The Tax Benefits Aren’t That Great… Or Are They?

by | 06, Nov 2021

For today’s episode, we will be talking about a confusing topic, taxes!

This week we’re going to unpack how to understand the tax component of owning real estate.

We will talk about these things…and more in another episode of Multifamily Investing Made Simple in under 10 minutes.

The audible version Passive Investing Made Simple: How to Create Wealth and Passive Income through Apartment Syndications coming soon!

Tweetable Quotes:

Generally speaking, you should look at the investment itself as a tax-efficient vehicle, not as a solution to your high taxed income at your earned income job. – Dan Kreuger

“Unless you qualify as a real estate professional or your spouse qualifies as a real estate professional, you’re not going to be able to take advantage of the full breadth of tax benefits associated with real estate.” – Anthony Vicino

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Anthony Vicino and Dan Krueger
Passive Investing Made Simple – Available NOW!

The Tax Benefits Aren’t That Great… Or Are They?

Anthony Vicino: [00:00:14] Hello and welcome to multifamily investing made simple to the podcast, it’s all about taking the complexity out of real estate investing so that you can take action today. I’m your host, Anthony Vecino of Invictus Capital, joined by the man, Dan. I said that backward, Dan, the man Kruger.

Dan Krueger: [00:00:33] I think it works both ways. I don’t know what your problem is. I’m the man. I’m Dan, the man, and just a guy. All of the above.

Anthony Vicino: [00:00:40] Just a man. I nailed it. I kind it did. Now, for those who are listening and have never seen the video, they were like, Well, I’m glad to finally have clarification. Dan is, in fact, a man, and he does go by basically. Yes, he, they?

Dan Krueger: [00:00:55] Those are pronounced on the day. It depends on the day today. He is a pick your own for me, whatever you want. He’s a

Anthony Vicino: [00:01:00] Herm today. I don’t even know what that is.

Dan Krueger: [00:01:03] Yeah. Well, we’ll dive into that on the next episode today.

Anthony Vicino: [00:01:07] What are we doing today?

Dan Krueger: [00:01:09] What are we doing here? We have no place. We came in completely unprepared. We have no topics. I’m kidding. We do have a very important topic. Actually, it’s one that we’ve been finding recently that there’s a lot of confusion about out there and that’s taxes. And it kind of sounds like it might be one of the most boring aspects of real estate, but it could be one of the most powerful aspects of it. However, that can be a little bit misinterpreted, as we found out talking to a lot of investors over the years, and we’ve been kind of correcting them in their understanding of the tax component. So I thought we’d, you know, unpack that today and just really talk about the tax situation and try to simplify the concept for people.

Anthony Vicino: [00:01:47] Yeah. So one of the best reasons to own real estate is the tax benefits. The tax treatment is fantastic. We get to use depreciation to offset gains. That’s fantastic. Now let’s well unpack that. But specifically, what we’re going to talk about is taxes for limited partners in apartment syndication. And one of the things is we hear people come to us all the time, doctors and lawyers, these high net worth and people who are earning a great income and they’re like, I heard I can invest in this deal and I can reduce my taxable liability on my ordinary income. And that’s just probably not true for a myriad of reasons. But let’s unpack what are the benefits of passively investing in a syndication from a tax perspective for high net worth individuals, somebody who’s earning a lot? And how could we structure it in a way so that you could use the depreciation in the passive losses against your ordinary income? It’s not an easy hoop to jump through, but it can be done. So let’s break it down, Dan.

Dan Krueger: [00:02:48] Yeah, I think the most important thing to realize there is that a lot of people hear that real estate is a great way to reduce your tax liability, right? You hear about somebody like Donald Trump, right? He got a lot of press when his tax returns came out and you got to see that he made, you know, millions doing the apprentice. And then all of his depreciation losses from his real estate wiped that out pretty much entirely. Now that is available for real estate professionals, we’ll dive into what that is. But the main thing that people need to realize is they need to look at a real estate syndication as a passive investor, as something that is a very tax-efficient investment so that the money you make in that investment is going to be taxed at a very low rate. We don’t want to go into details because your CPA will do that for you, but it in and of itself in a vacuum is a very tax-efficient vehicle, but you’re not going to wash out all of your personal income with those depreciation losses. It’s possible to do for some people, which we’ll go into. But generally speaking, you should look at the investment itself as a tax-efficient vehicle, not as a solution to your high taxed income at your earned income job.

Anthony Vicino: [00:03:49] Yeah. And the way I want I like to talk to people about this is if you’re a doctor and your wife is a lawyer and you guys are making a ton of money investing in these vehicles, what it’s going to do is you’re pretty much going to get cash flow tax-deferred. And that’s great because then you can take that cash flow and reinvest it into other things. So the investment itself is very tax-advantaged, but your goal is really to invest in as many of these deals as possible, get the cash flow and all the appreciation benefits of that. So that offsets your income from these other jobs so you can afford to work less at those other jobs. That’s the real beauty there. Now, unless you qualify as a real estate professional or your spouse qualifies as a real estate professional, you’re not going to be able to take advantage of the full breadth of tax benefits associated with real estate. But if you are a real estate professional, then the world opens up to you in a glorious way. So, Dan, let’s talk very generally because again, we are not tax professionals, we are not experts on this particular topic. We encourage all our investors to go talk to their CPA. If you think you might qualify as a real estate professional, go get very clear on this because this is one of the most audited things by the IRS as people saying I’m a real estate professional and then they come back and say, No, you do not pay up. So from a high level, what is a real estate professional?

Dan Krueger: [00:05:10] Well, that’s the thing. It’s from a high level that that’s where everyone. Right, they talk about what it is from a high level and they’re like, that’s it, and it sounds great on paper, but it is. And you might have to remind me here a certain number of hours per week, which I think is about 17 hours per week, and it’s

Anthony Vicino: [00:05:24] Seven hundred and fifty in

Dan Krueger: [00:05:26] 50 per year, which is kind of like somewhere between 15 and 20 hours a week. I think which you’d look at it on the surface and say, Oh, that’s like a part-time job. I can just fill my spare time with real estate stuff, right? That’s what it sounds like. But you actually have to spend the majority of your working hours on these types of deals actively, right? So you can’t have a W-2 income and hit the number of hours per week requirement. You’d need to be doing that real estate stuff as your main thing, and you’ve got to be actively participating in the management of that deal, which is not the case if you’re a limited partner on syndication. So for individuals like ourselves, it’s a great deal because yes, we are actively involved in the management of these deals. And what that means is we can take all of those depreciation losses, which are way more than the income on the properties, and use that to offset earned income. And in my case, I can also offset my wife’s earned income at her W2 job, which is a great resource that’s not available to everybody. But honestly, at the end of the day, the benefits for LPs are great. So even though you don’t get to pay any taxes on anything, which is something that’s available to some people, our government loves real estate investors because we provide a valuable resource for society.

Dan Krueger: [00:06:42] So there’s a lot of incentive for us to go out and take the risk by the properties and rent them out to people. It’s very valuable. That’s why that resource is there. But it’s still a great resource because I’d like to tell people that if you make the let’s say you make one hundred thousand profit in a deal, you can make one hundred thousand dollars profit in the stock market as well. You’re going to pay less in taxes than you would in the stock market, no matter what your situation is. I’m almost certain I’m not a CPA, but I can say that with some pretty with a pretty high degree of confidence. So it’s all about just keeping more of what you make. That should be the goal. With real estate, you’re not going to be washing out all of your taxes unless you or your spouse go and actually get a full-time job in this stuff. And if they do great, then go for it, go for it, go out you can have a heyday with that. But for everybody else, just look at it as getting to keep more of the money that you make your profits, right?

Anthony Vicino: [00:07:34] Yeah. And I do. I want to revisit and simply take another crack at the real estate professional and break it down to the three guidelines. If you’re thinking, maybe you qualify, maybe you don’t. Let’s go through this again, because one is seven hundred and fifty hours per year, that’s the easiest one to hit for most people like, oh yeah, I spent seven hundred and fifty hours working on my real estate portfolio. The other part is over 50 percent of your income has to come from this thing. So to Dan’s point, if you’re working a full-time W-2 and you’re not 50 percent of your income and 50 percent of your time is not coming from this, this endeavor. So you’re going to have a very hard time if you have any kind of full-time W-2 now, you could have a part-time W-2. And now we get to the third criteria. And this is the hardest one is you have to materially participate in the active management of the asset. And this is where people get really messed up as they think, Oh, I read this book, or I went to this networking event or I talked to this broker to go find this deal and they count those things as material participation. It’s those that don’t count. Education does not count. Time to spent finding the next deal doesn’t really count. It’s actively managing the asset. So again, for the general public person coming into an LP position in syndication, you’re probably not going to get to wipe out your ordinary income. But you do get to limit the tax liability on the earned income from the investment itself, which is super powerful.

Dan Krueger: [00:09:03] It’s pretty great. Yeah.

Anthony Vicino: [00:09:04] So that’s all I got on taxes. I just we just wanted to put that out there because we get I think there’s a lot of misinformation or people coming in with much grander schemes of tax avoidance, not evasion. Evasion is illegal. Avoidance is good.

Dan Krueger: [00:09:20] Yeah, I would say that you know, the main thing to take away from this episode is to find a really good CPA that has a robust understanding of these types of deals. And you’ll be good, right? You don’t need to become the expert on this stuff. You just need to have that expert on your team. And so find a really good CPA that has experience with real estate investors, specifically LPs, and they can wrap their head around some pretty advanced stuff. If you find that person, you’re going to be good at, they’re going to punch you in the right direction.

Anthony Vicino: [00:09:47] All right, that’s going to do it for us, guys. We appreciate you taking a little bit of time out of your day to join us before you get out of here. Go over to iTunes and leave us a review. Pretty, please, if you do. Dan’s going to do a special dance for you on the next episode. So on the next episode? This one, you got to earn it first. Go leave a review and Dan is going to dance on the next episode and we will see you next week.

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