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Steve and Cliff discuss the many tax benefits and incentives available for real estate investments.
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Episode Transcript
Intro:
You’re listening to the Practical Tax podcast with tax attorney Steve Moskowitz. The Practical Tax podcast is brought to you by Moskowitz LLP, a tax law firm.
Steve Moskowitz:
Welcome everyone. Thank you for joining our podcast. And we’re looking forward to telling you a lot of tax savings in a very good area here, real estate. Traditional wealth has been built with real estate and there’s all kinds of advantages to it. One of my favorites is OPM, other people’s money. And there’s all kinds of things here. For example, one of the things that Cliff is gonna tell you about, there’s a government deal where the government will pay for 39% of the real property you choose to buy. You like that? I’ll say it again. The government will pay 39% of the price and guess what? That’s a gift. They just give it to you. It’s not a loan. You don’t have to pay it back. They just give it to you. And when somebody gives you something nice, what do you say? Well, most people say, thank you, but lawyers say more. I want more. Want to talk about all kinds of things like how you can make a real estate investment, a tremendous amount of money, profit and legally not pay any taxes on it. And this is the type of things that people look at and they say, look at the wealthy, look at the Fortune 500. They’re making all this money, sometimes billions of dollars they’d be in profits and not paying any taxes legally, how can that be? And here’s why. There’s two purposes for the tax law. One we all know about is get money out of us, extracting taxes, but the other one is in democracy, the government can’t order us to do things, even though it’s good for the economy or it’s good for society, they can’t order us.
So, how’s the government get you to do something they want you to do, but they can’t order you? They give you a tax benefit. And that’s what this is all about. And you know, a lot of people just grumble and cry about, oh they take so much taxes out of my earnings. And that’s true. But what we’re gonna talk to you about today, although the wealthy people do it, you don’t have to be wealthy. This applies to any socioeconomic group. You can be a regular normal middle class person, do all these things, and our goal is to get you to be those people that other people point to and say, look at that wealthy guy, look at all the money he’s making and he’s not paying any taxes on it. And maybe some of that’s because you listen to us on this webinar. Without further ado, I’m gonna introduce my friend and colleague, the head of our tax department, who’s also an accountant as well as being an attorney, Cliff . Cliff, you want to take it away?
Cliff Capdevielle:
Sure, Steve, thanks. So, lot of wealth in America has been generated with real estate. And as you say, Steve, one of the key differentiators is the ability to leverage, use other people’s money, take out loans and put down a fraction of the cost of a piece of real estate and then reap the rewards as the value of that real estate increases. I’m up in Incline Village. It is now the average, Steve, the average price for a home up here and this zip code, can you guess?
Steve Moskowitz:
That’s a toughie. Coming from San Francisco, shacks go for millions.
Cliff Capdevielle:
It’s five million dollars is the average house. So, that is skewed because you have Larry Ellison and the other Silicon Valley billionaires up here with properties in the 50 hundred million dollar range. But you can make a lot of money in real estate just by holding it for a long period of time. And you can purchase real estate, as you said, using other people’s money, leveraging that and deducting the interest that you pay for real estate. Now, it’s recently been limited on personal residences, but on investment property, you can still deduct a hundred percent of the mortgage interest.
Steve Moskowitz:
There’s also some tricks to the trade. For example, what Cliff was talking about, under the tax cuts and jobs act, on your personal residence, you can only deduct the interest on $750,000. But that’s per taxpayer, not per house. So if you have a very common situation, John and Mary, boyfriend and girlfriend, not husband and wife, buy the property together, they each get a deduction on 750. So the couple is deducting on one million, five. And the pioneer here was Mr. Voss, V-O-S-S. And he said, you know, IRS, we can each deduct it, and the IRS said, oh no, you can’t Mr. Voss, that’s just 750 for the whole house. And Mr. Voss said, oh no, IRS, you’re wrong. Mr. Voss took it to tax court, tax court said, Mr. Voss, you’re right. So that’s one of the tricks of the trade. And of course, if you’re getting a rental property, then that’s a whole different story. We can deduct massive interest here.
Cliff Capdevielle:
Yeah. And interest deduction is only the beginning, Steve. On rental property, you’re also entitled to depreciation and the typical straight line depreciation on residential rental property, 27 and a half years, commercial property, 39 years. But with a little planning, we can dramatically increase the depreciation deduction, can take advantage of the rules regarding accelerated depreciation and cost segregation, Steve and a cost segregation is worth it’s weight in gold. And how does cost segregation work, Steve?
Steve Moskowitz:
So, what happens with cost segregation is normally when you have a rental property, you have to depreciate it over 39 years if it’s commercial or 27 and a half if it’s residential. But with , we send an engineer to your property and here she examines the properties. Well, this portion is 39 or 27 and a half year, but this portion is 15 year. This portion is 10 year. This portion is five year. And this portion you can write off on this year. And then what happens is you can have a massive deduction. This is the time value of money. This is how banks make their money. You would rather have a benefit today than 39 years from today because you write a smaller check to the IRS, the money you would’ve given to the IRS, you can invest and now you have earnings on money that had you not done the , you would’ve given it to the IRS instead, you’re earning money on that money, you legally didn’t have to pay to the IRS. So you can have, what I call are the sweetest words in the English language, a positive cash flow with a tax loss.
So, let’s say that we had a parental building that took in 10 million dollars worth of rent and there were nine million dollars of cash expenses. We have a one million dollar cash profit. Well, suppose, now with cost , we can have an extra million and a half of depreciation. So, we say, well, now, instead of having a million dollars profit on the books, we have zero profit on the building. And again, we didn’t write a check to depreciation, it’s just an accounting entry. Cliff makes an accounting entry there. Now, we’ve got an extra half a million left over. And the question is, Cliff, if somebody says, hey, their spouse works and they make some money, could you offset this extra half a million loss on the rental property against the spouse’s wages, dividends, interest or profit from business, what would you tell them?
Cliff Capdevielle:
And we would say if that spouse qualifies as a real estate professional, we very likely could take a much larger deduction and use that deduction to offset earned income. So we have spouses where one of the spouses is a physician or a dentist, they have a large number of rental properties. After cost segregation and after leveraging those properties, they have a large paper loss on those rentals, even though they’re throwing off net income. We can use that loss against the ordinary income for that dentist or physician spouse, and guess what, Steve? Their tax bill evaporates.
Steve Moskowitz:
So folks, just imagine that. You have a situation where the building threw off a million dollars of profit in cash, but because , we have an extra depreciation of a mill and a half, so we wipe out the profit from the rental, so we pay zero tax on that million bucks. And then let’s say that the wife was a brain surgeon and she made half a million bucks from her practice, we wipe out her income with the other half a mill, so this couple has earned a million and a half dollars and paid zero income taxes. That’s why people that are aware of these things save so much in taxes and everybody else works so hard and grumbles how much they’re paying. Remember, there’s two purposes, never forget it. There’s two purposes for the tax law. And one of the purposes is to encourage you to a certain thing, real estate is a very, very favored area, and you can do all these kind of things and a lot more. Cliff, I have a question for you. During the buying these properties, what if somebody says, you know, I heard that guy, Steve talking about out 39% and I only have to come up with 61% of the building and the government will give me 39%. What’s that all about?
Cliff Capdevielle:
Yeah. So now we’re getting into the area of credits. Credits are absolutely one of the most important areas. And one of the least understood areas by real estate investors. Most people are familiar with the idea of flipping houses and certainly can make money that way. The government incentives for certain types of properties can absolutely put money in your pocket, whether prices are going up or down. And we’ll talk about a couple of real estate credits that are really worth looking at. First one is the rehabilitation credit or the historic rehabilitation credit. This is for historic buildings, Steve, and typically these are in downtown areas. They don’t have to be, but certain historic buildings, the government will pay you essentially to fix them up. These are buildings which are still structurally sound, but they may have an outdated floor plan. They may have asbestos or other environmental issues that are… Most real estate investors would be reluctant to deal with, except for these giant credits that the government makes available for real estate investors. So, for real estate investors who are interested in historic buildings, converting them to office buildings, restaurants, et cetera, we can show you how to do that and get a big help from the government on your way. The new markets credits is what you’re talking about, Steve. The 39% credit for investing in certain areas, typically, these are low income areas, and if you’re interested in that, in addition to the rehabilitation credit, and we’re gonna talk a little bit about opportunity zones, you can stack these credits together, Steve and save a tremendous amount of money. The government is really interested in helping develop certain areas in this country. And for real estate investors, it’s an opportunity to save a huge amount of money in taxes.
Steve Moskowitz:
So, let’s look how this is shaping up. First, we start off the government gives us a lot of money whether it’s the new markets credit and or other credits. So, even just a new markets credit alone, I mean, imagine, look at the price of real estate and you only have to pay 61%. The government gives you 39%. That in and of itself’s a great deal, but then they give you more credits. Then you have the building and you get all this extra depreciation through cost SEG. So now, even though you’re making a profit from the building, in my example, a million bucks, you didn’t pay a penny of income taxes on the million dollars of profit, and then you still have paper loss left over, and in my example, you wiped out your spouse’s wages or profits from a business, and in my example, the couple made a million and a half dollars of tax free money. They didn’t pay any income tax on that. Or again, we say, but you know what? I still want more, and this opportunity zone is so incredibly worthwhile. Tell us about the opportunity zone.
Cliff Capdevielle:
Sure, Steve. So, this is another government program to encourage real estate investors to move into certain depressed areas in the country. And this, really, you can use this in conjunction with accelerated depreciation with your mortgage interest deduction and the other deductions in credits and really save a bunch of money. The most important aspect of the opportunity zone is guess what? You don’t have to pay any capital gains tax in certain circumstances. In other words, you can roll over the gain from other investments into an opportunity zone and pay zero tax. In many cases, it’s better than doing a 10 31. And guess what? At the end of the day, when you finally want to cash out of that investment, oftentimes you can save a tremendous amount of money when you cash out, sometimes avoiding capital gains on most of your income. So it’s a tremendous opportunity.
Steve Moskowitz:
And there’s even more to it than that because, you know, as you know with 10 31 exchanges, under the tax cuts and jobs act, they took away the ability to do the exchange for anything other than real estate, but here, this is a backdoor way of doing with property, because what happens is you say, okay, as long as you identify the property, do this transaction within 180 days of the cap gain, you can go ahead and take those capital gains from things real estate or other than real estate, put it in the opportunity zone, defer your taxes until 2026, and then if you hold the property just for 10 years, there’s no capital gains. So you can have a zillion dollar profit and pay taxes on that. And something else that’s real cute is, some of these neighborhoods are challenged neighborhoods and somebody might come up and say, well, you know, I’d like the idea that first of all, I’m deferring my capital gains on something else, then I do all this fancy stuff, and I get all this extra depreciation, and even though I didn’t have to write a check, I’m not paying the income taxes on the profit from the building and then not paying taxes on the wages or the profits from the business or dividends. I like all that stuff. And then I turn around and sell the property, and because I held it for 10 years, I’m not paying any capital gains. That’s fantastic. But you know what? You told me these were challenged neighborhoods and that concerns me, the government thought of that. And you set up a company and you only have to put 63% of your money in the opportunity zone. The other 37%, and you can do this anywhere in the country, the other 37%, you can put in the ritziest area of town.
So what happens is, let’s say that property goes through the roof. Then even if there was a challenge in the opportunity zone, you’re still way ahead, because the fancy property went through the roof. And that’s something a lot of people miss. It’s not just putting all your money in the opportunity zone. You only have to put 63% of your money there. The other 37%, you can put anywhere in the United States in the fanciest neighborhood that you want, make a ton of money on the capital gains and not pay a penny of capital gains tax. I mean, what an incredible deal that is.
Cliff Capdevielle:
So Steve, you’re telling me, I know you have a lot of clients in Silicon valley who’ve made a bunch of money in internet stocks and you have crypto investors who cashed out big time this year, are you telling me they can roll all of that capital gain into opportunity zone funds and potentially not pay a nickel in tax?
Steve Moskowitz:
So, what we have here, Cliff, is even better than that. They get to choose, they can put all of the capital gain in if they want and if they don’t want to, which you can’t do in most other areas like 10 31, or you could put part of the gain in, you defer all the tax until 2026. Again, you have all those years to go ahead and earn money on money you otherwise would’ve given to the IRS and the state, if you’re in a state that charges state income taxes, and then you go into an opportunity zone and with the opportunity zone, because you’re holding that investment more than 10 years, you’re not paying any income tax on that. And remember, remember, you only have to put 63% of your money in the opportunity zone. 37%, you can go ahead and put in the fanciest neighborhood anywhere and you’re not paying any capital gains tax on that. Folks, do you see how this stuff builds on each other? It’s not just one thing, it’s many things. This is how wealthy people in big corporations legally don’t pay any taxes. You can do it too. Just call us toll free at 888 Tax Deal. That’s 888 T-A-X-D-E-A-L. 888 Tax Deal. Or Moskowitzllp.com. M-O-S-K-O-W-I-T-Z-L-L-P.com.
Outro:
You’ve been listening to the Practical Tax Podcast, with tax attorney, Steve Moskowitz. To hear more podcasts, go to Moskowitzllp.com/practicaltax. The information contained in this podcast is based on information available as obtained at the date of it’s release. MoskowitzLLP and it’s affiliates are under no obligation to update this information as changes occur. Applying this information to your specific situation requires careful consideration of all factors, which may be applicable, and any information is not to be considered tax advice or legal advice. Further, this is attorney advertising and the facts and circumstances displayed in this case are dependent entirely on the facts of that particular case. Please consult your tax advisor before acting on any matters discussed.