Tax Strategies for Real Estate Investing
Amanda Han and Matt MacFarland discuss tax strategies for real estate investing.
About Today’s Guests
As both tax strategists and real estate investors, Amanda Han and Matt MacFarland combine their passion for real estate investing with their expertise in tax strategies. Their goal is to help investors with strategies designed to supercharge their wealth building using entity structuring, self-directed investing, and income offset opportunities to keep more of what they make.
Amanda and Matt have a highly rated book Tax Strategies for the Savvy Real Estate Investor on Amazon and they have been featured in prominent publications including Money Magazine, Talks at Google, CNBC’s Smart Money Talk Radio as well as BiggerPockets podcasts. Amanda and Matt have a passion for animals and founded Animals for Armed Forces, a non-profit organization that has helped to place over 1,500 shelter pets with forever homes.
Summary
Tax strategists and real estate investors Amanda Han and Matthew MacFarland join Nate and David on this week’s episode to discuss tax strategies for real estate investors. They share an overview of the tax-related benefits pharmacists can achieve through real estate, including depreciation and various real estate specific deductions. Amanda and Matt also go through how to determine if your tax write-off is legitimate or illegitimate.
With the general idea in mind that pharmacists, many of whom are detail-oriented, already keep meticulous records, Amanda and Matt advise listeners to keep tax records in a manner that works for them. Real estate investors should also consider creating a tax strategy for future real estate investment plans with their tax professionals and meet regularly to discuss those plans and their impact on taxes.
Amanda and Matt cover a variety of topics and tax questions. They get into some detailed tax questions, explaining depreciation and the tax write-offs related to that topic, as well as a 1031 exchange, how a 1031 exchange compares to 1 section 121 exemption, and how that will impact taxes. Lastly, they tackle how owning properties as an LLC does or does not affect your taxes and other compliance issues real estate investors may face regarding contractors and payment.
Mentioned on the Show
- The Book on Tax Strategies for the Savvy Real Estate Investor: Powerful techniques anyone can use to deduct more, invest smarter, and pay far less to the IRS! by Amanda Han and Matthew MacFarland
- Money Magazine
- “The Book on Tax Strategies for the Savvy Real Estate Investor: Amanda Han & Matthew MacFarland Talks at Google
- BiggerPockets Podcast 370: Tax Hacks to Juice Your ROI with Amanda Han and Matt MacFarland
- Animals for Armed Forces Foundation
- QuickBooks
- Stessa: Landlord Rental Property Tool
- Turbotax
- H&R Block: Tax Preparation Services Company
- CARES Act
- BiggerPockets Podcast
- Maui Mastermind: Build a Business, Not a Job
- Join the YFP Real Estate Investing Facebook Group
- Keystone CPA, Inc.
- Keystone CPA Podcasts
- Download Your Free E-Book: 5 Cashflow Strategies for Real Estate Investors by Amanda Han and Matt MacFarland
- YFP Real Estate Investing
Episode Transcript
Nate Hedrick: Hey, David, how’s it going?
David Bright: Hey, good, thanks. How are you doing?
Nate Hedrick: Good, good. We’ve got an exciting episode today. I’m really pumped about this one. We’ve been talking a lot in recent podcasts about having a good team, and so this is kind of an extension of that.
David Bright: Yeah, we’ve talked with an insurance agent recently, you as a realtor recently, we’ve talked about how to work with contractors, we’ve talked about a lot of these different team members. But I know one that we haven’t talked as much about is that tax professional or CPA and how the tax planning side comes into this, not just the making sure you do the taxes right when April comes around but that you’re planning intentionally on the tax side to have a little bit of strategy there. I know I picked up a copy of Amanda Han’s and Matt MacFarland’s book on tax strategies for the savvy real estate investor a few years ago. And I assumed it would be this boring book on taxes, kind of like most people probably think a lot of pharmacy books are boring, and we get into it. But this is one where I assumed it would be boring, but it was one that I read straight through in one night because it was written in a way that was just full of stories and examples. And that really helped me to understand a lot of big picture things about tax strategy, not remotely that I became a CPA overnight or anything, but it got me at least conversational about some of these topics so that I could talk with my CPA and ask questions and have more intelligent contribution to a little bit of this strategy discussion.
Nate Hedrick: Yeah, and I think it’s something that many investors may not think about, especially first-time investors may not think about up front because it seems like, well, it’s just one property, it’s just two properties, this isn’t that big of a deal. But it really can be. And it can really make or break the difference between a good investment and maybe an OK investment. And so having that strategy up front, knowing how to understand things like depreciation, when to buy or sell, how to avoid or delay taxes, what kind of record-keeping you need to do, again, things that might sound uninteresting but become a super, super important part of the process. And you can really set yourself up for success by doing this the right way up front.
David Bright: Yeah, and just like the tax book was not boring, I love that the interview — you’d think that an interview with people talking about — I didn’t think it was boring either. Like we talked about a lot of different things, we talked about a lot of tax strategy and there were examples and things that come up in here as well that I just loved the conversation that we got to have with them.
Nate Hedrick: Yeah. Amanda and Matt were fantastic. And if you’ve not heard them before or aren’t familiar with them, Matt and Amanda have actually been featured on a lot of different talks in the past. Again, their book “Tax Strategies for the Savvy Real Estate Investor” is available on Amazon or pretty much anywhere you get podcasts — or excuse me, everywhere you get books. They’ve been featured on Money Magazine, talks at Google, they were on CNBC’s Smart Money Talk Radio. They’ve been on Bigger Pockets’ podcast, which is where I had heard of them previously. They’re incredible, incredible individuals. The other really neat thing they do is that they actually started a foundation called Animals for Armed Forces. They’re a nonprofit. They’ve actually helped place over 1,500 shelter pets with forever homes to veterans and things like that. So it’s a pretty incredible story. Their book, their website, everything, it’s worth checking out.
David Bright: Yeah, and they obviously have a grasp on a wide variety of real estate topics. You know, we’ve heard questions come in and we’ve had guests in all kinds of different areas of real estate, from larger multifamily to short-term rentals, and so talking about all of that, we kind of jumped around to a lot of different topics. We tried to throw a lot of things at them to maximize the amount of content in there. So there’s a lot of different things that will come up, anything from cost segregation to how you strategically may write off part of a vacation or all the record-keeping, bookkeeping, software, when to engage with a CPA, so many different topics. So hang on tight, we cover a lot of ground in a short period of time.
Nate Hedrick: Yeah, poor Amanda and Matt. They didn’t know that if we got them on the show, we just ask them all of our questions rather than trying to streamline it. But yeah, definitely for those that are familiar with the basics, perhaps, this is a really nice kind of level-up. You’re going to have some refresher of some of those basics but also some thoughts about the future. I know there were things that we talked about that I had not considered in the past or that maybe I was not doing in the most efficient way possible, so really excited to have them on the show and cover so many different areas.
David Bright: Yeah, even just little examples of strategy that they throw out there. Like I know we’ve had on a recent webinar and other conversation, other things in the Facebook group about people that are jumping in by moving out of their home and converting their prior home to rental property. And they shared some examples about the nuance there of if you live in a property for how long, what that means for capital gains when you go to sell it and the strategy of when to sell a property. I mean, so much that I think Nate, to your point of even if you have no real estate investing or you’re just getting started, like there’s so much intentionality that can come even right out of the gates from a tax standpoint. And so hopefully some of the stories and some of the content that they cover today can help share that same thought.
Nate Hedrick: Yeah, absolutely. So definitely look for the stories like that because I think it’s just an overall great episode with a lot of examples. So hope you guys enjoy, and again, thanks to Amanda and Matt for coming on the show. Just an excellent interview with them. So here you go.
Nate Hedrick: Hey, Matt, Amanda, welcome to the show.
Matt MacFarland: Thanks, guys. Thanks for having us. Appreciate it.
Amanda Han: Good to be here.
Nate Hedrick: Yeah, we really appreciate it. We’re big fans of the book, we heard a lot about you guys from other podcasts, and we just knew you’d be the perfect people to bring on to talk all things taxes. So we really appreciate your time this afternoon.
Matt MacFarland: Yeah, thanks so much.
Nate Hedrick: So why don’t we start off, maybe just give us a kind of a big picture overview of some of the tax-related advantages that someone might obtain through real estate. I think we hear a lot of things, there’s a lot of myth and rumor and things floating around. But give us that big picture overview of what people might get as an advantage from a tax perspective.
Amanda Han: Yeah, I mean, there’s so many. There are so many benefits to real estate investing. I think, you know, big picture perspective, most people hear — when it comes to taxes, you always hear about when they say, ‘Oh, if you’re a business owner, you get to have a lot of tax writeoff and tax deductions,’ right, that our tax code is skewed towards business owners. And one of the main things to understand is as a real estate investor, you’re not just an investor, but you’re also a business owner as well. And what that means is first and foremost, a lot of these “business expenses” that are available to maybe someone who owns like a franchise or something or a medical practice or a pharmaceutical practice, those expenses generally are also eligible for real estate investors as well. And you know, this is true — I’m sure we’ll talk more in depth later on today — but this is true regardless of whether you are an investor who have an LLC or a corporation or not. So simply being in the business of real estate investing does provide you the ability to take certain tax writeoffs that maybe you otherwise might not be able to if your only other income is from a source like a W2.
Matt MacFarland: Yeah, and I think the one thing that comes to my mind is just I guess a good way to look at it might be to compare rental real estate investing to investing in the stock market or stocks, bonds, and mutual funds, right? Well, you know, in both of them, the goal is to make income, right? With stocks, bonds, and mutual funds, you’re making dividends, interest, capital gains. With rental real estate, your goal is to have positive cash flow. So the main difference I think from a tax perspective is that with rental real estate, you get to use depreciation expense, which we call a paper writeoff, if you will, to offset your cash flow from a tax perspective so you’re not paying — hopefully not paying any taxes on that cash flow right now. But when you invest in a stock, you don’t get to write off the cost of your stock over time. You only get to write off the cost of the stock when you sell it down the road. So I think that’s a big picture, 30,000-foot look, the big difference between rental real estate, that advantage I think from a tax perspective.
Nate Hedrick: That’s great.
David Bright: Yeah, Matt, I really like that you brought that up because one of the first things that I was told when I started getting into rental real estate is that there’s some kind of accounting magic called depreciation even though the property is appreciating in value. Like depreciation doesn’t mean that the property is losing value, right? Even when the property is gaining in value, you can depreciate it. Can you walk us through that a little bit more and if that’s avoiding taxes or delaying taxes and what all that means.
Matt MacFarland: Yeah, I mean, essentially, what the — it’s kind of like a loophole the IRS is giving you. From a tax perspective, the assumption is that your property is decreasing in value because of the normal wear and tear, right? So you pay $500,000 for a property. Let’s say 80% of it is building and 20% is land, so the 80% in that example, $400,000, they allow you to take a deduction, a depreciation deduction, spread out over 27.5 years or 39 years. So since you’re kind of writing off a portion of the cost of building every year, because it’s being used and again, theoretically being worn down. But you know, yeah, to your point, at the same time, it obviously could appreciate by $300,000 while you’re still taking a writeoff for it.
Amanda Han: The other thing I really like about depreciation is that the calculation is actually based on the purchase price of a rental property and not necessarily related to the down payment of a property, which a lot of people think sometimes. So you know, in that example, if someone bought a building for $100,000, even if they only put $10,000 or $20,000 as a down payment, the depreciation calculation is actually based on that $100,000 building purchase price. And so you know, effectively, you’re able to take a tax benefit today on borrowed money as well, right? So writing off money that the bank has effectively lent out currently.
David Bright: And you mentioned both 27.5 years, 39 years. It sounds like there’s some nuance to that. And I’ve heard of accelerate depreciation and other things as well. Can you walk us through some of those numbers as well and how that all factors in?
Matt MacFarland: Yeah, I mean, the 27.5 years is just the — what would be called the useful life. It’s depreciation like for a residential rental property. So you know, something where somebody is living in a single family house, duplex, fourplex, apartment building, versus 39 is what the depreciation period you get for a commercial property, which could be medical building, office, strip mall —
Amanda Han: Shopping center.
Matt MacFarland: Shopping center, stuff like that. That’s the general way of how you depreciate a building. But yeah, to your point, I mean, there’s other ways that you can — we kind of call like supercharging it, right, where you can take some parts of those and maybe depreciate over a quicker time period like five years or seven or 15 years. The benefit of that is that you’re writing it off sooner than later, right? So we’re getting more deductions now, reducing our income, reducing our taxes now, hopefully using that tax savings to reinvest to go buy more income-producing assets. That would be the idea.
David Bright: And then for the supercharged, in order to capture all that, what kind of information is needed or what kind of things should an investor be thinking about in order to make sure that they’re collecting all of the information that a CPA would need to guide through that?
Amanda Han: Yeah, that’s a great question. So there’s actually two components to that. The first part is what we call cost segregation. And that’s basically, you know, for the investor, you’re working with your CPA, you’re working with a cost segregation firm. And what they do is they break out the components of a building. So whereas earlier, if we use residential rental as an example, where Matt said OK, well if we have a residential property, we’re going to depreciate the building over 27.5 years, right? So if it’s $100,000 building, maybe we’re writing off about $3,600 per year. Now, working with a cost segregation firm and a CPA, what they do is they can break out the components of the building. So instead of just saying, ‘Here, I bought a $100,000 building,’ it’s the cost segregation from going into the building or getting the plans and the drawings for it and breaking out what makes up that $100,000 building. OK? So the result could be well, of that $100,000, maybe $30,000 was for flooring, $15,000 was drywall, $10,000 for cabinets. And those different categories that we just named, a lot of them have different tax depreciation lives. And so a lot of those other ones might instead of being written off over the 27.5 years, they might be written off over five years or seven years. And right now, we have an even added benefit, which is called bonus depreciation. So a lot of the assets that are within these shorter lives, you can actually write them off completely in the first year under bonus depreciation. And you know, the result is going to differ from property to property, right? But as an example, if we said OK, we had $100,000 building, maybe normal depreciation could be like $3,600 a year. With the cost segregation, industry average, we sometimes see the writeoff in the first year to be anywhere from $15,000 to even $30,000. And so you can see kind of the — a big difference between those ranges. So you know, if you’re someone that’s in the 40% tax bracket, right, that’s saving $.40 on the dollar if you can get the $15,000 writeoff or the $30,000 writeoff. So that’s where you know, the depreciation and the bonus depreciation and cost segregation can be highly beneficial. So for that part of it, there’s not really too much the investor actually needs to do because the cost segregation is just — it’s done by a specific cost segregation company. All you really need is to provide them with the closing disclosure, the appraisals, and a couple other items. There’s another way to accelerate writeoffs or depreciation on improvements that the investor is making. And so those would be like after you bought the property, if you are rehabbing it, putting in a pool, redoing the flooring, that’s where a little bit of the work might come in from the investor’s perspective.
Matt MacFarland: Yeah, and I mean, with any of those, the improvement side, the cost segregation, obviously this is not a do-it-yourself thing. But you know, the same as getting your information ready for a CPA, with improvements, on the improvement side, what we tell clients is just keep as detailed as possible of the work that you’re doing on the property. And then at tax time, provide that to us or your CPA. And then what they can do is they can analyze that to see, OK, what are some of the exceptions where we don’t have to depreciate the entire remodel over 27.5 years but there’s certain things that we can either expense right away or maybe we have to depreciate over 15 years but then maybe we get to take bonus on it, that kind of thing. So it’s just kind of making sure you’ve got your documents in place and that you’re keeping good records, obviously.
Amanda Han: Yeah, and I think the key thing too for our audience is it’s not your job to become a CPA and learn how do you break out a building or how many years is the cabinet versus flooring. Really, your only task is to make sure that when you’re doing improvements that you have a fairly good listing of how much you’re spending on what. You know, $30,000 for capex, $20,000 for flooring. And that’s really your role. And then your CPA will be able to help you in maximizing that writeoff based on your situation.
David Bright: Yeah. A couple things you said there that I really like is one, that this is not a DIY thing. This does sound pretty complicated. But it also sounds pretty achievable if as an investor, all I need to do is make sure that I am keeping track of what’s spent on what, those receipts, and that those receipts are relatively itemized so it’s not just like a contractor gives me a $20,000 bill for a bunch of work but that that’s kind of divided out there or something like that.
Amanda Han: Yeah. Exactly, exactly.
Nate Hedrick: And our audience should be pretty familiar with documentation, right? If you didn’t document it, you didn’t do it. So that translates well from pharmacy over to real estate in this case. So one of the things that kind of always comes up at this point too is, you know, OK, well there’s depreciation, what other magic can I work with writeoffs and things to get away with? And I feel like it quickly devolves into like, ‘Well, I heard you can do this. I heard you can write off this, and I’m sure it will be fine.’ Are there things that people think are legitimate but actually aren’t or things that you advise your clients, like, ‘Hey, this is important. We need to follow it this direction so that you don’t get audited’? Are there examples that come up like that that you can think of?
Amanda Han: Gosh, well, there’s so many. What one person can write off could be very different from what another investor could write off, right? And the two people both might be in pharmacy as a daytime career but also doing real estate.
Matt MacFarland: Yeah, you hit the nail on the head. The old, ‘Well, I talked to my neighbor and he said he writes off this.’
Nate Hedrick: Right.
Amanda Han: Yeah.
Nate Hedrick: Exactly.
Amanda Han: It’s going to be very different person-to-person and also transaction-to-transaction. But I think a good practice for any investor to get into is to make sure that they always have taxes in the back of their mind. And what I mean by — you know, I don’t mean like walking around thinking or talking taxes — I just mean that when you’re spending money on things throughout the day, throughout the week, always kind of have a little voice in the back of your mind asking, you know, is this something that is ordinary and necessary for my real estate business? And the reason that this question is important is because in order for you to write off anything against your real estate income, it has to be what we consider to be a business expense. And something I mentioned earlier, you know, business expense doesn’t necessarily mean it’s paid from an LLC or a corporation. It simply means that the expense was ordinary and necessary in order to run your real estate investment activities. And so you know, examples might be if I’m driving over to Home Depot to get some supplies, you know, is it reasonable that this is a business mile? Well, certainly. Right? Or if you’re going to Costco when you have to buy stamps and supplies for the office, you know, is it reasonable that these are things that you can use for real estate? If the answer is yes, what you should do is make sure you have a copy of the receipt — talking about documentation — whether it’s the actual receipt or you take a picture of it, but make sure you have a documentation of it, that it’s being tracked. And then at tax time, when you meet with your CPA, make sure you provide that to them. Because I like what you said, you know, if you didn’t document it, it didn’t really happen, right? And that’s a big problem too for people when it comes to taxes because we’re not filing our tax until next April. And by then, odds are you would have forgotten what you spent money on today or yesterday or a week ago. So it’s important to kind of create a system so that you can track all of your expenses.
Nate Hedrick: That makes a lot of sense. I think the one I always think about when I think about this example is people that take a vacation somewhere and they say, “Oh, it’s a real estate vacation. I’m going to look at properties.” And they try to write off the entire vacation, even though they spent a week and a half on the beach and an afternoon looking at one house. And it’s — like you said, is it ordinary and expected to be with that business expense and obviously not in that case.
Amanda Han: Yeah. And you know, for vacation type of — or just travel in general, one of the key things strategically is to make sure that you have pre-determined business activities. And this is something that we’ve talked about previously in our book is it’s one thing to say, “OK, I’m in Florida for vacation, I happened to stop by and look at some real estate.” Well, then you can’t really write off the flight or the hotel because you were really there on vacation. You just happened to do some real estate. Now, on the other hand, if before you booked the trip, you have a lot of pre-determined, pre-scheduled activities where you’re meeting with local realtors and brokers and lenders, maybe local real estate clubs or events, it’s perfectly fine to have a little bit of personal pleasure time. The IRS doesn’t want you to have to work 24/7 every day. But the key is to be able to show that the main purpose and the reason you were going there was for real estate. That helps you to maximize your writeoff on that trip. Now, it may or may not be 100%, but it will still be a lot better than this other notion of, ‘Hey, I was there, and I sort of happened to run into some real estate things.’
Nate Hedrick: That’s a great tip.
David Bright: Along with that, we’re seeing in this market all kinds of craziness with values going up and people starting to think about selling. And one of the things that I keep hearing and seeing is people talking about this 1031 exchange when they’re going to sell a property that’s appreciated a lot in value, they have a big gain, and they’re worried about the tax consequences of selling a house that has a big gain. So I wonder if you could talk for a minute about what are those consequences of selling a house that has a big gain? And how does a 1031 exchange fit into that?
Matt MacFarland: Well, you know, if the taxpayer goes and sells an investment property down the road, they’re going to pay taxes on any “gain” they have for tax purposes. Now, how we measure gain is really sales price minus selling costs. And then it’s minus your tax basis in the property. And so this goes kind of back to what we were talking about earlier. Tax basis is — the way we look at tax basis is your original cost minus the depreciation expense you got to take over the years. So you’ve got the benefit of some of that costs that you paid for the property before, so it’s going to kind of come back as additional income on the back end. So yeah, when you sell it, you’re going to have capital gains income if you’re selling it over — have held the property more than a year. That can be anywhere from 15-20% for the IRS, sometimes 25% on the depreciation recapture piece. And then you’ve got state income taxes, depending on what state you live in obviously. So now, the great thing is if people are making — if their ordinary income, if their wages and everything else are in a high tax bracket, paying 32%, 35%, 37%, the nice thing is that right now under current law, the capital gains from the sale of an investment property generally isn’t going to be taxed at those higher rates. You’re getting some sort of preferential rate on the federal side. Kind of fast forward, where that 1031 exchange comes into play that you were asking about is when someone that’s got a large enough gain and a large enough expected taxes that they are saying, “Hey, I don’t really want to pay taxes right now. I’m going to sell this property. I’m planning to reinvest into more rental real estate anyway. Why don’t I do a 1031 tax-deferred exchange?” Essentially what they’re doing is they’re following a bunch of rules, working with the right people, to sell existing property and buy replacement properties. And if they meet all the rules, then they don’t have to pay taxes right now on the gain that they should have been paying taxes on. So it essentially defers that taxes, kicks it down the road.
David Bright: Perfect. And then how is that different from — I keep hearing about this two-in-five of if you live in a house for awhile, you get to avoid that entirely. Does that fit in there at all?
Matt MacFarland: That is — what that’s referring to with respect to people’s primary residences. So if somebody sells their primary home and they’re expecting gain on sale, only if they’ve lived in the property for two of the previous five years, they can — a single person can sell it and have the first $250,000 in gain be tax-free. A married couple can have up to $500,000 of tax-free income. But that’s on your primary residence where the 1031 exchange doesn’t apply to primary residence, it applies to kind of investment real estate like rental real estate.
Amanda Han: And something interesting too is we actually have clients who’ve used both in conjunction with each other, meaning there’s a property that they lived in it two of the last five years.
Matt MacFarland: Someone’s going to be driving their car right now and just like crash on the side of the road because their mind was blown.
Amanda Han: And then that home is turned into a rental property. And what could be done is when they actually sell that property, they can use the capital gain exclusion. And if their gain is beyond $250,000 or $500,000, they can actually do a 1031 exchange on the remainder. So they lock in part of whatever should be tax-free and then the rest they could still defer it via the 1031 exchange. So that’s an interesting one that we sometimes see or we have investors work with.
Matt MacFarland: Again, not a do-it-yourself thing.
Nate Hedrick: No doubt.
David Bright: No, that sounds complicated. But it also sounds not uncommon. I know we’re hearing from a lot of our listeners where they buy a house, live in it for awhile, move out, and keep their old house, turn that into a rental, and so it sounds like there may be some advantage of either keeping that only for a shorter period of time and then selling to avoid some taxes or it sounds like leveraging the 1031 exchange is another option as well if they keep it as a longer period of time as a rental.
Matt MacFarland: Yeah, definitely. I mean, that’s where kind of looking at the numbers, right, looking at the numbers of what’s my gain going to be if I sell it now, what’s it going to be in two years. Instead of selling now and replacing with something else, what’s my appreciation cash flow going to be on that? That’s the kind of numbers you have to look at.
Nate Hedrick: I feel like the theme of this episode is becoming plan ahead, right? These are not decisions you make and then go back to your CPA and say, “Hey, I did this thing. Can you help me make sure that it’s not going to tax me terribly?” Like you want to plan this alongside your CPA, like in lockstep with them because all of the things you’re saying, it takes that prep work, it takes planning. I mean, that’s the thing that I’m getting from this so far.
Amanda Han: Yeah. It’s so great that that was what you picked up on in this conversation because I don’t think a lot of people ever mention that or just — yeah, even on other podcasts that we go to. But yes, you’re exactly right. You know, a lot of people will come to us and say, “Hey, can you do my tax returns for last year?” And the reality is, you know, whether you’re working with us or another firm, the results are probably going to be very similar when it comes to filing last year’s tax return because all the transactions have already occurred, right?
Matt MacFarland: Right.
Amanda Han: I mean, you already did what you did. You either tracked your expenses or you didn’t. You either did a 1031 or you didn’t. And so there’s very few things that could be done. But really, to be effective at saving taxes, it is really all about proactive tax planning. So really, what we’re looking at going forward are what are the transactions you have because those are ones where you could still make decisions and there’s different options that you’d be able to see, might result in a lot of tax, a little tax, or zero tax. Right? And that’s the important part. What I always tell people is it’s not as important who’s filing your tax returns. It’s more important who’s helping you with the planning during the year.
Nate Hedrick: That’s a great tip.
Amanda Han: And you know, unfortunately, I think what we’ve seen is that a lot of CPAs that are just tax advisors are really focused on the tax preparation side. It is a necessity. We all have to file taxes, and so that takes up a lot of time for people. And so it is really important whether it’s your existing CPA or you’re looking for a new CPA to try to find out what is it that they do when it comes to tax planning. What is the process? How often are you meeting? Those are the kind of questions that you’ll want to know because really, that’s the main piece to success or the key to success is making sure you’re doing things ahead of time. And you know, I think a lot of investors are scared when it comes to taxes or just people in general are scared when it comes to taxes. It sounds very complicated, it’s never really pleasant. Nobody likes to track expenses and talk to your CPA and keep receipts. Nobody likes that. But I think it is, you know, nonetheless important to make sure you have a system set up so that a lot of these could be automated and the more time that you invest into learning about some of these things, the better you will be. And the goal is not for the investor to become a CPA and know all of the nitty-gritty but at least have enough of a knowledge to have a good conversation with your CPA and know what are the right questions to ask.
Nate Hedrick: Yeah, that’s huge. Especially knowing those questions and saying, you know, hey — and working with somebody that has the experience to be able to kind of guide people to that. That’s super important. So how does that change with legal entity formation? I don’t want to touch on the legal side of it, right, the legal protection side. I know that’s not — that’s a whole different episode. But from a tax standpoint, like how does that change if I’ve got an LLC that’s actually running this or an S corp for example that’s running this?
Amanda Han: Yeah, that’s a great question. And the answer, you know, again, is going to differ from taxpayer to taxpayer.
Nate Hedrick: Sure.
Amanda Han: But the general background is if you are a landlord, right, meaning you’re just someone investing in rental real estate, whether it’s single family, commercial property, there’s generally no tax difference whether you own your properties in your personal name or in an entity like an LLC or a partnership. And by no difference, what I mean is you can have the same writeoffs either way, writeoffs like your car or your home office or maybe you’re shifting some income to your kids because they’re helping you out with your real estate or your business travel, right, to look at properties. So all of these are tax-deductible regardless of whether you have an entity or not. The key is that you’re in the business of rental real estate investing. OK? So from that perspective, the only reason to have an LLC is for asset protection purposes. And the questions of where should I form it? Is it Nevada? Is it Wyoming or my home state? That answer is best answered by your asset protection attorney because even amongst attorneys, they have differences of opinion in terms of where to form. So that makes it very simple on the tax side when it comes to rental real estate. The complexity comes in a little bit more when, you know, if you have an investor who’s doing more active real estate like they’re flipping or wholesaling or syndicating a deal where they’re pulling investors together. In those types of income, it’s very different than rental income. Sometimes it could make sense to earn that type of income in a corporation, whether C corp or S corporation, because that helps the investor to reduce self-employment taxes that we pay into Medicare and social security, things like that. So the distinction would be if you’re in an investor who’s doing just more of the rental side or you’re an investor who’s on the active real estate side.
Nate Hedrick: That’s great. That’s good to know.
David Bright: Yeah, that seems like just one more thing of some proactive planning that goes into this, not just this like, ‘Whoops, I did a thing, can you help me figure this out?’ But no, like ‘I want to go do this. How do I do this properly so that I don’t get in trouble or have a huge tax bill later?’ I know that was one of the major things that I saw from your book and the stories that you had in there. It’s just these like, oh my gosh, I need to make sure that I talk with someone before I go and do these things.
Amanda Han: Yeah, and you’re exactly right. It’s funny because as much as we kind of talk about it and try to educate people and wrote about it in the book, we’re still seeing these kind of similar errors. And in fact, right before our show today, I was talking to a new client, looking at their structure, and it was just from two years ago, but I don’t know what the reason was, but their old CPA had them in the wrong type of entity. And one of the problems is when you do something incorrectly, it’s never an easy or clean way to fix it. You know, so in this example, the good thing is yeah, we can fix it, it’s something that could be fixed but not without headache and cost and potential IRS exposure. And that’s why it’s important to make sure you’re set up correctly from the beginning so you don’t have this headache in trying to unwind something or to clean up something later on.
David Bright: Yeah, and I like what you said too about making sure that you’ve always got taxes in the back of your mind too because if you’re proactive in this, you’re thinking about this, as you are going through the year and you’re getting property manager statements or receipts from contractors or any other expenses, hopefully you’re documenting and keeping those receipts so that at tax time, it’s not a nightmare in January of where did I put that? Where did I put that? Where’s that box? Where’s that — so pharmacists are super detail-oriented and used to keeping records, but anything else that you’d recommend as far as keeping things and trying to track the books?
Amanda Han: Yeah, I think one of the questions we get all the time is what should I — what system should I use? You know? There’s Quickbooks or Stessa or just property management software. And what we typically tell people is it’s — you know, it’s not important what the system is for me, as a CPA. What’s important is what is a system that works for you as the investor? And the reason for that is because, you know, if you’re someone who is great with software, then something like Quickbooks is perfect, right? It helps you automate a lot of things, and it can help simplify things. But on the other hand, if you’re someone who is not great with software or you really don’t like to learn software, then Quickbooks is not the best for you because what’s going to happen is if you buy Quickbooks, you’ll probably just put it on the shelf and really try not to look at it and then by, like you said, next January, kind of have a panic attack because nothing was tracked. And so it’s really important I think for each investor to figure out, what’s the best way that they like to use, they like to systematize, whether it’s Excel or Quickbooks or even a notebook. And the reason that’s important is because when you find a system or you even create a system that works for you, odds are you’re going to use it more frequently. And that’s our goal. Our goal is that you have a system where you are using frequently throughout the year because that’s the only way you can ensure that nothing is lost and that you’re capturing everything that could provide a tax benefit.
Nate Hedrick: That’s a great tip, and it’s something that I finally started adhering to better this year with my own real estate business was actually tracking my mileage with an app. I used to literally come down and spreadsheet it and I would forget half the time, I’d see a client somewhere and be like, how far was that? And my CPA at the end of the year was like, “Nate, this is awful. I can’t track any of this stuff.” So I finally switched over to an app this year, and it’s made it so much easier. I just hop in the car, hit the button, and it’s recording it. So you’re right, finding your own system feels like the way to go. So the other thing that I wanted to bring up too that David, you actually mentioned this about contractors, and I learned this in the past year and I’d love kind of your advice or oversight on this: When you have a contractor, let’s say you’re having a contractor do a fairly large job throughout the year, talk to me about issuing them a 1099 or something like that. Because that’s something that I don’t think I hear a lot of people talking about, but it’s come up this year at least for me in the past, and it seems pretty important.
Matt MacFarland: Yeah, it’s definitely important because it’s something that the IRS requires people to do in certain circumstances. Now, when we’re talking about issuing 1099s to people, keep in mind that this has got to be related to your business, right? So if someone — if you’re remodeling your primary residence, you don’t have to issue a 1099 to your contractor obviously. But you know, if you’ve got an investment property or you’ve got your own business and someone is providing services to your business, one threshold is you’ve got to — usually, you have to pay the person over $600 for the year before it becomes an issue. The other thing is usually, you only have to issue the 1099 if you’re paying them via cash, you know, or a check. So if you’re paying them like a credit card or Venmo, PayPal, Zelle, one of those other things, typically you don’t have to issue them a 1099. And the reason is because those companies, it’s on them now to issue the 1099 to the recipient.
Nate Hedrick: Oh, wow.
Matt MacFarland: So it kind of — if you paid them through one of those platforms, it takes the burden off of you. And then the other thing is if they are taxed as a C corporation or an S corporation, regardless of how much you pay them and whether you pay them with a check or just cash, you aren’t required to issue a 1099 to them. Now, you’re not going to know that unless you give them a W9 when they start doing work for you. A W9 is kind of that IRS form you can download from the IRS website and basically, you give it to the service provider, they fill it out with their name, address, ID number, and then the most important one on there, it’s to check a box to say, “How am I taxed?” They sign that, they give it to you, that’s your document, you keep that in your file, it doesn’t need to go anywhere. You basically use that paper at the end of the year to say, OK, I paid them more than $600, but I look at this form, they’re an S corp, so I don’t need to issue a 1099 to them or they are a partnership or sole prop, well then maybe I do need to issue a 1099 to them. So that’s kind of the thought process and things to think through.
Nate Hedrick: And is that something that your CPA can help you with? Or is that something you need to do on your own?
Matt MacFarland: Oh yeah, for sure. I mean, it’s kind of a — we just recommend to clients, first and foremost, the most important thing is two recommendations: get them to give you those W9s. Now a lot of times, that’s obviously a lot easier when you start the project versus hey, it’s February and I’m trying to get a W9 from a contractor. They may not be willing to sign it at that point, right? But yeah, get the W9s in your files and then you can provide the information with the W9 and how much you paid somebody and how you paid them to your CPA. They can probably quickly look through that list and determine OK, of these 10 people on your list, you’ve got to issue a 1099 to four of them or something like that, you know.
Nate Hedrick: Yeah, that was definitely a tip I learned early on or learned the hard way early on was that don’t ask for the W9 like six months after they’ve done the job because they don’t care. They don’t want to give it to you then. Ask them before they start the work, that way you don’t miss it.
Amanda Han: Yeah.
David Bright: Yeah. There’s a lot of tracking and remembering in some of this stuff too. As we’re talking, it’s definitely starting to feel like a lot. I know for me, I was really good at forgetting a lot of these things without some kind of reminders and systems and thinking back to some of the “bookkeeping” that I used to do that as I learned more about bookkeeping wasn’t even close. Like I probably was terribly annoying to my CPA in the reports and things that I would put together. So can you tell me a little bit about looking for a bookkeeper or someone to help keep track of all this and help keep things moving throughout the year so that January-February isn’t a nightmare and even just preparing documents for a CPA.
Amanda Han: Yeah. I think so like for our clients, for example, they have a checklist every year. And so it kind of is a way for them to know what are some of the things that we need at tax time and also it helps them to gauge during the year too, what are some of the things I need to make sure I’m saving? Closing disclosures, refinance closing documents, obviously income and expenses from each rental property is a big one. You know, the decision of whether a particular investor decides to do the bookkeeping themselves versus outsourcing it and hiring a bookkeeper, I think that’s going to differ from person to person. Right? One of the things to look at is you know what, there is something that you enjoy doing and you’re good at. If so, that’s perfectly fine to do it yourself. But you know, we also have clients who are just not good at it or it’s just not something that they enjoy doing or want to be doing.
Matt MacFarland: Or it’s not the highest and best use of their time and they recognize that.
Amanda Han: Yes. Yeah. Exactly. That’s one of the key things is is that the best use of your time? You know, what’s the hourly rate that you would otherwise be making if you weren’t doing this type of a task? Then figure out OK, does it make sense for me to hire someone to actually do the bookkeeping?
David Bright: Yeah, and I think pharmacists are definitely used to all of the pharmacy work being a team sport and having other people around them, so I think of a bookkeeper could be a logical person to seek out. I think another one as we’re talking here and kind of one of our last of our main questions here is it seems like there’s only so far that you can go with tax software yourself without any of the knowledge behind it. And so can you help us understand at what point does a pharmacist need to think about I really need to talk with a CPA as far as both tax preparation and tax strategy? How does someone make that leap?
Amanda Han: I think that also would depend on the investor themselves. You know, we — I have —
Matt MacFarland: They’re going to start calling us lawyers. We keep saying that answer.
Amanda Han: You know, I have a client, a planning client, who is a physician. And he did his own tax return for many years. We just helped him review it this year. He had, I don’t know, a dozen properties, did cost segregation, just all kinds of very complex stuff. And the return was fairly good condition. I was somewhat surprised.
Nate Hedrick: Wow.
Amanda Han: But you know, we have other people who just kind of don’t really know even where to begin, right? It’s like it’s easy when you have a W2 and a primary home to do something like TurboTax. But once you get into rental real estate, there’s depreciation, there’s a lot more things and where do you actually put that in the software? That can become a hurdle. But to be fair, you know, the softwares are good. Whether it’s TurboTax or H&R Block, generally, the software are able to perform the right calculations. We don’t ever see errors there. The errors we see are user errors. When they ask you a question, are you understanding that question correctly? And this is where we kind of see mistakes where sometimes we might review a tax return where there’s no depreciation, right? And the investor is like, “Hey, I did enter the information,” but maybe it was entered in the wrong way or wrong format so it didn’t really take. Or sometimes, we’ll see a rental property that’s reported as a sole proprietor schedule C, like an online marketing business or something. So those are the kind of things where a user error might come into play. So I think a lot of that depends on the confidence level or the competency level too of that particular investor in the preparation side. But I think it’s always good to talk with someone for proactive tax planning, unless you are a pharmacist who’s also very well versed in real estate for some reason. Otherwise it’s always a good idea to work with someone on the planning side because on the planning side, you know, there are changes to what you’re doing on the investment side of things. You know, maybe you have long-term rentals but getting into the short-term rental space or you’re renting out to traveling nurses or whatnot. And there’s different tax rules for those. And then add on top of that, there’s always tax changes, right? We saw that a lot last year with COVID and the CARES Act. Probably more coming down the pipeline as well with upcoming tax changes. And so it’s a lot for a non-CPA to kind of be aware of all those things. And that’s where having someone help with planning makes sense.
Matt MacFarland: In fact, it’s a lot for a CPA to be aware of.
Amanda Han: That’s true. That’s true.
Nate Hedrick: Yeah, I bailed immediately. As soon as I had my first rental property, that year I was like, yeah, no, I’m not doing this anymore. This is crazy. TurboTax, see you later.
David Bright: Oh, same here. One property was all it took for me. Yeah. Oh yeah.
Nate Hedrick: It’s just not in my class of things I want to figure out. You guys are much better at it than I am. Well guys, this has been awesome. I want to make sure we flip over to our final infusion questions. These are three questions we ask all of our guests in some capacity. And the very first one is what is one tangible strategy to make working in your business not distract from working on your business?
Amanda Han: That’s a good one because I think that’s one that we struggle a lot with ourselves as well because you know, we have — for our CPA practice, we have real estate, and you know, just personal stuff that comes up all the time. So what we do, we just block it out on the calendar. We have what we call A time, A just meaning the most priority. And that’s the time where when the time comes, that’s what we do. There’s no client meetings that are booked over it. It’s basically the time that we focus on working on the business and just more big-picture things, how do we systematize, how do we grow, what’s the goals? Yeah, I think for us, we have to calendar that in otherwise it gets lost in the translation or on a to-do list that’s never done.
Matt MacFarland: I think from kind of a numbers side of answering that question, it’s a great time to look at financial statements, so not waiting until 12 months later to look at your year-to-date financials. You can look at them throughout the year as you have these times set aside and say, ‘Hey, you know what, this is — I don’t know — this rental is not performing as well as I thought it was,’ or, ‘I’m doing fix-and-flips and I sold that property and I only made $5,000 when I thought I made $25,000.’ And that’s the kind of stuff that could tell you that sooner than later so you can make tweaks in your business that you can change how you’re doing things to hopefully improve going forward.
Nate Hedrick: Great tip.
David Bright: And that proactive strategy is just so important because it’s so easy to get in the groove of busy life and just keep doing, doing, doing. But learning those things can help make those tweaks in the business that can be huge. What’s one resource that’s been most helpful to you in your real estate or business journey, whether that’s a book, podcast, person, author, website, whatever that would be?
Amanda Han: Well, I think on the real estate side, Bigger Pockets obviously is something that has been super helpful for us both from the perspective of, you know, an investor but also just on the CPA practice as well, just there’s so — it’s such a great way for us to connect with investors, you know, not just locally but also outside of the U.S., just learning from other investors who are doing slightly different things and kind of what’s working, what’s not working. I think that’s really been helpful. I think a non-business one, we attended an event called Maui Mastermind many years ago. It was kind of one that helped business owners with how to take your business to the next level. I think that’s a program that really helped us earlier on in our career to figure out how to grow our tax practice in the right way.
Matt MacFarland: Yeah, I think another one that comes to my mind is — and this can apply to anybody in any business — is make use of your network and your colleagues, you know? So when we started our business, we had had a lot of colleagues that had already taken that path before us, right? And so it’s really been really helpful to kind of pick their brains over time, sit down with them a couple times a year and figure out what’s working in their business, how do they deal with this, how do they deal with that, we’re having this issue or something like that where I think that gets overlooked a lot where people don’t reach out and don’t utilize as much as they could.
Nate Hedrick: Yeah, that’s a great tip. And it’s exactly why we have the YFP Real Estate Investing Facebook group. So if you’ve not had a chance to check that out, there’s an awesome community of other pharmacists talking about real estate, talking about pharmacy. It’s a place to go. So a really good point, Matt, because that community can be, that network can be so, so hugely important. So our last question then is what’s one piece of advice that you’d give to someone that’s contemplating a start in real estate investing? Again, I know you guys are coming at this from two perspectives, but even if you were to look back at the first — when you bought your first rental property, you know, what’s one piece of advice you’d give someone that’s contemplating that start?
Matt MacFarland: My piece of advice is to do it.
Amanda Han: Yeah.
Matt MacFarland: Don’t get caught up in the numbers. What are they called, the paralysis analysis or analysis paralysis or something, you know. That’s where a nerd like myself gets sucked into and maybe even a detail-oriented pharmacist might get sucked into, you know?
Nate Hedrick: Exactly.
Amanda Han: Yeah. Yeah, and I think a similar thing of the just do it, one of the issues sometimes I see with new investors is kind of the shiny object syndrome where there’s so much education out there now where one day, you’re learning about rental real estate. Next day, you’re kind of learning about mobile home investing or, you know, short-term rentals. And I think sooner rather than later, make that decision. What’s the product you’re investing in? What’s the market area? Then you’ll be able to kind of really dive into that and kind of faster start versus kind of jumping from opportunity to opportunity and never really finalizing kind of what the first step is. So I think that’s also important. And you know, the first deal doesn’t have to be a home run deal. A lot of that is for learning experience, and it should be a decent deal, of course, but I think that’s where we see sometimes when an investor year after year is still in the startup phase, which is what you’re trying to avoid.
Nate Hedrick: Yep.
David Bright: No, I love that. Getting started and diving right in is something that, yeah, eventually at some point, we all have to get past that analysis paralysis and do it. And I think one of the things that I know I’ve taken from your book and just talking with you today is that there’s people out there that can help you with those questions along the way that you have to make sure that you’re doing it right, doing it safely, and so those resources are available. So speaking of those resources, where can people find you? And how else can they plug into what you’ve been able to do to help other real estate investors?
Amanda Han: The best place to find us — I’ll go with that first — is on our website. That’s www.keystoneCPA.com. We actually — we have a lot of great resources on there, you know, recent podcasts that we’re always posting the most — latest information. We also have a free downloadable ebook. It’s called “Five Cash Flow Strategies for Real Estate Investors.” So if you’re wanting to learn more about how do I pay my kids for a tax writeoff or what are some considerations I should think about before I form my legal entities, so a little bit more in-depth on some of the things we covered today, definitely check those out. Again, you can find those on our website at www.keystoneCPA.com. But yeah, I think I love what you said about just understanding that you don’t have to be an expert in all things real estate, legal, tax because there are great people around who could help you with that. And that’s actually our tagline for our firm is “Tax planning made easy” because we want people to understand that, you know, taxes are hard. But your role as an investor is easy as long as you know what are those simple things you have to be doing during the year.
Nate Hedrick: Great advice. Guys, I sincerely, sincerely appreciate you both being on the show today. It’s been absolutely incredible, and I think you’re giving a lot of great tips for our audience to make sure that they can plan ahead so they don’t have to panic come April. So really appreciate all your time and wisdom, and we’ll make sure to put all those details in the show notes so people can track you down. And again, just thanks for being here.
Matt MacFarland: Yeah, thanks so much, guys. That was fun.
Amanda Han: Thank you.
David Bright: Thank you.
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