Episode 125 - 8 Tax-Saving Strategies in Commercial Real Estate!

Today hosts Braden Cheek, Brian Duck and Joel Thompson discuss various ways to save money on your taxes in commercial real estate.

Ok. What is up and welcome back to another episode of How To Invest in commercial real estate. And today we have a super exciting show. It's about taxes so exciting. Now, why are we going over taxes again? Is because in your lifetime, the biggest expense you'll have is paying taxes. It doesn't really matter what job you work. And so it makes sense if you want to make more money to reduce the biggest expense you have. And real estate is one of the best ways we found to be able to do that. So today we're gonna go over eight strategies that uh people can use to either lower their tax bill or pay zero taxes, right? Brian number one self directed Ira or invest through your Ira. Yeah. So this is an easy 10 obviously because you can use the self directed Ira to kind of defer taxes for, for pretty much anything right that you can invest through with your self directed custodian. But real estate is also one of those ways and a lot of people don't realize they can invest directly into an LLC, a private LLC. Exactly how we buy real estate and use their self directed Ira.

Every single time I told somebody we take retirement money, their mind is blown and they're like, oh man, I kind of forgot about my Ira or, or whatever it is. And I have a question, you know, I know when you leave a job and you have a 401k, you can roll it into a self directed Ira and that gives you flexibility on which investments you can invest into. So when you at a company, they may offer you a range of mutual funds, uh stocks, bonds, all that stuff. And then, you know, you're pretty limited in what you can invest in. But when you roll, when you leave that job, you can roll it over and then you can invest in pretty much anything. Is there another way to get to a self directed Ira that you can invest in real estate? You just start one, you can just start one. OK? You can start your own. Um You don't need no company. Yeah, but uh it, it may be different in that. Uh what are the, what are the tax advantages? Uh You know, like 401k, it's, it's tax free money in but an Ira you're, you're gonna, don't you pay taxes? An I an Ira is post tax or you don't like an IRA is taken out pre-tax, right? You can have a traditional Ira.

You can have a Roth Ira. Yeah. So a Roth Ira, you can withdraw the earnings completely tax free because you've already paid the tax. So, which one do you have? Is there one or the other that you have to put your, a four O A 401k, a traditional 401k and a traditional Ira. You can have a Roth version of both, but you, you pay the tax on the way out, I believe. Ok. Anyway, so if you've left your company and you have it, uh you've left your 401k sitting with your old company, you're gonna want to consider rolling that into a self directed Ira. You can still keep the same mutual fund investments, but at least it gives you the option to look at real estate and, you know, not just us uh investment syndicators have the option to use those self directed Ira funds, uh and invest in our real estate deal. Is there a, is there a downside to use an IRA? Can you use all your deductions in a self directed Ira? Like you can through a, you know, if, if you were going through an Ira? Yeah, so you don't get any extra deductions. I mean, it can offset whatever else is going on the IRA, I believe. Maybe not, but, but it can't offset anything outside the IRA.

No, no. And the biggest note on um Ira s or really any sort of tax deferred retirement account is you want to be putting your highest taxable events in there. So, whatever that is, I would use that first. Right, because you're constantly deferring the taxes. So right now our development deals right, where we're in and out of in 18 months, you know, we may not have a tax return with a full depreciation from a building just because by the time we finished construction and sold it, that may be before the end of the second year. So that would be, you know, that may be a decent taxable event. It's not like a long term hold like some of the others. Yeah. Anyway, uh consult your financial advisor, whoever's got your 401k currently or if you've already rolled it into a self directed Ira and ask them about potentially investing in commercial real estate. Next. Ok. Number two would be uh hold your property for more than a year. Why do we want to do that? Yeah. Easy Braden moves in the long term capital gains. Yeah. So your income is short term, uh short term income tax and its ordinary ordinary income and anything you invest in that you sell within 12 months is treated just like income from your job, which is the highest taxed percentage that you can collect.

So just to confirm a job, a W-2, a 1099 ordinary income or any investment you sell, you hold for less than a year will be treated like ordinary income and tax at that level. Gotcha. So we're immediately getting a tax break by just if if you make money that you didn't work for, it sounds like. Right. Because any, anything you have to work for you wouldn't be paid over the course of, you know, longer than a year. Right. So you're immediately getting a tax break just by being an investor. It sounds like I would say most people that have the financial wherewithal to invest in commercial real estate are already paying or already in a tax bracket with their ordinary income over 20%. So, any, uh, any investment opportunity you hold for longer than a year, uh, you're going to sell that and you would be paying long term capital gains, which is at 20% currently. And so it's a great way to save, especially for high income earners, doctors and lawyers and CEO S and business owners. You're gonna be in the 30 40% tax bracket. And so wouldn't it be great if you could earn, uh, equivalent income and pay half the taxes? Well, depending on how much it is, it could also be 0%.

Capital gains tax is paid or it could be 15% but over a certain amount it's gonna be, it's gonna be 20%. Um, ok. Next is, uh, live in the property for at least two years. Yeah, I debated putting this on the list. Uh, but, you know, a lot of people ask is, how do I get involved in, uh, in commercial real estate? How do I create the nest egg. Where do I get the initial funds? And, you know, I think some people know this but not everybody is single family home that you live in. If you and your wife, let's say you're married, uh, or your significant other live in a, uh, your home for more than two years and then you sell it, the gain up to $500,000 is tax free. Ok. That is amazing people because there's a lot of markets where, where houses are going up in value. Uh pretty fast, maybe not as much in Oklahoma, but in some of the, the growing states like Texas or California or New York. And so that could be one of your strategies to build a nest egg to invest with us is uh you know, buy a fixer, upper, right. Fix it up, live in it two years, flip it after two years. Let's say you make $350,000 on that house or 100 and $50,000 on the house.

0% taxes on that money, which is, I mean 100 and 50 let's say you made 100 and $50,000. That's like putting $30,000 in your pocket. Easy, easy. That's right. And you can do it again. So let's say you take that money, you can, you can roll it into the next house and live in another picture. Upper another two years. But the limit is once you reach 500,000, each time you can do it. Ok. Consult your tax professional. But I think each house that you live in 200/2 years you can, you can make up to $500,000 on that home and not pay a dime of taxes. I wonder if you could file separately and a married couple could go up to a million bucks. Uh, no, it's 250 per individual. It's two 150 per individual that 500,000. So this is actually my favorite point. I just realized because I think this is the point that really unlocks all of the tax advantages for a traditional limited partner. And, and here's why, yeah, I, a true limited partner that is not considered a real estate professional on their tax return is not able to always use all of the depreciation they have access to on their K one because they can only use like they can't go negative and they can't offset their active earned income with their passive, um, depreciation and losses.

Exactly. But once you have this fixer upper that you're living in and, and fixing up and trying to rent or sell or whatever it is that pretty much can, makes you a real estate professional. And in, in my consideration, in his professional opinion, living in a house and fixing it up makes you a real estate. I think we need to ask an account about that. You do. I'm just saying it's worth, it's worth the question, right? Because a lot of people have a lot of depreciation that they, they can't use because they're not a real estate professional. So finding things to do in real estate to get, again, get those hours in for the calendar year to, to again prove and earn the real estate professional designation can save you a ton of money on taxes. It has to be a lot of hours though because the IR Irs says it has to be, you have to spend at least half of your time and your business on real estate. Right? So if you work a 40 hour job, your real estate is gonna have to be 20 hours a week. So, so, uh, that, that's a separate point, but it, but it is, it's a valid point to consider and uh, consult your tax professional.

Right? Number four is uh, 1031 exchange. We've covered this ad nauseam before, but we had to put it on the list because it is one of the strongest, uh, tax advantages in commercial real estate. And so we'll just go over it again really quickly. You buy a property, let's say you buy uh, a million dollar property and you, uh own it for a few years and you sell it for $2 million and you're like, I don't want to pay taxes on a million dollars. I say that. Uh, anybody should say that. Uh, so how do you get out of paying that? All you do is you take all the proceeds from that sale. You buy an equivalently sized or, uh, valued property or bigger with that money. That's it. So if you, let's say that you had a loan on your million dollar property, you owed 600,000. So you were walking with $400,000 plus the gain of that million. So you're walking with $1.4 million you go buy a $3 million building with it. You can, uh, eliminate the tax bill on that $1.4 million. So there's a lot of rules and regulations and things you have to go into and you have to use an intermediary. So we've covered that with another show that was quick, but make sure to go watch the other show on 1031 exchanges if you haven't seen it instead of just like, oh, he said you could just sell a property and go buy another one.

You don't have to pay any taxes. Joel Thompson said that you can hear it now. No, but it's very, very powerful and it works on $100,000 property and it works on $100 million property. There is no limit to the 1031 exchange if you, if you abide by the restrictions and the rules governing that part of the tax code. Yeah. And it, and it really makes the real estate investment treated like a 401k investment or, or something like that to where it's allowed to cumulatively grow as long as you're not taking the money, as long as you're not taking the money, which is a beautiful thing. I always kind of wondered why they set up these rules and it's really, I mean, it's got to be, to get us more money. So we spend more money and put it back into the economy. That's right. We're investing money out there, investment money out there supporting the businesses. And in general, uh number five is to maximize all your deductible business expenses. Ok? I like this one because when I was first starting out and I wanted to be a real estate investor. Uh I was starting to look at properties but I didn't own any real estate and I actually didn't have any real estate income. So does that mean I can't deduct uh expenses?

No, he says, and so, you know, as soon as you decide you want to invest in commercial real estate, ok. There are massive deductions that you can start taking. It sounds like you just started a business venture when you decided that you did. And so here's how it goes is let's say that you decide you're gonna invest in real estate. And so what are the first things you do? You start driving the market, you start uh looking at properties you start talking to brokers mileage. Uh And so, yeah, I'm gonna go through a few that just come to mind what we wanna try to do is to take ordinary expenses that you're already paying. And we want to convert those to deductible expenses because you're now a real estate investor. And so let's say your cellphone, you know, you need your cell phone in order to locate properties to call brokers, uh you know, to look up uh properties online. And so you can deduct your cell phone, you can deduct your internet, you can deduct newspaper, uh you know, subscriptions online, subscriptions to different websites. That'll give you information on commercial real estate, your car expenses. Here's one, let's say you want to go to Dallas with your wife uh for an event.

Well, you need to set up to look at some properties. Maybe there's some real estate in Dallas that you really want to buy. Maybe you set up a meeting with a couple of brokers to learn the market. Well, now you've got travel expenses, hotel deductions, all of those that you would have spent otherwise I think you're allowed to do first round, last round. I mean, you're allowed to write off an obscene amount of things. Yeah, with meals and entertainment, it's 50% of the expense, but with the travel expenses, it's 100%. So once again, you have to get good advice from your tax account to make sure that you do it the right way. But this is a great way to start getting deductions on your ordinary income before you've ever bought a property and before you're ever making income in this new venture that you're trying. Yeah. And I, I want to rephrase the last part of that because I've never met a CPA that loves to give advice. Right. You have to go in armed with questions and, and pressure them to help you with these things, right? Give them a copy of all of your expenses and say I really need more write offs. What can I write off, you know, and, and press them on. Why can I not write this off?

Why can I write that off? Ask questions to your CPA almost always gets you more write offs just asking questions and look when we started, when I started in 2002, 2003. Uh in order to get all this information, I had to read seven different books. OK? On all the tax strategies and all the deductions and all the business expenses. But now you're a Google search away from getting all this information. So when I say consult a tax professional, I don't necessarily mean set up a meeting with a EPA, I just mean get online and do your research and understand the, the, the nuances and the technicalities of the tax code and make sure you're maximizing this because once again, taxes are your biggest expense. 25 30 40 50% of your income, the government's taking that and so we wanna minimize the biggest expense we have and this is the best way to do it, these, these ways that we're talking about. So. Alright, number six on our list is uh to depreciate your properties. All right, Braden hit it. Well. Um yeah, we not only depreciate properties, we accelerate the depreciation on those properties because a dollar today is always better than a dollar tomorrow.

Um And when you're paying the, the depreciation back when you sell the property, um it's what, 20% 25% 25% is depreciation recapture which um for, you know, high income earner, that's, I mean, that's a decent tax rate, right? And you get to write it off and not actually incur the expense. So a lot of times for the first several years, you're able to cash flow these properties and distribute that cash flow to the investors from those properties, but write off this expense that you're not incurring depreciation minus what accelerated depreciation is accelerated appreciation is just changing. Um the, the schedule. So a typical tradition, a typical depreciation schedule is 27.5 years or 3939 years, one of those two. Yeah, depending on commercial residential. Um So when, you know, that's a long period of time and, and it's typically flatlined or, or however it is. So we go in, you can do a cost segregation study. It's, you know, 1500 a few 1000 bucks depending on the size of your property.

And it basically just front end loads, the depreciation. So you're able to take, you know, 20% of the, the depreciation that first year. Almost a, a lot of the times actually, you're able to take up to 20% of the allocated value to the building, which is typically, you know, 70% I would say is, is a good number to say because you have to allocate something to land and you can't depreciate land. So 70% of your purchase price is typically allocated to buildings and then you can get 20% of that typically written off the first year regardless of what day you bought it in the calendar year, which is a beautiful thing. You could buy it the last day of the year right off 20%. And you know, it's gonna be hard to just describe how powerful this tax advantage is, but this is one of the strongest uh uh kind of this along with 1031 is, is kind of some of the strongest uh tax deductions you can possibly have. We use it and it allows us to make a lot of money with commercial real estate and not have to pay federal income tax. Uh Because of this rule, we're buying really large buildings and we're accelerating the depreciation and, and that depreciation those first few years is higher than the income that the properties are producing.

So not only do we get to, to write off all of the income the property is making us, but then we have this leftover depreciation that we can use to offset other income. OK? And that's how powerful it is. So if you, if you buy enough property and you have enough depreciation, you can offset uh all the income you have. Now uh if you are not a real estate professional and you don't do this full time and you're just investing passively, then you may, you're not gonna be able to use that depreciation to offset your active earned income from your job. OK? That's a whole another show on how to get to do that, but it still accumulates. So let's say you're a passive investor in one of our investments and let's say it generates $2000 a year in income for you, but we give you $4000 of uh depreciable income. That means that, that $2000 right off, sorry, right off. And so that means that, that $2000 that we paid you, you're gonna pay $0 in taxes on that, but it's even better than that because you're gonna take that extra $2000 and that's gonna roll over to the next year. And so you save that depreciation and if you have income next year, it's gonna write it's gonna, you know, allow you to write that income off and not pay taxes on it.

Yeah. So, I mean, most businesses, most small businesses, so a business under 250 employees, that's most businesses in the United States. Most of those businesses don't have a lot of assets. They don't have a lot of depreciation. So, their, on their only way to offset income is to actually incur an expenses to actually spend money. That's why you see everyone buying trucks at the end of the year. Oh, new truck. Gorgeous. Oh, I had to, my accountant said I had to buy a truck. I'm so sick of that. Like, buy a building. Like you don't have to actually incur an expense to get a loss. Real estate is the perfect proof. It's a great example. So, yeah, you buy a truck, you get the truck and you get the write off, but you had to buy the truck for 70 grand. But if you buy a building for $100,000 or a million dollars, not only do you get the write offs associated with that? But you get the income, the business, the building gives you and your million dollars is still there. So the building could, if you buy a million dollar building instead of a car that's gonna depreciate. Right. Right. So you buy a million dollar building, let's say you buy it cash and you make $100,000 on it right in cash.

But you're not gonna pay a dime on that because you're gonna, it and the building's gonna go up 50,000 $100,000 in that year. So you're winning on all fronts and paying zero taxes while you do it. Stop buying trucks for buildings. Like a lot of people need a truck. I get it right. But there's better ways to get right off. So this is, this is one of them, right? This is one of the beautiful ways. This is one of the best things about commercial real estate is depreciation. Eventually you will depreciate it to zero. And I think this may be the next, the next point. Right? Well, I got a couple of things to say about this. So uh you depreciate the building down to zero or down to some number. Uh when you sell, if you don't 1031 exchange into a new property, then you're gonna have to recapture that depreciation and you're gonna pay 25% on that. Now, two things about that first is you're most likely in a higher tax bracket than 25%. So it's still a benefit. But the, the better thing is this, you may not sell that property for 15 years, right? So you get the tax benefit for 15 years before you ever have to recapture it cumulatively grow your wealth.

Yeah. So now you're growing your wealth, it's like a, like a 401k. The money goes in tax free and grows tax-free. That's kind of like this is, is that you're gonna get all this money tax free and you get to reinvest and double it and grow it and double it and then 15 years from now, maybe you get to recapture it at 25%. That's a win for you guys. OK. Number seven is don't sell borrow. Yes, I love this one. What do you mean by that? We we all want to say something. I wanna let you go. So uh I is borrowing a taxable event is borrowing a taxable event is pay taxes on borrowing money. Ok. So this is the in the underlying incentive to why we want to constantly re leverage up our properties instead of selling our properties because typically our properties are appreciating not through just the inherent cost of the stones that it costs to build the property, but because of the rent growth, right? And the income associated with that. So years and years down the road, the income is going to grow and the property is going to be able to afford a higher debt service and the property is going to inherently be worth more because of that. So when your loan expires, which is typically not a fully amortized loan, hardly ever unless it's some you know, government low housing or light tech or you know, fan are, are Fannie Mae loans fully am not usually H loans can be.

So there's a balloon payment, you know, 57, 1015 years when, whenever it is, the loan expires and at that point, you're left with a, with a decision to refinance or sell the property and somebody should be doing a refi or uh sale analysis for you. And that is the one analysis you need to do those tax, right? Because that's the staggering difference in my opinion. So I'll give you a real life example. Uh because we've done this several times and this has absolutely changed my life. This, this one piece of advice here, we bought an apartment complex that was about 20% occupied for a million and a half dollars, ok? And we spent, let's call it a half a million dollars, uh fixing it up and, and getting those units ready for tenants. Uh So now I'm in two mil, right? And, but once I start filling those tenants up, the income's shooting up. And so 23 years later I go to get a new loan and I get it appraised and it appraises for like $6 million. And so I could have sold that property and then I'd have to pay taxes on the $4 million that I made in profit.

And, and, and it was like, it was longer than a year, but it was fast. I don't know, it was longer than a year. So I would have had to pay 20% or 2524 point something percent uh for capital gains over a million dollars on that 4 million. So all we did was, we said, hey, uh lender, can you loan me money? And they're like, yes. And so they, we, we appraised it at about 6 million. We got a 75 or 80% loan on it and we pulled out uh $4.8 million let's just say, uh it was something really close to that. And so now II I was in for 2 million and now I got a loan for 4.8 million. So I, I literally got $2.8 million in my pocket. Zero, taxes, zero. And you'll send after 1031 I didn't have to do anything. I just put it in my pocket. I could go invest it tomorrow. I could go buy a house with it. I could do whatever I wanted to with it. And you, you know, I hear some voices saying, well Joel, you know, yeah, but you gotta, you gotta pay the loan back. No, I don't have to pay the loan back because if the property is a present for 6 million, that means my income, my net operating income is sufficient to repay the loan.

I'm gonna blow everyone's mind if anything, you not only didn't pay taxes on the $2.8 million but by borrowing it, you incurred an additional expense interest to write off so that borrowing $2.8 million tax free allowed you to offset even more income and beautiful. And so what's gonna happen now over uh let's say that loan is on a, on a 25 year AM. What's gonna happen? I got the $2.8 million in my pocket. Well, over the next 25 years, the tenants are gonna pay that loan off to zero, right? That 4.8 million is gonna go to zero and that property over 25 years is gonna triple in value, right? So then in 25 years, that $6 million property is gonna be worth $18 million and I'm gonna owe zero on it. So who had to pay back the loan? Not me. Right. And all the while that, that this property is tripling in value and, and the tenants are paying off the loan, I've got $2.8 million that I can go buy another $10 million building with that's gonna triple over the next 25 years. This is hugely powerful guys buy a property, let the value increase or increase it through renovation and then don't sell it.

Keep it right, refinance it and take those proceeds and buy another property, buy another building with it and keep the original property. Now, your assets have doubled and you haven't, you haven't paid any taxes. I think people refer to this as equity farming. Don't they something like that anyway, we've done it successfully many times. It's one of the most powerful things we've done in commercial real estate is is buy rent, you know, properties that need renovated, renovate them, get a higher value let appreciation and inflation work its magic uh and take 80% of the proceeds out through a loan and pay zero taxes. All we're getting along. So let's number eight is and last one is die owning your property. Why do you want to die? Owning your property? We don't want to die. We just are going to die. Alright? This one's easy and it's really really interesting how the government has set this up. So if let's say you have and I'm gonna use a million dollars because it's just easy. Uh you buy a million dollar property and then you're gonna depreciate that taking advantage of all the tax benefits and you're gonna appreciate that to zero. You're gonna incur that loss without actually spending the money, right? You're not gonna, and the property's gonna make you money and now you're getting old and you're about to die and you're like you know I'm not gonna sell that, I'm gonna die and I'm gonna still own it but it's gonna pass to my heirs.

Ok? Well what happens is let's say that $1 million property is now worth 5 $5 million ok? But you've depreciated it to zero. So if you sold it, you'd have to pay capital gains on $5 million which the bill would be a million bucks. Ok. But if you get, if you pass it to your heirs upon your death, they get a step up in basis to the $5 million. And so they could sell it for $5 million and take 5 million tax free because the, the government allows you through an estate sale or through the estate when you die to, to, to give, you know, I think it's up to $15 million. Now. I, I'm not only the exact number but like 12 to $15 million you can pass to your heirs tax free. So that is amazing guys. So, is everything over 15 million that you pay a state tax on and through a step up basis, they don't even have to pay uh ordinary income tax. Long term capital gains tax. Nothing. And there should be an inherent tax bill because you'd appreciate it to zero. Correct. But when you die, it transfers to your heirs and they get a step up on basis and then what do they get to do?

Like, let's say that $5 million property is making $500,000 in income every year. Well, your, your heirs aren't gonna have to pay that because they can depreciate starting from 5 million down. And so the depreciation will most likely offset 100% of the income that property is making or close to it. So now they could choose to sell and take 5 million tax-free or they can choose to, to keep that property, let it keep growing in value and take that income tax free or at least mostly tax-free because they're gonna start depreciating it all over again. And then I'm assuming they would, they would pay ordinary income from, in depreciation, recapture from their basis the day they inherit a 5 million dollar basis. OK. That makes sense. Holy shit. It's, it's powerful. That's good. All right. Those are eight ways to maximize tax benefits or lower your tax bill. And guys, this is why we're in this game because you can make a lot of money and pay very little money in taxes and the government lets you do it. It's legal. Make sure you get the right advice. Uh And if you have questions, hit us up, right.

We, we covered most of it, but pretty high level. So you may ask specific questions, send us a message, let us address it on the air, on our next podcast. Uh Brady. You got anything else? Yes, we wanted to thank everyone for coming out to the new investor networking event we had at the co-working space up in Owosso um A few weeks ago. It was awesome. We got a lot of good conversations going there. We had some lunch. Um Good times hung out and talked for like an hour. So, uh we'll probably end up doing this every single month. So if you are interested in stopping by, make sure you are on our email list and we will get you plugged in. All right, thanks guys.