-free, and you can still deduct expenses that you, that you use the PPP funds for. So basically the PPP loans are officially tax-free it's essentially like the capital contribution in your business. So that was a nice boon for business owners. For real estate investors, anybody that's owning commercial real estate, or non-residential real estate Congress made a technical correction to Qualified Improvement Property. So when the 2017 tax cuts and jobs Act passed they passed 100% bonus depreciation and a Qualified Improvement Property was supposed to get a useful life less than 20 years to make it eligible for bonus depreciation. But they actually forgot to make that that clear in the 2017 tax cuts and jobs ACT. So as part of the CARES Act, early 2020 Congress made a technical change to Qualified Improvement Property. And that is now eligible for 100% bonus depreciation. What is Qualified Improvement Property?
Adam Hooper:
Thank you. Let's dig into that a little bit for everybody.
Brandon Hall:
Yeah. So, that that's any interior made on. And remember, we're talking about commercial and non non-residential property, any interior improvement, that's not structural is Qualified Improvement Property. So that can be a lot. It can be a lot of things. You typically think of like restaurants or retail stores, they have a ton of Qualified Improvement Property, a lot of things that go into the inside of the property. That's not directly structural, that's all Qualified Improvement Property. So if you had Qualified Improvement Property in 2018, 2019, you can retroactively claim bonus depreciation on it. So you should review your tax returns. If you have commercial or non-residential property, and then going forward, any sort of Qualified Improvement Property that you add to the interior of your non-residential property or commercial property, you'll be able to 100% bonus depreciate, but this doesn't work for multi-family investors because that's residential. It's not non-residential. So if you're buying single family homes, residential property, multi-family property, that's all residential, and it's not going to qualify for Qualified Improvement Property.
Adam Hooper:
And then for listeners out there that may be new to the space. What is the effect of depreciation and bonus depreciation on either other income or the income from that asset?
Brandon Hall:
Yeah, so that's a good question. So let's say that I have a $39,000 Qualified Improvement Property improvement or $39,000 improvement that qualifies for QIP. If I don't have bonus depreciation available to me, then I take $1,000 a year over 39 years. That's how I recover that $39,000 costs that I have to capitalize it. And then I depreciate it over 39 years. So I get a $1,000 depreciation deduction, even though I spent $39,000 today. What bonus depreciation allows you to do is it allows you to take the entire $39,000 today. So from a tax perspective, if I'm in the 37% tax bracket, a thousand dollars on 37% is 370 bucks, $39,000 on 37% is I don't even know, but like $14,000, something like that. So the tax benefit is drastically different.
Adam Hooper:
Again, depreciation is a reduction of taxable income, right? It goes against the taxable income and reduces that dollar for dollar.
Brandon Hall:
Yes. Yeah. Think of it as a tax benefit that Congress allows for people taking the risk of buying real estate. So I buy a rental property, hundred thousand dollars. My cashflow might be three thousands, my net operating income. Let's just say that it's all the same thing $3,000. So $3,000 hit my pocket. But if I book $6,000 of depreciation, even though $3,000 hit my pocket, I get to tell the IRS that I lost $3,000. $3,000 of net operating income, minus that $6,000 of depreciation. I get to tell the IRS, I lost six, even though 3000 hit my pocket. So depreciation doesn't cost me anything I paid for the asset upfront. It doesn't matter if I pay cash or finance it. I get to depreciate the cost of the asset over the useful life of the asset. And all it is a tax adjustment that reduces my taxable income.
Adam Hooper:
Perfect. Okay. So we had this, the QIP that you talked about cleared up some of the PPP language. Was there anything else in the CARES Act that would be relevant as listeners are getting ready to file if they haven't already done their 2020 taxes that are material changes to be aware of?
Brandon Hall:
Yeah. In the CARES Act not necessarily for 2020 but 2021 and going forward excess business losses are going to come back into play. So they pause the excess business loss rules, and then they said that they would enact them again in 2021 and an excess business loss is any business loss in excess of my business income. So if I have $1 of business loss and I have $0 of business income then I have a $1 excess loss. Now, how does this work? Well, let's say that my CPA firm that I'm running produces $0 in income, but then let's say that I go and buy a rental property. I depreciate it. I get the tax loss of $3,000. Well, I have $0 of income from my CPA firm, which has business income, but $0. And then I have a $3,000 tax loss for my rentals so that's a $3,000 business loss, potentially I say, potentially because we're still trying to figure out exactly how this applies to rental real estate.
Brandon Hall:
But definitely if I'm a real estate professional well, I guess I should all sit potentially there to potentially if I'm a real estate professional that $3,000 loss, my rental real estate is going to be considered a business loss. So if I have $3,000 of business loss for my real estate, $0 of business income for my CPA firm, then I have a $3,000 excess loss. If I have $3,000 of business income and $4,000 of a rental loss, then I have a $1,000 excess loss. So the excess losses over my earnings from whatever business that I have, you exclude your W2. W2's not business income. Excess business losses are capped at $250,000. If you're single $500,000, if you're married, starting January 1st, 2021.
Brandon Hall:
So who does this hurt? Well, let's say I'm a high-income W turner. Maybe I'm a physician. I are $900,000. My spouse is going to go be a real estate professional. We buy $2 million worth of real estate assets. During the year I cost segregate the $2 million. And because I cost segregated, I'm able to bonus depreciate about 30% of that $2 million. So I get a $600,000 bonus depreciation deduction. And let's just say that that creates a $600,000 tax loss as well. So I've got a $900,000 W2. My spouse is a real estate professional generates a $600,000 tax loss. We use that tax loss to offset my W2. In years past, I could take the full 600,000, but now going forward, my W2 income of 900,000 is not business income. So that's $600,000 of rental loss that my spouse generates. That's a $600,000 excess business loss, and it's capped at 500K.
Brandon Hall:
So I can only take 500 of that 600K loss. The remaining $100,000 carries for use in future years. So it's going to hurt people that don't generate business income. It's going to hurt people in Silicon Valley who receive a ton of options and RSU income, or who are cashing out because capital gain income. That's not business income. So if you're trying to use business losses to offset that income, it's not going to work anymore. And it just means that you gotta be a little more intentional about your tax planning, if you're a high income earner.
Adam Hooper:
And where… So those losses can go to offset regular ordinary income, but what do you use those losses for? What income does that offset going forward?
Brandon Hall:
So that $600,000 example, I have a $600,000 loss. I can use $500,000 of that loss to offset my $900,000 W2 income. So my ordinary income, but I can't use all 600 because I'm capped now [crosstalk] the 500K excess loss.
Adam Hooper:
Got it. So you said that's coming back into play. That was paused. That's now coming back into play here for 2021 going forward.
Brandon Hall:
2021 going forward. Yep.
Adam Hooper:
Yep. So then where are you guys paying attention to? What are you watching for listening or insights on the new administration and their approach towards tax changes. You guys generally, and then more specifically as it relates to real estate investors in practitioners?
Brandon Hall:
Yeah. Well, before I jump into that, there is one more cool change for anybody that's running a business and that's that you can now deduct 100% of the cost of your business meals. So in prior years it was 50%. If I took you out to lunch and our lunch was a $100, I could deduct $50. And now I can deduct the full almost said $100,000. It'd been an expensive lunch. I can deduct the full $100 cost of the lunch. So it basically doubles your tax deduction for going to restaurants. That's an effect for 2021 and 2022 only. So it's temporary. Any meals that you have there. But what do we, what are we watching going forward? So the Biden administration the byte administration is going to change a few things.
Brandon Hall:
They we've got a lot of stimulus checks that are being sent out. There is a lot send out. A lot of programs to stimulate the economy in 2020, there's going to be a lot… It's going to be very expensive. It was expensive. It's going to continue to be expensive. And how do you cover the cost? Well, things have to change tax code wise. So the three things that I do expect to happen, I expect the top tax rate to go from 37 to 39.6%. If you're earning more than 600 and $20,000, that's [inaudible] joint. I do expect the long-term capital gain rate to go from 20% to 39.6%. If you're earning more than a million dollars. So we've got to to be earning a lot of money to be impacted, but I do expect to see those changes.
Brandon Hall:
And I do expect to see the Social Security piece of payroll tax added back in for every dollar that you earn over $400,000. So right now, if you have a W2 job, your FICA taxes consists of Social Security and Medicare. It's a total of 7.65%. If you are self-employed, you pay 15.3%, because when you're self-employed, you have to pay the employee or half and the employee half. But when you're an employee, you only pay the employee half you employer is going to pay the other 7.65%. So you pay this employees and employers collectively pay this 15.3% tax all the way up to about $137,000 in earnings. After $137,000 in earnings employers, employees collectively pay a 2.9% tax because Social Security drops off. So Social Security gets phased out. You only pay 2.9% tax on every dollar of earnings it's about $137,000.
Brandon Hall:
But what the Biden administration wants to do is they want to, they want to essentially create a donut holes. They're going to say, yeah, up to 137, you have to pay the full 15.3% between employers and employees. Between 137 and 400,000, you just pay the 2.9% tax. But over 400,000, every dollar over 400, we're going to enact this 15.3% tax again. And so if you're earning over 400,000, every dollar over 400,000, when you take into account state tax rates, your marginal tax rate at that point if they do add Social Security back you can very easily find yourself at a marginal tax rate of about 60 to 70%, depending on the state. So it's going to get very expensive for you to earn over 400 kids can get very expensive for your employers to pay you over $400,000. So that'll be interesting to see how it plays out and if it gets passed.
Brandon Hall:
But I do expect something like that to eventually pass. There are three things that are maybes. One is that they're going to eliminate that 20% pass through deduction that was added with the 2017 tax cuts and jobs Act. I would say of these three things, that's the most likely to go away because it was added in the 2017 tax cuts and jobs Act is a Trump admin win. And the Biden admin wants to dismantle that. And that's just politics. The Trump admin wanted to dismantle Obama wins as well. It's just the way that the world works. So I do expect that to go away. The other one that everybody's talking about is stepped up basis right now. If I buy, if I buy a property for a $100,000 I hold it for a long time and I die.
Brandon Hall:
My heirs inherit inherited at the stepped up basis. So maybe when I die, the property is worth $500,000. My heirs inherit it at $500,000. Their basis is now 500,000, not my original 100K, which means that they can sell it immediately at 500,000 and not pay any capital gain tax because their basis is 500 and they sold it that 500, or they can make it a rental and they can start depreciating it at their basis of $500,000. So that stepped up basis is really nice way to shelter estates from income tax. The Biden administration has talked about potentially eliminating the stepped up basis. So now if I buy the property at 100K, it grows to 500K I die, I pass it on to my son. My son sells it at 500K my son's got a gain of $400,000 immediately that he has to pay tax on.
Brandon Hall:
That's what happens if you eliminate that stepped up basis. I'm not sure that that's going to happen Biden, believe it or not is, is pretty moderate. Especially compared to everybody else or a lot of other folks in the party. And he doesn't really want to implement a wealth tax and the stepped up basis is a wealth tax. So it'll be interesting to see if that actually gets passed. I would probably say that that's not going to happen. And then I know we've been talking here for a few minutes, but the last one is the big one, the 1031 exchanges that everybody's been talking about. The Biden administration has cited that they want to eliminate the 1031 exchange. I don't expect this to happen that the 1031 exchange has been on the chopping block many times in the past, because here's what happens… here's the way that it works.
Brandon Hall:
I want to propose a $2 trillion package part of proposing that I've got to balance my budget, or I've got to try to reduce the budget deficit when I pass this package. So I hire teams of attorneys that scour the tax code and look for ways to drive revenue and ways to drive revenue or eliminating tax deductions for people that will drive additional tax revenue. So if you eliminate the 1031 exchange, it's going to drive a ton of tax revenue, and that's why the 1031 exchange is always on the chopping block, because it's just, if we get rid of this, we immediately drive a ton of tax revenue. But there've been a lot of studies over the years that have shown that 1031 exchanges actually stimulate the economy and they help more than it would be detrimental to eliminate them, but they are on the chopping block again. So who really knows I just don't think that that one's actually going to happen.
Adam Hooper:
So you would say you listed those in order of a likelihood, so removing the 20% pass through fairly likely step up and basis on inheritance fairly unlikely, 1031 even less likely.
Brandon Hall:
Yeah. Yeah. That's a good way to think about it.
Adam Hooper:
Is there anything that investors should be thinking about in structuring or considerations today about some of these potential changes or you, will there be any retroactivity to these? Is there anything they should be doing today to maybe think about how some of these changes might impact their tax scenario or just business as usual until we get clarity around any if any of these changes occur and then react at that time?
Brandon Hall:
Yeah, that's a really tough, it's a really good question. And it's a really tough question to answer because there is precedent in history for retroactively implementing tax changes, but it's very rare. Normally the tax changes will take effect at some point in the future, like the 2017 tax cuts and jobs Act for example, was September 27th, 2017. Anything after that qualified for a lot of the provisions in the 2017 tax cuts and tax cuts and jobs act. So, I don't know you could certainly make the case that if you are earning more than a million dollars or your total taxable incomes, more than a million dollars, then you need to think about liquidating some long-term assets that you were planning on liquidating sooner rather than later, but also know that if you do that, you could theoretically be faced with a retroactive long-term capital gains tax rate for the beginning of 2021, even if they pass it later this year.
Brandon Hall:
So I don't know. I think that the best thing to do is to get on a few CPAs and tax attorneys newsletters, and okay. Because we're watching the bills that are passed passing through Congress and we're updating everybody all the time. So I would just say, get on some of those newsletters and keep your ear to the ground. That way you know, of changes that are coming up before they're actually implemented.
Adam Hooper:
Perfect. And we'll have a link in the show notes for anybody that wants to get signed up on your [inaudible] content. You guys always put up.
Brandon Hall:
Appreciate that.
Adam Hooper:
So is there anything that in terms of making tax life easier, right? It can be as complex as we want it to be, or we can try to simplify things. Is there anything that listeners can be doing to simplify that going forward, or maybe where some of the mistakes that you see that unnecessarily complicate things when it comes time for taxes?
Brandon Hall:
I think that the easiest, well, I shouldn't say easiest. The best thing for anybody to do is to understand that when you're making investments, you are responsible for the documentation and you need to make sure that you have clean documentation. You need to take it seriously. You need to be very organized. If you are organized, then like when it comes to tax planning, we can see the entire playing field at that point. I can't tell you how many times we get people that come to us and they're like, I need you to save me tons of money. And we look at their situation we go, oh my gosh. Yeah, we can save you probably $20,000 just based on, the information that they, they share with us. And then when we start doing a little more digging, we realized the books haven't been done for two and a half years, the tax returns are potentially not even credible.
Brandon Hall:
And all of a sudden we're talking theory. Yeah. You could do something like this, instead of saying, you should do this because here's the result. So when you have up-to-date records, when you have really clean records, I'm talking good accounting, good budgeting. If I ask you for an entity flow chart or organization chart, you can pass it to me in a matter of five minutes. That means that you're, well-organized, you're going to reap the benefits of tax planning. If you ever engage a CPA for tax planning. And it's also going make tax preparation way easier, way less painless because we're going to request all that information to any way to prepare your tax return. That's honestly, my number one tax tip is just to keep really good records.
Adam Hooper:
And not just bring you a shoe box full of receipts and say, have at it.
Brandon Hall:
Yes, exactly.
Adam Hooper:
Are there any tools out there or any best practices, I guess if you could paint the picture of your ideal client is that spreadsheets, is it QuickBooks? Is it other accounting platforms out there? Are there any tools that you've found to help people be successful in that preparation and an organization stage?
Brandon Hall:
The best two tools are, is going to be some sort of cloud-based storage system like Dropbox box, Google drive, something like that. The second best tool is going to be QuickBooks online for your accounting and bookkeeping needs. A lot of people don't want to migrate to QuickBooks online they try to do everything out of Buildium AppFolio instead. And you have to understand that Buildium AppFolio are great from a property management perspective, but they're not great from an accounting perspective, we need more information. We need cleaner information, and that's what an accounting program will give you like QuickBooks online. But you do have to get to a certain point of scale before. That makes sense. So until you get there, we just say, spreadsheets just use spreadsheets, but do it in an organized way. On one tab, put all of your income, every transaction, you can import them from your bank.
Brandon Hall:
We don't really care. We just want to see all the transactions on the next tab, put all of your expenses, every transaction you want to categorize these transactions, right? So create a column that says rental property, that it applies or investment syndicate that it applies to. Create another tab called category is this rental income is this laundry income is this pet fee income is a security deposit income. What type of expenses? It is a property management. Is it legal? Is it taxes, insurance, et cetera, et cetera, et cetera. You want to track every single expense you can export from your bank account and import to the spreadsheet. So you've got two tabs income tab, expense tab. The third tab is going to be a consolidation. If you know how to run a pivot table, you can run a pivot table very easily and create a profit loss table for us.
Brandon Hall:
If you don't know how to do that, then you might want to code a profit loss statement. You just do the equals and start summing everything up. But we want to see something that looks similar to schedule E, IRS schedule E it's got rental income. Then below, it's got all the expense categories. It's a profit and loss statement. If you can give that to us, then that's really what we need to prepare your taxes and ask questions and do some tax planning.
Adam Hooper:
And do you guys help in terms of templates or anything like that? It's fairly straightforward income expense, and what's the sum of those. Is that something [inaudible]-
Brandon Hall:
We do have a template for our clients that's relatively automated. Yeah.
Adam Hooper:
Perfect. So that's really helpful. Again, I think organization is key to make everybody's lives easier. And especially in, like you said, to be able to identify and unlock that value that you guys are trying to add, you have to have clean information. You have to be able to get a full picture of everything to see where those opportunities are. So definitely understand that point. When it comes time to sit down with you guys though, what does that look like? So I'm an investor. I've maybe got a couple multiunit properties and I've got my data and my information for you. When should I be talking to you? When did we start planning? What does that process look like?
Brandon Hall:
So for new clients, we always upfront do some level of tax planning. So first we would have to figure out what level of tax planning do you need. And on an ongoing basis, we just touch base. Whenever you're wanting to touch base, some of our clients want to meet quarterly, some want to meet semi-annually some just want to meet once a year during tax season, when we're putting everything together for them. It just depends on your sophistication level. It depends on your needs. We do have that conversation with you to set expectations, because we want to make sure that we are touching base often enough to mitigate your taxes. So it just depends on everybody's situation, but upfront we'll do some sort of tax planning. And then on an ongoing basis it's up to you.
Adam Hooper:
Whatever it fits the needs of that client is what you guys react to.
Brandon Hall:
Yeah. Yeah. I guess to answer your question, I would say if you are not doing any tax planning with your CPA today, then you need to meet with your CPA once every November.
Adam Hooper:
To get ready for your end and preparing taxes for that year.
Brandon Hall:
Exactly. Yeah, we can look at your situation. Your earnings are pretty well known at that point. There's not going to be a lot of variation or changes so we can do some year-end tax planning moves before moves that you need to make before December 31st of that year. And then we can also just start the process of document collection for tax preparation.
Adam Hooper:
And what are some of the questions that listeners should be asking of their CPA? Is there the things that you like when clients ask you, are there things that you think will help if they're asking those questions will unlock some of that value that you guys are trying to add?
Brandon Hall:
Yes and no. So not necessarily. I think for the most part, we're pretty good at identifying what you need. We will ask you questions, what you should come prepared with. So if we're going to meet in November, what you need to come prepared with is how did I do this year? What properties did I purchase? What improvements did I make to my properties? Because we're going to want to see all that information and what am I trying to do next year? So we always like to get clarity on your goals for next year. Because we can tell you all sorts of fun tax strategies, but then if they prohibit your ability to achieve whatever you're trying to achieve, it makes zero sense.
Adam Hooper:
Yeah, it makes sense.
Brandon Hall:
So that's what we want you to come prepared with. Now questions you can ask would be a somewhat simple questions and more so just to remind your CPA that these things exist. This can get relatively challenging unless you're aware of these things. So one of the big things that landlords miss all the time is something called partial asset dispositions. Basically if I buy a property for say a $100,000 even if I don't do a cost segregation study the roof on that property is worth something. Maybe it's worth six grand, the windows are worth something. The doors are worth something, the flooring's worth something. And that's true. Even if I don't do a cost segregation study because when I buy $100,000 building, I don't just buy the building. I buy all the components that make the building up the roof is one of those. So let's say that you have a $6,000 roof. Maybe you didn't do [inaudible] study, but maybe that's the value of the current roof that you bought $6,000 roof.
Brandon Hall:
You later replaced the roof and you spend $10,000 replacing the roof. Well, the question is, should I be depreciating $16,000 worth of roofs? Or should I be depreciating only $10,000 worth of roofs? And the answer is you should only be depreciating $10,000 worth of roofs because you only have one roof. So that $6,000 roof no longer exists. And because it no longer exists, you should write off the cost of that $6,000 roof. So whenever you put that $10,000 roof replacement in, you also get a deduction for the roof that no longer exists equal to $6,000. That's called a partial asset disposition. So questions to come prepared for would be, I did a renovation. Can we take partial asset dispositions? I did a renovation. How do the tangible property regs or the repair regs regulations? How do the repair regs help me here?
Brandon Hall:
How are they going to be applied? And if you ask those questions, you're going to make your CPA, think about it. Or at least you're going to remind them that, oh yeah, the partial asset disposition thing exists. Let me go look through your tax returns to make sure that we're optimizing for that, or I'll make a note whenever we're preparing the tax returns to make sure that we're optimizing for that. So you owe it to yourself to understand that these things exist. You don't need to know how to do it. A lot of it is compliance on the back end. So it's a lot of preparation stuff that we're going to have to do and document collection information collection, but knowing to ask can save you thousands of dollars in taxes over time.
Adam Hooper:
Yeah. So there's two questions on that. Absent a cost segregation analysis. How are you coming up with those values? Is there art to that? Or are there tables that they set base values for some of those partial assets is asset dispositions. And then second if listeners aren't working with a real estate experienced advisory CPA are these things, are [inaudible] nuances that a real estate specialist will know how to optimize that a non real estate, more general practitioner CPA might miss, right? Or those are some of the things, I guess when we're talking about questions to ask some of those real estate specific points that maybe aren't as known, right? That can save fairly substantial amounts. If those right questions are asked.
Brandon Hall:
Absolutely. So let's take the first one. If you don't do a cost segregation study, can you still write off the cost of the replacement or the property that no longer exists? The component that no longer exist? And the answer is yes. Depending on what type of an improvement it was you might be able to use the producer price index, which you can find information on online and it's public information. But the producer price index often inflates the cost. So you would have to be careful whenever you're applying that. And that's where that art piece comes in. That's where you talk to a CPA that knows what they're doing. And they'll be able to guide you with properly allocating value to that component that no longer exists because you replaced it.
Brandon Hall:
So you do have to make sure that you get that value, right? And it is an audit item. So you have, you need to watch out. But it's also extremely valuable and you should be doing it. Now in terms of talking to a generalist versus a specialist it's definitely you will get a lot more, you're going to get a lot more clarity and a lot more value talking to a specialist than you would a generalist.
Brandon Hall:
It's just like anything in the world. We can look at NFL players. They're there because they had thousands and thousands and thousands more repetitions than I did playing high school football. I'm a specialist here because every week I get hundreds of real estate repetitions answering tax questions, doing some accounting work for my clients versus a generalist who might be working with a lot of local business owners. Maybe they have a lot of W2, people that don't own real estate. How many hundreds of repetitions are they getting over what period of time they're going to miss the nuances.
Brandon Hall:
A lot of people can get the high level stuff. A lot of people can say, yeah, real estate, professional status, 750 hours, more than half your time. You're good to go. But a lot of people forget. You've also got to materially participate in your rentals, by the way, the education, the research time doesn't count. We can cite half a poor verse commissioner and a couple other tax court cases to prove it to you. It's just the nuances that the generalists are not going to catch. So you expose yourself to audit risk. If you're going to be doing any of this stuff, you expose yourself to audit risk. If you work with a generalist.
Adam Hooper:
And how frequently do you see audits? Is it fairly standard practice? Is it pretty rare? Is it if there's obvious red flags and people are probably trying to push things, that'll get flagged or is it generally accepted part of business that audits will occur?
Brandon Hall:
Well, published audit rates are below 1% and they've been decreasing, but the way that we work with our clients is we basically say, we expect you to be audited and we want to prepare for that audit. Even if it never happens, we hope it doesn't happen. But even if it does happen at some point, we'll be ready.
Adam Hooper:
And we talking about IRS audits, not audited financials for-
Brandon Hall:
IRS audit.
Adam Hooper:
Internal. Yep. Okay. So let's before we jump out of here, I definitely want to touch on opportunity zones. Something that there was a ton of buzz around. Everybody out there was trying to raise a billion dollars, half a billion dollars for an opportunity zone fund. And I don't know that we really saw the space materializes as it was as jazzed up to be. So what did you guys see last year for opportunity zones and where do you guys see that here in 2021?
Brandon Hall:
Yeah. Well, we did get clarity with some regulations but we had, we had the same experience. So we, we actually, we were really excited when the opportunities and stuff first came out because-
Adam Hooper:
I think we all were.
Brandon Hall:
… we thought. Yeah, we did a whole bunch of research. We put out white papers, podcasts, content, all sorts of good stuff. But what we found was we couldn't make any money at it. People would call us up and we'd do the 20 minute consultation. And that was pretty much [inaudible]. So the only CPA firms making any money at this are the ones that are actually managing the really large funds, because a lot of like the Mom and Pop Funds, just didn't materialize, kind of like what you said, it's a lot harder to pull off than, I guess it seems at first blush. And then a lot of our clients that they have zero interest in investing in opportunity funds because of the 10 year old period. They don't want to put their money away for 10 years.
Brandon Hall:
So I can't really comment a whole lot. We know it Thomas Castelli actually [inaudible] that you… he's a partner in my firm. He's really good at opportunity funds. I am not. But that's just because we just didn't see as much traction as we originally thought.
Adam Hooper:
Yeah. And I think a lot of it too was early days, there wasn't a full picture of what compliance looked like. There was still, when the original regs came out, there was still additional rule-making to be had and uncertainties around different components of it. And by the time that clarity came, I think people had somewhat softened on it.
Brandon Hall:
Yeah. Yeah. I agree. And we are now out of that seven year window, right? So opportunity funds, if you hold it for five years, the game that you invested, you get a 10% decrease. Whenever it becomes due for tax if you hold for seven years, you get an additional 5% decrease. If I put a $100,000 into an opportunity fund after five-year hold, I only pay tax on $90,000 of it after a seven year hold, I only have to pay tax on $85,000 of it. But 2026 is the year that everybody has to pay tax. Everybody has to pay tax. If you put money to an opportunity fund, you're paying tax on that gain in 2026. So if you invest now, there's only going to be five years that materialize between now and 2026. So that's seven seven year, additional 5% gone.
Brandon Hall:
But it still might be beneficial. The people that we have seen invest in opportunity funds typically have large equity holdings. They've got like a ton of AAPL Stock, for example, and they liquidate that they put it into an opportunity fund and they're going to reduce their tax exposure on that rollover. And they're going to hold for 10 years. And the additional appreciation on their investment will also be tax-free.
Adam Hooper:
Maybe, yeah. Everybody that wrote this, a GameStop Express on the way up, maybe.
Brandon Hall:
Yeah. Yeah, exactly.
Adam Hooper:
Have you guys seen anything from the current administration about changes there? I know there was, again, some talks about one of the things that we felt was lacking from the original legislation was accountability. How are you tracking the impact that these projects are having? How do you track the actual benefit that some of these programs we're having out there on what the intent was to bring capital into communities where it maybe wasn't naturally going before? So there's been talks about maybe some changes to that to increase accountability and visibility into the effects of these investments. Have you guys heard anything in terms of updating the regs from a new administration opportunities zones?
Brandon Hall:
I have heard that they are going to be updating the regs to add clarity. I have not looked into that to see what that means.
Adam Hooper:
Okay. We will keep an eye on that. And as new more news comes out, we will maybe get Thomas back on.
Brandon Hall:
Yeah, absolutely.
Adam Hooper:
Anything else that's that we should be talking about, thinking about here in 2021 as we as we look forward?
Brandon Hall:
No, I think that as long as you, do what I said, find CPAs and tax attorneys that put out content on an ongoing basis and subscribed to whatever they have going on, because there will be tax changes coming down the pipe this year and next year. And you're going to want to know real estate investors are going to want to know what those changes are sooner rather than later.
Adam Hooper:
And how would they find out about you if they wanted to listen to some of your content and read what you guys are putting out?
Brandon Hall:
Yeah. You can go to www.therealestatecpa.com. That's our website. We've got a ton of content there. Different ways to subscribe to different things. So I would just say, go there first and check out the website and feel free to subscribe.
Adam Hooper:
Enough, Brandon. We definitely going to appreciate you coming back on here. Updating us on everything you guys are seeing and thanks for spending some time today.
Brandon Hall:
Absolutely. Thanks for having me on. I really appreciate it.
Adam Hooper:
All right, listeners that's all we've got for today. As Brandon said, therealestatecpa.com, go check them out. They put out a bunch of great content. That's all we've got. If you have any questions or comments, send us a note to podcast@RealCrowd.com. And with that, we'll catch on the next one.
