Year-End Tax Updates, New IRS Interest Rates, and URGENT News for LLCs

Dave:
Hey, everyone. Welcome to On the Market. I’m your host, Dave Meyer, and today we’re going to be talking with Brandon Hall, who you might recognize from a previous show on On the Market where he came and talked about taxes, and today he’s going to be sharing his knowledge, yes, about taxes and things that are changing in the world of taxes for real estate investors, but we also get into new requirements for anyone who owns an LLC, we talk about bonus depreciation, and how to save some money on your taxes going into 2024. So, if you’re an active investor and you don’t like paying more taxes than is required, you are going to like listening to this episode. All right, well, that’s all I got. We’re going to just get right into this interview. We’re going to bring up Brandon Hall, who is the founder and managing partner of Hall CPA. Brandon Hall, welcome back to On the Market. Thanks for joining us again.

Brandon:
Thanks for having me back, Dave. I appreciate it.

Dave:
For those who didn’t listen to your first appearance here, can you just give a brief introduction about your involvement in real estate and as a CPA?

Brandon:
Sure, so my name is Brandon. I run a CPA firm called Hall CPA. In the market, we’re kind of known as the real estate CPA. Our website’s therealestatecpa.com, so hit that early for SEO purposes, but my firm, we have about 50 US staff and we’re all remote, so it’s all over the United States. We service about 800 clients across the United States. We are 100% niched in real estate, so all of those clients are investing in real estate to some degree. And myself, I own 25 units, so I’ve got multifamily, single family, short-term rentals, kind of doing it all, trying to figure out what I like.

Dave:
That’s great. Which did you do first? Were you a CPA or a real estate investor first?

Brandon:
That’s actually a good question. I think I got my license like a month before I bought my first property, so it was pretty much simultaneous, but I built my entire firm on the BiggerPockets forum way back in the day, just answering forum questions, tax questions, and it’s built it to really what it is today. So, I owe you guys a lot of my success.

Dave:
That’s super cool. I remember hearing about you when I first joined BiggerPockets eight years ago, and you’re definitely one of the OG power users of the forums and were the go-to CPA, so we appreciate you adding all that value to our community. I think it’s funny, I have this theory that most real estate investors start by just completely ignoring taxes, and then over time it just becomes the focus of your entire portfolio is taxes, and it seems like you probably started from a better place than most people being a CPA, so that’s a good advantage.

Brandon:
Well, and we try to help people think about all those tax issues early on because I do agree, people will get into different deals and then ask, “How does this impact me from a tax perspective?” And they typically ask that question around April 15th of the following year, which is also typically a little too late, so kind of gets in some sticky situations from time to time.

Dave:
Well, hopefully this episode will help people start thinking about these things a little bit earlier, so you’re not frantically emailing Brandon or your CPA when there’s no time left for you to make any decisions, but today we’re going to talk about some changes that are going on in the tax world, seeing as the show is focused on news, data, trends in the real estate industry. Brandon is here to talk about some changes in the tax world. So, the first thing is there’s something called the Corporate Transparency Act. What is this?

Brandon:
So the Corporate Transparency Act, it’s not necessarily a tax thing, but I’m finding that a lot of people don’t realize that this is coming. So the Corporate Transparency Act, it kicks off January 1st, 2024. If you have an LLC, you probably have a filing requirement under the Corporate Transparency Act starting next year. So if you have an LLC today, meaning before January 1st, 2024, or if you open an LLC between now and the end of the year, so your LLC is open before January 1st, 2024, you have until January 1st, 2025 to file this form, and I’ll talk about the form in a second. If you open an LLC after January 1st, 2024, you have 30 days to file the required form, and this is everybody. Everybody has to do this thing. So, the form is a beneficial ownership interest form. So, what’s going on as we’re reporting to FinCEN, who the beneficial owners of the entities are. It’s very, I guess you could say, intrusive.

Dave:
What is FinCEN?

Brandon:
FinCEN is the… I actually don’t know what the acronym is, Financial Crimes Enforcement Network, that’s what FinCEN is. So, what they’re trying to do is they’re trying to identify people who are committing fraud, money laundering, that type of thing, but it effectively impacts everybody. So if you have an entity, you have to look at whether or not you have a filing requirement. There are exceptions, so if you are a large company, you’ve grossed $5 million in the last 12 months, you might have an exception there. If you’re a nonprofit, if you’re a bank, you might have exceptions there. But for most of us that are buying rental real estate through our LLCs, we’re not going to qualify for an exception, so we have to file this… They call it a BOI report, beneficial ownership interest report, and that report basically says, who are the direct owners and who are the indirect owners of this entity?

Brandon:
So what you have to do if you have an LLC, is you have to work with either your attorney or your accountant to file these forms and you have to meet the deadlines because if you don’t meet the deadlines, it’s a $500 per day penalty that you’re late.

Dave:
What?

Brandon:
So, you can’t just open up an LLC and forget about this thing. You have to get this done. The penalty does cap out at $10,000, but still, that’s incredibly expensive, and there’s also criminal penalties. I don’t think anybody has to really worry about that, unless you are committing fraud, but the $500 per day penalty is pretty steep. So, this is something very serious that you have to educate yourself on. There’s currently conflict in the accounting industry as to whether or not accountants can file these forms on behalf of their clients and whether or not it’s the unlicensed practice of law, and it seems to be a state by state issue. So, the point of that is to just say you have an attorney and you have a CPA on your team, hopefully, if you don’t, you need both of those professionals. Your CPA might not be able to file this for you, so you might have to use your attorney to get this done.

Dave:
Wow. Well, I just wrote this down. I literally just added this to my to-do list because I do not want to be charged $500 per day. I assume that’s per LLC, which [inaudible 00:07:40]-

Brandon:
Per LLC, man.

Dave:
… Really expensive.

Brandon:
It’s pretty steep, but again, if you have the LLC open right now, you have until January 1st, 2025, so you’ve got some time, but every future LLC you open-

Dave:
But still, just do it January 1st.

Brandon:
[inaudible 00:07:56].

Dave:
Well, that’s interesting. I’m curious, so I guess the point is to prevent money laundering and fraud. I guess if you’re really good at fraud or money laundering, they don’t care because if you made more than $5 million, you’re fine, but this to me… I don’t know any other example of having to report LLC ownership or file documents to the federal government. To me, all my LLCs are in one state, I have always ever dealt with the Secretary of State’s office. Is this unusual or this kind of this whole new thing?

Brandon:
Oh yeah, it’s new. Entities don’t really report to the federal… I don’t know of an instance where they would report to federal other than this. Individuals will have… If you have foreign bank accounts or you’re investing overseas, you might have FBAR requirements where you have to report to FinCEN. So it’s not unheard of, and we have a lot of clients that report to FinCEN, but reporting your LLC to FinCEN is brand new, and you really have to look at the beneficial ownership piece because what we’re finding and what we’re learning is the indirect owners, it’s not as simple as just saying, Brandon owns 100% of this LLC, so Brandon is the only one that shows up on the report. You have to look at all of the indirect owners too. So, if you have options and grants and things like that, you have to start factoring that in, and it could get relatively… It could get pretty complicated pretty quick, so don’t just take it at face value. This is something very serious. You want to get it right, work with an attorney or a CPA to get those things filed.

Dave:
All right, this is one of those things I’m very glad you told me about and very mad that I have to do, but so be it. All right, what about cost segregation studies? This has obviously been a very hot and popular thing to do in real estate. Actually, before we get into what’s changing, can you just explain what a cost segregation study is for those who aren’t aware?

Brandon:
So when you buy a property, let’s say you buy a $100,000 home and we have to break out the land value. The reason we have to break out the land value is land cannot be depreciated. We only depreciate the value of the purchase price, that constitutes components that fall apart over time, like the building, and the windows, and the carpet and all that type of stuff. Land doesn’t fall apart over time. So when you purchase a property, you have to allocate some amount of that purchase price to land, and we call it the land value. The remaining that is not allocated to land is allocated to the building and it’s depreciated over 27-and-a-half years by default. So, we buy a $100,000 property and we allocate $90,000 to land, our annual depreciation expense that we get to claim is 32, $3,300 a year.

Brandon:
All right, so every year we get to claim that expense, I don’t have to come out of pocket for it, I don’t have to pay anything else for it, it doesn’t matter if I paid cash for my property or if I financed it 100%, or if I financed it 70%, it doesn’t matter. Every year I get the 32 to $3,300 depreciation expense and it helps to shelter my cashflow. I could cashflow $3,000, cold hard cash hits my pocket, but then I get 3,200 bucks of depreciation, so I get to actually tell the IRS, “I lost money on this property,” even though I actually made money. So, that’s where this depreciation benefit comes into play. Now, a cost segregation study says, “Well, you bought the property for 100, 10,000 was land, so 90,000 is building, that’s what you’re depreciating over 27-and-a-half years,” but there’s a lot of components that go into that $90,000 that will not last 27-and-a-half years.

Brandon:
There are components that will only last five years, some will last seven years, some will last 15 years, and maybe the rest will last 27-and-a-half years. So, a cost segregation study is essentially the practice or the science of identifying those components that will only last five, seven, and 15 years, so that’s what you do. And the purpose of doing that too is think about $10,000 of value. If I depreciate $10,000 over 27-and-a-half years, that’s $360 a year in depreciation expense. But if I get to depreciate $10,000 over five years, that’s $2,000 a year in depreciation expense for five years. Now, if we have accountants listening to this, I know that there’s double declining balance, but I’m trying to keep it simple, so it actually changes a little bit, but simply $10,000, if I can take that out of the 27-and-a-half year bucket where I’m getting 360 bucks a year for 27-and-a-half years, now if I can put that into my five-year bucket thanks to a cost segregation study, then I get to claim $2,000 of depreciation expense for five years and then I have zero after it’s fully depreciated.

Brandon:
So, a cost segregation study not only identifies these components that won’t last 27-and-a-half years, but it enables you to front load your depreciation expense. So, instead of claiming $3,200 in annual depreciation, like we were mentioning, I might have $10,000 in first year depreciation, $8,000 in second year depreciation. So, I get to really increase my expense, and then what everybody then references is bonus depreciation. So if I have a cost segregation study that has identified five, seven and 15 year components, I can use bonus depreciation to really write those things off. In 2022, it was 100% bonus appreciation, 2023 it’s 80%, and then 2024 it’s going to be 60%, and it’s going to continue to fall off 20% until it reaches zero, I believe, in 2027.

Dave:
So, that seems like a big change, it’s this declining amount of bonus depreciation. And first of all, thank you for explaining that, it’s very helpful. From my understanding, cost segregation has been around for a while, but the bonus depreciation, that’s relatively new, is that correct?

Brandon:
100%, bonus depreciation was new, 50% bonus depreciation has been around for a while.

Dave:
I see. When did that come into effect?

Brandon:
So, 100% bonus depreciation came into play in 2017 with the Tax Cuts and Jobs Act.

Dave:
Got it.

Brandon:
And it was always planned on starting to phase out because you have to balance the budget and everything.

Dave:
Got it, so that’s phasing out and we are now in the midst of phasing out, and can you just remind me of the tiers you just said of how it’s being phased out?

Brandon:
So, prior to January 1st, 2023, if you bought a property and placed it into service and you did a cost segregation study, you could 100% expense any component with a useful life of five, seven, and 15 years. So on single family homes, these cost segregation studies will allocate like 15 to 18% of the purchase price to five, seven, and 15 year properties. If I’m buying a 100K property, then I’m getting a $15,000 first year deduction, and that just multiplies as my value multiplies. On multifamily property, it’s like 20, 25%, so it starts to go up, and then there’s other types of property that can get you to like 50, 60, 70% and just depending on what you’re buying. So, the bonus depreciation is phenomenal, it’s a phenomenal tax benefit, but in 2023, it dropped from 100% to 80%. In 2024, it’s dropping from 80% to 60%, and then it’s going to keep going down 20% until it reaches zero, which again, I believe is 2027.

Dave:
So, what does this change, from 80% to 60%, mean for investors? I know that giving advice is very individual, so it’s hard, but what are some things that perhaps our audience should think about given this change?

Brandon:
I think that the main thing is that cost segregation studies will become less valuable, but I want to make sure I caveat that by saying cost segregation studies will still be valuable because you’re still accelerating depreciation. It’s just that you’re not able to fully extract the tax benefit from your rental property because you can’t fully expense the amounts identified with the cost segregation study. So from a time value of money perspective, we want to pull the tax savings out of the property as fast as we can and then redeploy those tax savings into other investments, whether they be rentals, equities, bonds, whatever. And if I can’t fully pull those tax benefits out, then I’m going to lose some value from a time value of money perspective. So, the point is to really kind of say, if you were really used to 100% bonus depreciation, knocking down your tax bill, it’s just going to change a little bit. It’s not going to necessarily… I can’t foresee people saying, “I don’t want to do a cost segregation study,” but I think the conversation around cost segregation studies will change.

Dave:
Do you think we’ll see a rush of people trying to still capitalize it? Because like you said, it’s still valuable and 60% is still better than what it used to be, or is now it basically at the value that it is traditionally?

Brandon:
Traditionally, bonus depreciation was 50%, so I don’t think we’re going to see any sort of rush to purchase property, especially in this environment. It’s a pretty tough market out there right now. So, we try to coach our clients on don’t let the tax tail wag the dog. You have to buy property that you think will perform well and fits your investment criteria. And unfortunately, a lot of people do not do that, especially in the short-term rental markets. They’ll just buy property bonus depreciate it, and then later realize they have to operate it to make money. So, I don’t think that we’ll see a rush to acquire property, but people do it as… At the end of the year, there’s always people saying, “Can I buy property now, place it into service before the end of the year, so that I can bonus depreciate it?” So, there are people that do acquire from a tax motivated standpoint.

Dave:
What about any other changes? We’ve heard about the Corporate Transparency Act and just as a reminder, everyone, you should be… If you have an LLC, try to do that as soon as you can in 2025. We’re also hearing that cost segregation studies, while still valuable, bonus depreciation is declining from 80% down to 60%. Brandon, are there any other tax developments investors should know about?

Brandon:
I think those are the real major ones going into next year. At the end of the year, there’s always some legislation that gets passed. So we’re always looking at Congress to… Or we are always watching Congress to make sure that nothing crazy is going on. It doesn’t appear to be anything in the works at this point, but that’s not to say that something couldn’t be spun up at the last minute, but we’re going into an election year, so into 2024, we might see something come about, a new legislation that might change some tax laws, but those are the main things, the main real changes I think that investors should be aware of going into 2024. The one other thing that I do want to mention, the IRS interest rates now are at 8%, which means that if you work a W-2 job and that’s kind of your main source of income, you can tune this part out.

Brandon:
But if you run a business like me, or if you are primarily making money from real estate, buying, selling, flipping, whatever, you should pay attention. So with interest rates being so high, it becomes very costly not to make quarterly estimated tax payments. So with low interest rates, a lot of people, and myself included, would just wait until the end of the year, make one big, major lump sum payment, and you’d eat the $2,000 cost associated with that, but today, that cost has significantly increased. And I think what a lot of people don’t realize is if you extend your tax returns on April 15th and you don’t make a payment or the total payment that you’re supposed to make had your returns been totally prepared, whatever that delta is, that payment that you should have made, not only is it accruing interest, but it’s now accruing a half a percent per month payment penalty that you also have to pay.

Brandon:
So if you take $20,000, if you should have paid $20,000 on April 15th with your returns, but you extended, and you don’t get them filed and paid until October 15th, that $20,000 will accrue like 14 or $1,500 of additional penalties and interest. And we have clients that it’s like $100,000, so it gets extremely costly. What I’m trying to say is if you’ve never had a tax projection performed or a custom quarterly tax projection performed or a tax estimate performed, you might want to start looking at that with your accountant. We’re starting to field a lot more requests from clients on that, but it’s just that rising interest rate environment makes it a lot more expensive to hold onto the tax bill and not pay it on a quarterly basis. So, if you’re making money from business or from liquidation of real estate where you’re not withholding federal taxes, you might want to get a quarterly tax estimate performed for you and it costs money, but it will probably cost less money than not making the payment.

Dave:
That’s a great point. You see a lot of people on social media being like, “It’s an interest-free loan from the government to hold onto your taxes,” it is not interest-free.

Brandon:
Certainly not anymore.

Dave:
And to your point, if it was 3% and you were earning five or 6% annualized rate on whatever, then it was actually a good trade, but now earning 8% on your money is no longer a layup, and so the delta is not necessarily working in your favor. Great, well, that’s very good advice. Thank you. Appreciate that. Last question, Brandon. How do people find a good CPA, specifically one who knows something about real estate?

Brandon:
Well, my self-serving answer is going to be, if you look online, we all have websites, ideally. If your accountant doesn’t have a website, that’s probably concerning.

Dave:
It seems like a red flag.

Brandon:
Especially today, but we all have websites, so what does the website say? Does it show we have 15 different industries? Does it show two different industries? Does it show our website, one industry? That’s typically a good place to start in terms of, are they working with other people like me, like real estate investors? Another good place to start would be a local real estate meetup group, ask for referrals.

Brandon:
You can ask on the BiggerPockets forums. I know people are always asking for referrals there, so asking your peers is a great way to go as well. So, I would say either one of those, just looking online, looking at the website, who do they target, and then asking peers for references or referrals, that type of thing is going to be a good way to find a CPA. It’s hard to actually ask the CPA, “Do you work with real estate investors?” Because they might tell you yes, but you might be their first one.

Dave:
Right, yeah.

Brandon:
That’s why I say you want to look for these other indicators that kind of build that almost social proof, if you will, or build that authority and that way you know that they’re working with people like you.

Dave:
Great advice. All right. Well, Brandon, thank you so much for joining us. We appreciate your time.

Brandon:
Thanks, Dave, for having me on. I appreciate it.

Dave:
Thanks again to Brandon. We really appreciate his advice. I definitely added a couple of things to my to-do list. That LLC requirement is nasty. I don’t want to pay $500 a day, that seems extremely punitive, but luckily you have a year to comply with that, so add that to your to-do list. I personally also learned the lesson of the estimated tax once. It is a very costly thing. So, if you are earning a substantial portion of your income from a job or income source that does not withhold taxes for you, you probably want to talk to a CPA about making those payments, so again, you are not paying any penalties or more tax than you are required to.

Dave:
I hope you all learned a lot from this very tactical and practical episode. These things are not always as exciting as making bold predictions about what’s going to happen in the economy next year, but they really make a huge difference in the performance of your portfolio. So, hopefully you learned a lot and can make better decisions about your tax and your LLCs and all of that in 2024. Thanks again for listening, we’ll see you next time.

Dave:
On The Market was created by me, Dave Meyer and Kaylin Bennett. The show is produced by Kaylin Bennett with editing by Exodus Media. Copywriting is by Calico Content, and we want to extend a big thank you to everyone at BiggerPockets for making this show possible.