You Too Can Pay Less in Taxes!
When I first started my entrepreneurial journey, I used to think of CPAs, accountants, and the IRS as the necessary evil that I just have to deal with. Ten years later, I understand how detrimental it can be to brush those things aside. The Tax Code offers so many opportunities to those who know how to utilize it.
Our CPA, Jordan Empey from SKR + Co, was a big part of that mindset shift for me. His company taught us a lot about commercial real estate investing and the tax benefits you get in that space. We switched from the residential fix and flip business to full-time commercial because we understood we would keep a lot more of our money.
Today I invited Jordan to share that knowledge with you because these tax benefits are there for the taking. Financial literacy is the key!
“The Tax Code isn't out to get you—it actually presents opportunities to reduce our taxable income.” - Steven Libman
The Tax Benefits You Need to Know About
Jordan has been a tax partner at a CPA firm that’s been around for 25 years. He’s specialized in real estate deals, be it multifamily or land development. Some of the main tax benefits he mentioned in our talk were capital gain rates and depreciation, so let’s talk about that!
Short vs. Long-term Capital Gain
Capital gain investments include anything held over a year. And as one of the founding partners of SKR + Co put it: "You'll never go broke paying capital gains tax." Why is that?
Capital gains rates are often better than ordinary income tax rates. While your income can be taxed up to 40%, some capital gain rates are near zero.
Getting into long-term investment deals is something that you should plan if you want to build generational wealth. The quicker you get to capital gains rates, the better.
These types of investments can be built over time. If you have a rolling portfolio, you can use losses from new investments to offset gains from an older investment. That way, you can build a healthy passive, or active income subject to capital gains tax.
Depreciation
Depreciation recapture happens when you sell a property. That means that when you buy a property, you get to recapture some of the purchase cost over time. And if you’re in the top earners’ bracket, you get to benefit from the 12% difference between your max tax bracket and 37%. Over time, that 12% you get on recapture can compound into significant amounts that you can then roll back in other investments.
Real Estate Professional vs. a Passive Investor
To become a real estate professionals, you have to spend more than half of your time working in real estate-related fields. However, there are a lot of investors who are limited partners and who invest passively.
The biggest difference between the two is that real estate professionals can take losses today. Passive investors and limited partners still get the losses, but there’s a difference in timing.
What's more, all passive investments get grouped. If you have any other passive income, the real estate losses, such as depreciation, go into that bucket, and you get a loss. For example, if you get a million dollars from somewhere else and a million dollars of depreciation, you don't pay tax because they are all set to zero.
And if you put money into an active investment, you will pay active income tax. But with passive investments, you can compound losses over the years. The delta continues to grow along with your depreciation, and that’s how generational wealth is created.
The CARES Act and What Does It Mean for You
The CARES Act was adopted to support people during the pandemic. One of the things that were introduced was the net operating loss carryback.
Before the tax reform in 2018, you could always carryback and get money back from the government for the losses you had in the current year. However, the IRS tan made it mandatory for the losses to go forward so you can never get the cashback, but basically, just offset future taxes.
The CARES Act changed that, and they reinstated a five-year carryback. That means you can choose whether you want to carry your losses forward or back, which opened up a cash scenario for a lot of people. The decision isn't so clear cut, however, and strategizing is key in this situation.
Another thing that came into play is the possibility to defer payroll taxes for a while, even if you got the PPP. And for heavy real estate investors, an important thing to note is the excess business losses. The CARES Act introduced a lot of changes that could impact you differently in different tax brackets, and Jordan thinks there's still more to be rolled out.
Wall Street vs. Real Estate Investments
Obviously, we prefer commercial real estate, but I wanted to know what Jordan thought, tax-wise, was a better investment for passive investors. Why choose one or the other?
With the market, everything is a little bit out of control. What Jordan likes about real estate is that there’s a sense of ownership and tangibility. You can quantify the risk on a smaller scale and get immense tax benefits. There’s also a feeling of pride in taking a more active role in your financial future.
The best idea for smart investors is to diversify. With real estate investments, you get more stability and consistency in your portfolio. With your money in a long-term real estate deal, you pay fewer taxes, keep more of your money, and build generational wealth faster.
The Importance of Right Information
If you're in the real estate game, make sure your CPA is well-versed in real estate. A great CPA who knows this field inside and out can mean a huge difference in your accounts and the amount of taxes you pay.
When it comes to professional services, you can look at it either as a cost or an investment. We choose to see it as an investment because the wrong kind of advice could cost you millions of dollars over a lifetime.
