In my last post of 2015, Top 5 Reason to Buy Real Estate Not Named Cash Flow I brought up some reasons that investors may consider real estate a potentially sound investment due to other reasons than cash flow. Before I bought my first property, my taxes sure were easy. I just inserted the amount that my employer sent to me on the year-end W2 form. I took no deductions, sometimes I'd get some money back, sometimes I'd pay in an extra thousand dollars or two, but it wasn't such a big deal.

Running a small business for the past 8 years, I was a weekend warrior, coffee break maniac, and late night administrative machine. What am I talking about? I worked in Software Development for 8 years and the hours were long. Working 50-60 hours, more/less, at my day job and then trying to acquire a property or two a year on the side, while managing properties from 2000 miles away kept me running around like a mad man all-day, every day. I started to take advantages of the tax benefits of real estate back then using 27.5 year depreciation deductions, mortgage interest deductions, and a variety of expenses incurred due to maintaining my properties including travel, repairs, administrative, permits, and accounting. This did make a significant dent into my tax bill each year.

Close to two years ago, I quit working for somebody else and made myself the boss. It's been a rough transition. I've never worked more hours in my life. I estimate that I work on average 80-90 hours/week. Growth is hard. I went into this thinking, "ok, you've left behind a six figure job, you better do this to the best of your ability and make something of this." Moving from New York to Cleveland was not a seamless transition.

Before I arrived in Cleveland, I started the operation with a family member. He had dropped out of school, young, directionless, he needed a fresh start, I thought. With mixed results in the first six months of sending him to Cleveland, it was finally time to quit my job and run the business full time. I was very excited to get started. Upon my arrival in Cleveland, I was shocked to find out that I had been lied to over and over again. The property that was supposed to be ready to sell was destroyed. His girlfriend had moved in to the duplex that I bought and where we were all living together. It quickly became evident that she had a drug problem. By this point in time, I had four properties, two of them were rented out (one was going through an eviction), we were living in another, and the last property was scheduled to start a full gut renovation on. This was the most stressful Summer of my life. We worked 16 hour days. Clearly my family member and his girlfriend were used to staying up all night long and sleeping all day. We threw out 40 yards worth of dumpster materials in the house that we were living in. I was lectured about "not respecting my things" from the drug addict girlfriend.

Bills under my name had gone unpaid, utilities were being shut off, evictions had to take place, and money was flying out the door. I don't know how things could get worse. After hiring a few more people we met along the way, the Summer of 2015 was about putting out the flames in a business that was entrusted to a family member. After three weeks, I told his drug addict girlfriend to leave my house. I am originally from Minneapolis so I roughly paraphrased the Semi-sonic song "Closing Time" with the lyrics, "you don't have to go home, but you can't stay here" sweety. It took three months to clean out the house that they were living in. At one point, probably during one their benders, she decided to paint the polyurethane refinished floors with gray paint in a 2x2 square. The filth in the house was indescribable. Rotten food, dog crap, sex toys, drugs, boxes of junk, and really just decay and my business that I took 8 years to grow collapsing.

What's this all have to do with taxes? I experienced a lot of losses in 2015. Due to my inexperience as a manager, I was trusting people too fast, too early. I kicked the girlfriend out of my house, fired my family member after a year of total incompetence, and fired another employee who worked without any sense of urgency. They were difficult decisions at first, until you realize that by protecting these types of personalities you are actually burning down everything else in your life. It became clear to me that when someone clearly does not have your best interests at heart, you must eliminate them. They are a cancer, it will kill you, if you don't eliminate them.

I've had to get mean. It's not my first choice. I do feel for employees, tenants, and even clients, however, I learned to expect the same out of others as I expect out of myself. If you can't get that, then act quickly to amend the situation. For example, I don't pay my mortgages or rent late, so why would I let someone pay me late or not at all? When I went to work for a company that hired me, I always took the viewpoint that these people took a chance on me. They could have hired a lot of other candidates, but they bet on me. I took that personally. Why didn't the people I hired take that same attitude? I learned that warning after warning after warning of people not taking you seriously, it's time to act. They were not taking me seriously because I was not taking myself seriously. People respond to strength and action.

In 2015, I brought in 152K in rents across my entire portfolio, but in purchasing new properties and expenses from building a business I had total expenses of 397K. This certainly appears dire when you put it like that. However, after I looked at my itemized expenses, it appears that with cutting a lot of the fat that I should be able to slash my expenses by 150K in 2016, at least. In 2016, the first goal is to eliminate bad debt and replace it with good debt. The second goal is to grow revenue. In 2015, it is the first year that I can consider myself a real estate professional. By IRS rules that means that I can legally deduct unlimited passive losses. In the past I was capped at 25K in passive losses. That in my mind is the main reason to quit your job from a dollars and cents basis. If you want to perform value add on properties, you will show losses but being a real estate professional enables you to recoup a lot in taxes paid in. Anytime you take on a rehab, you will incur passive losses. When you take on seven in one year and you have less than professional people lead your operation, you will incur much more than 25K in losses. After personal gains in 2015, I will most likely be looking a significant refund check this year even bringing in revenue of personal and business combined of 260K+. (I still am waiting to determine my personal gains in 2015 exactly, but that's a pretty close guess).

I'm also excited about something else in 2016, my variable costs will continue to drop. In other words, to frame in a door, you need wood no matter what, but you will also need drills, skill saws, table saws, and what have you. Buying many of the bigger ticket items such as a paint spray machine or power washer are expensive if you are doing just one project, however, as we continue to move forward, our costs are dropping. My team has improved its skill set as I've fired low-productivity workers and replaced them with highly-motivated and talented workers. Experience is also a good teacher, some of what I tried in 2015, I will no longer attempt in 2016. It was an exciting year that I am glad is complete. Now looking forward to a refund check, slightly pivot business operations, and a new start in 2016.

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Unlimited Passive Losses as a Real Estate Professional

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