YFP REI 96: Managing Risk and Taxes through a Real Estate Team with Thomas Castelli

Thomas Castelli, CPA, CFP®, a tax strategist and real estate investor, discusses the benefits of passive real estate investing for busy pharmacists and employing tax strategy to get the most out of your real estate investments from a tax perspective. 

About Today’s Guest

Thomas Castelli, CPA, CFP® is a Tax Strategist and real estate investor who helps other real estate investors keep more of their hard-earned dollars in their pockets and out of the government’s.

Episode Summary

It’s tax season! As a real estate investor, have you done your homework? This week, Nate Hedrick, PharmD, and David Bright, PharmD, MBA, BCACP, FAPhA, FCCP, are joined by Thomas Castelli, CPA, CFP®, a tax strategist and real estate investor. Thomas digs into the benefits of passive real estate investing for busy pharmacists and how tax strategy may help to get the most out of real estate investments from a tax perspective. Thomas starts the episode with a brief history of how he got his start as a CPA, ultimately leaving the corporate scene for something that better blended his CPA background with his passion for real estate. Thomas his beginnings in real estate through passive real estate investing in syndications and how being a passive investor allowed him to work with a mentor, see behind the scenes, and build his comfort level to become an active investor in a syndication deal. He explains his methods for finding and vetting a mentor, building or finding that expert real estate team, and the advantages of investing passively as a busy pharmacist. Nate, David, and Thomas tackle the differences pharmacists should anticipate if investing in long-term rental real estate versus a mutual fund, the advantages of being a passive investor over an active investor in syndication, and the tax benefits that come along with real estate investing. They close the episode with advice on formulating a real estate investment strategy, an overview of real estate professional status and how it impacts the tax picture, and a bonus question on using a 401k for real estate. 

Links Mentioned in Today’s Episode

• Tax Smart Real Estate Investors Podcast
• Rich Dad Poor Dad: What the Rich Teach Their Kids About Money That the Poor and Middle Class Do Not! by Robert T. Kiyosaki
• Investopedia: Tax Reform Act of 1986
• REPS 03: Strategies to Qualify as a Real Estate Professional & Busting the Myths of the Internet
• The Hands-Off Investor: An Insider’s Guide to Investing in Passive Real Estate Syndications by Brian Burke
• Left Field Investors
• Tax Smart Real Estate Investors Facebook Group
• YFP Real Estate Investing
• Join the YFP Real Estate Investing Facebook Group
• Your Financial Pharmacist Disclaimer and Disclosures

Episode Transcript

[INTRODUCTION]

[00:00:08] NH: Hello, and welcome to the Your Financial Pharmacist Real Estate Investing podcast, a show all about empowering pharmacists to achieve financial freedom through real estate investing. I’m Nate Hedrick. And each week, my co-host, David Bright, and I explore stories from pharmacists all over the country who are achieving their real estate goals while maintaining a meaningful career in pharmacy. Whether you’re a first-time investor or a seasoned pro, we’re here to provide education and inspiration about the world of real estate. 

Please note, this podcast is intended for educational purposes only and should not be considered financial or investment advice. 

Hey, David, how’s it going? 

[00:00:43] DB: Hey, good. Thanks. How you doing, man? 

[00:00:45] NH: I’m good. It’s the end of January, beginning of February here, which means we’re in full tax swing over here. How about you, guys? 

[00:00:53] DB: Yep, yep. This is 1099s, and uploading files and all those kind of end-of-year start of the next year things. And it’s probably good timing, right? We had a tax professional on the podcast this week, which is good to make sure that our tax compliance work is done, particularly this time of year, to make sure filing happens on time, all those things. But also, thinking about the tax strategy of where we’re going for the rest of the year. Because so much of real estate involves really intentional tax planning and not just making sure you get the right forms in the right places.

[00:01:26] NH: Yeah, absolutely. We were lucky enough to have Thomas Castelli, a CPA and actually podcast host over at the Tax Smart Real Estate Investor Podcast. He came on the show today. Talked to us all about passive investing and some of the things that go with the tax strategies and how to get the most out of real estate investing from a tax perspective, which was awesome.

[00:01:50] DB: I like that he also talked a lot about just that passive investing and reducing risk, which I’m confident that has to resonate with a lot of pharmacists of being a little risk-averse. Wanting to get into something but maybe not knowing exactly how because it’s not your full-time thing. It’s not what you went to school for. But by finding a really good team around you, he shares a story about he was able to get in with a lot more confidence by finding an expert team to invest with. 

[00:02:16] NH: Yeah. And he talks a lot about intentionality and having a strategy. And I think his background as both an investor and a CPA gives him a really cool perspective on how investing is not driven by taxes, right? It shouldn’t start with that idea of I’m investing in real estate to reduce my tax burden. Instead, it’s I’m investing in real estate because I like it. Now, how can I use that investing in the way that I have goals and the way that I have planned for to benefit myself from a tax perspective? And I think that’s a really important distinction. I really like that.

[00:02:46] DB: Yeah, absolutely. And this is one. We have done this very rarely. But this is when we grow after the final infusion. We circle back to one topic because there was one thing that I know, Nate, you and I were like messaging each other and being like, “We got to go back to this.” Because we hear this question come up and why we had a tax expert on. We wanted to get to one more final question. 

Stick around after the final infusion. We hit one more topic that I think may interest people particularly if you’ve switched jobs at some point in your career and you have an old 401k that you’re trying to figure out what to do with. Is there real estate play there? We go deep into that topic for a minute as well.

[00:03:23] NH: Definitely worth sticking around for. With that, we’ll take you guys to the episode with Thomas. And hope you enjoy. 

[INTERVIEW]

[00:03:28] NH: Hey, Tom, welcome to the show.

[00:03:29] TC: Hey, thanks for having me. It’s a pleasure to be here with you. 

[00:03:33] NH: Yeah, pleasure to have you here. I’ve been a long-time listener of your podcast. And so, excited to be interviewing you on this side of the mic. It’s cool to interact rather than just listen for a change. 

[00:03:43] TC: Yeah, I know. That’s awesome. It’s an honor to hear that. That’s awesome.

[00:03:49] NH: Maybe you can start by giving us just a quick background on what got you into the world of taxes being a CPA and where you are today? 

[00:03:56] TC: Yeah, that’s a really interesting question. It goes back a long time. My mom’s a bookkeeper. My aunt’s like a CFO. My entire life, I’ve been hearing the back ear, “Go become an accountant. Go to school for accounting.” That definitely had a part to do with it. 

And then also as I kind of started creeping up towards going to college, everybody kept telling me, “If you’re going to go to school for business, if you’re going to go – Go for accounting or finance. Those are the two business degrees that are going to take you somewhere. That’s what I’ve always been told. That’s kind of how I got into it. 

I went to school for business management and accounting. Came out of accounting. And I started at an internship at a national firm. That was really exciting. But then I kind of got into it and realized I’m not really the corporate type of person necessarily. When I was in their general assurance apartment, I was doing audits on these gigantic companies. And it didn’t really resonate with me. I really wanted to get into real estate. 

I ended up leaving that and ended up here where I’m at now, the whole CPA or the real estate CPA as it sometimes goes by. And that’s kind of how I got into here. I got to marry the background of accounting and tax with real estate, which is something I was really passionate about at the time. It’s kind of how I got to where I’m at.

[00:05:06] NH: That’s awesome.

[00:05:08] DB: Yeah. Let’s open the door then to some of the real estate. What got you fired Up about real estate? How did you get started as a real estate investor?

[00:05:15] TC: Yeah, that’s another great question. Actually, when I was in college, I picked up the book Rich Dad Poor Dad. And really heavily into real estate. I started going down the rabbit hole. Reading as much as I could. Starting going to local meetups. And I kind of just realized that a lot of really wealthy people invest in real estate. I was like real estate has to be part of my life in some way, shape or form. 

When I started going to all those meetings, I ended up meeting a group that was doing a three-day weekend on real estate syndication. They walk you through A to Z how to do it. That was the summer I had just graduated college and right before I started the internship at the accounting firm. I said, “You know what? I might as well go do this while I have the time.” 

So, went and did that. Fell in love with the model. Started going to their monthly meetings. And then eventually started investing as a limited partner with someone who would become my mentor. That’s kind of how I got into that side of things.

[00:06:07] NH: Yeah. And I want to break that down because I think that’s a really accessible point for some pharmacists and some of our listeners, that maybe they’re now suddenly making a good income. They’re interested in real estate investing. But the idea of being this active investor right away is just overwhelming.

You mentioned basically being a passive investor, a limited partner in a syndication deal. Maybe break that down for us a little bit and maybe why that was a good starting point for you personally? 

[00:06:33] TC: Yeah. When I first started in the game, I guess, of investing, I kind of realized this is a big undertaking. You’re dealing with a lot of money. And you make one little wrong move, it costs you a lot. I just thought, “You know what? Hey, why don’t I learn from somebody who’s already been doing this?” 

The relationship I developed with my mentor was kind of like if I’ll invest is a limited partner, but he’s going to take me and show me behind the scenes. That’s kind of how I got started there. I said, “You know what? I could still focus full time on my job at the internship at the time.” That eventually became my full-time job. And while still kind of learning on the side without having to take the risk and the responsibility of having to be the active investor at this point in my career, that’s kind of what attracted me to that model, was I could still learn, still see behind the scenes, still kind of get involved. But at the same time, just not have to carry that big burden of responsibility on real estate investing.

[00:07:27] NH: Yeah, I really like that. It feels like a baby step in, right? You know you want to do this. But how do you get to the table, right? And this feels like a way to kind of do that without taking as big of a leap. But how did you – I still feel like there is a step there, right? It’s not a leap, but it’s still a big step. How did you feel comfortable moving forward with that particular investor or with even just doing it in the first place? 

[00:07:49] TC: Yeah. Yeah. I think one of the big things that helped me was being around other people who were doing it and kind of – I don’t want to say immerse myself, because that’s maybe a little bit too intense. But I mean I was around people regularly enough who were doing this that over time you’re meeting with them month-in, month-out. You’re reading books on it. You’re at events. You kind of start getting comfortable with it. It starts to become like the norm for that group of people that you’re in. And you start to just build that comfort and familiarity with these people. And eventually, people do business with people they know, like and trust. And that factor is definitely there when you’re working with a group of people or you’re involved with a group of people. I say, for me, what really got me comfortable was not only the education component of it but also being around people and seeing people do it. And then that kind of got me comfortable to take that step.

[00:08:37] DB: Yeah, I like that a lot. I think that we talk often how pharmacists are pretty risk-averse. Being able to jump into something that feels a little less risky because it’s more of a team sport. And you’re engaging with other people that may see things from different angles or may have different experiences and bring that to the table and reduce that risk can feel really powerful. 

I’m wondering though about finding and vetting that mentor. Because it sounds like, right now, I’m seeing a lot of people out there in the syndication space. They’re saying, “Hey, come invest with me. Hey, come invest with me.” And I’m not convinced that all of them are necessarily a great fit depending on what the investor is looking for. How do you figure out that fit for you personally as an investor? And how do you vet that person that’s essentially, in this case, mentoring you? Or in a larger case, just running that project? 

[00:09:27] TC: Yeah. That’s a really good question. I’m going to be up front. In the beginning, I did not know exactly what I was doing. I did kind of take a little risk there. But really made me comfortable in that specific situation was the person who I invested with, their mentor. I knew their mentor. And they he came from a very strong group. And I knew that they had a very strong foundation. On top of that, he was also a broker for a while. So, I knew that he knew about what he was doing. There was some risk there. I did invest in some of the early projects. And they went pretty well. But at the time, to be candid, I was kind of taking a shot in the dark. 

But now, these days, certainly over the last 10 years or so, there’s been a proliferation of everybody, and their brother syndicating, and they all have the same terms, same deals. They all basically sound the same. My philosophy is very much of the Warren Buffett of the management team before you’re investing with is the strongest component of it. You could have a really strong manager, a really strong sponsorship team. And they could turn a bad deal into a good deal. You could have a really bad sponsorship team turn a really great deal into a bad one. I really do believe it’s the strength of the management teams. 

The way I kind of vet that is a few different ways. One of them is looking at what their track record is in the asset class that they’re going to present an investment to. If it’s multi-family for example, what is their track record with similar multi-family projects? Particularly, can they deliver on projections, right? What are they projecting? And are they delivering on that? Because that goes to show you that they kind of know what they’re doing. Also, how do they handle bad situations? I tend to ask those types of questions. 

And then there’s also another philosophy or another tactic, I guess you would say, or strategy I picked up from Warren Buffett. It was actually from this guy, Bill Fisher, who is an older investor. It’s called scuttlebutt. And it’s basically where you go and you start interviewing people who have experience interacting with that company, or in this case, investing with that company. I actually found groups of experienced people who invest passively like this and start to read what their experience was with various sponsors. 

I do my own research, first and foremost. You can find them on podcasts. And there’s no shortage of them out there. You could get on their email list. Go to events and stuff. But then I kind of go behind the scenes there and go into these like kind of private communities and kind of see what other people are saying? What are other investors saying about these sponsors? How have they delivered? 

It’s definitely very much my own due diligence vetting the sponsor myself. But then also looking at what are other people saying who have invested with them? Kind of like a reference if you will. And that’s kind of how I’ve been doing it today. Because today, it’s just everybody seems to be a syndicator. And it’s very hard to tell the difference. I think that doing that type of due diligence has been key.

[00:12:03] DB: I think that makes a lot of sense. And watching kind of someone’s background in that space. Maybe it’s one of their first few deals like you’ve said. But maybe they had a lot of experience before that working for somebody else, working in other projects. But in this case, if you found someone with a great track record, they’ve delivered well, that kind of homework, you can feel really valuable for making that feel like a less risky. Certainly, there’s still risk in all of this. But that can make it feel less risky. 

And someone that may be listening thinks, “Well, that might be a lot of homework for like a few thousand dollar investment.” But oftentimes, a syndication like this isn’t just a few thousand dollars. These normally have higher price points. Is that correct?

[00:12:41] TC: Yeah, you’re usually looking at minimum, most of the time, 25 000. But in many cases, it’s even higher than that. 50,000 to 100 000. When you are committing that type of capital and locking it up for three, five, seven years, this is usually how these terms go, it could be worth it to do your due diligence just because of the sum of money that you’re putting at play. Capital preservation is key. You never want to lose money. It takes a lot to recover from lost money. You definitely want to make your due diligence. 

But then also while you’re in the investment, as a limited partner, you don’t have much control. You are giving up that control to the sponsorship team. And you want to make sure that while – the way I look at it is I want to make sure that, while I’m in the deal, that I’m not going to have a lot of stress and issues. I want to know my money is protected. 

If you think about it, yes, it is a lot of work. But you do the due diligence and you’ll be putting yourself in a good position. On top of that, when you do your diligence and you go through all that, what ends up happening is, if these investors do perform, they do perform as expected, you become a repeat investor. You keep investing with the same people. You do a lot of due diligence maybe up front. But as the years go on, as you keep reinvesting, you kind of stick to maybe a handful of sponsors you kind of develop that trust with.

[00:13:55] NH: I like that a lot. And I feel like I can already hear the shift from that first, “This is somebody I know, like and trust. And I think this is a good idea. And I’m going to take the risk and do it.” Toward, “Now I understand this inside and out.” Is that when you started to feel comfortable switching? And then you have a couple of properties now or syndications where you’re actually an active partner in that. Is that when you felt comfortable switching over? Or what made you make that change? And what does that look like for most people? 

[00:14:20] TC: Yeah, that was interesting. I was at a crossroad in my career at one point when I was at the first national accounting firm I started out. And I kind of realized, “Okay, this isn’t really what I wanted to do.” I was like, “Do I want to go full time in real estate? Do I want to go full time or do I continue doing what I’m doing here in accounting?” 

And so, what happened was that same mentor who I started investing with, he goes, “Look, if you ever find a deal and you bring it, it’s a good deal, we’ll syndicate it. And you’ll be in the sponsorship team. We’ll make it happen.” I started picking up the phones and started making relationships with brokers. And after a while, it wasn’t overnight, after a few months, I finally came across something that was worth exploring further. We dug into it. Ended up flying down to Florida where the property is located in Jacksonville. Did the due diligence on it. And we ended up syndicating it. 

That kind of was just like a natural stepping stone from kind of like my initial learnings when I started investing as a limited partner, started learning behind the scenes, developed in that relationship with my mentor. And then I ultimately found a deal and we ended up doing it. 

Now, that deal went full cycle. We bought it in 2017 and we sold it. Actually, we’re under contract to close, really interesting story, on March 20th. Excuse me. March 2020. We’re supposed to close right when the pandemic hit. And because of that, we had a bunch of re-trades and that we had to renegotiate and extend it out, all this stuff. And we ultimately sold it. We ended up doing good on it. 

But that, during Covid, had really killed my momentum on the active side. And because I was working from home, I sunk a lot of my time and effort into my job. And that’s when I decided, “Hey, look, I’m going to focus on my career. Make sure that’s really solid. And then I’m gonna just continue investing as a limited partner for now.” 

Right now, I’m not really on the active side. At some point in the future, who knows? 5, 10 years from now, I might go ahead and start being active when I have a lot more capital to play with. But for right now, stay focused on my career and invest passive is kind of the strategy that I chose.

[00:16:21] NH: I love it I think. Again, I think that resonates with so many people. It’s so easy to follow some of the other names out there talking about real estate investing. And it’s all about here’s, “How you quit your job and start buying thousand-unit properties.” And that’s not a fit for everybody, right? This is a really good fit for a ton of people listening right now. And so, I’m really glad that you said that and walked us to that example. That’s great.

[00:16:42] TC: Oh, yeah. No. Yeah. No. Definitely, going active isn’t the only way to get exposure to real estate for sure. 

[00:16:48] DB: Yeah. Yeah. Then, speaking of your career as a CPA, I want to ask some tax questions while we have you. I think that there’s a lot of pharmacists out there that are probably familiar with maybe having a brokerage account or something like that, and long-term and short-term capital gains and tax consequences if they were to buy stocks or mutual funds, something like that. Real estate investing brings a lot of different complexity to the tax picture there. Can you walk us through some of the key differences that a pharmacist should expect if they’re investing in long-term rental real estate versus if they’re investing in something like a mutual fund long-term? 

[00:17:25] TC: Yeah. When you’re investing stocks, bonds, mutual funds, things like that through a brokerage account, really easy to buy and sell those. It’s short-term capital gains if you hold it in less than. A year long-term capital gains if you hold it for more than a year. Relatively straightforward. But when you’re dealing with real estate, you’re really investing in a business. And it’s a small business at that. 

If you’re investing, like yourself. If you’re going to go buy a single-family house or what have you, you’re really running a business at that point. You’re going to have income and you’re going to have expenses. And basically, what’s going to end up happening is you’re going to have rental income, you’re going to have all your rental expenses. And in many cases, thanks to an expense called depreciation, you’re also going to have a loss for tax purposes. What does this mean? That means you’re usually not going to pay for tax on the rental income that you’re generating, which is a good thing and a great benefit that almost any real estate investor can get involved with. When you sell the property, you’re going to be subject to depreciation recapture. It’s not just the pure capital, long-term capital gain if you hold for longer than a year. You’re going to be subject to depreciation recapture, which is taxed at a higher rate. Part of it’s going to be taxed at 25% rather than the top capital gains rate of 20% like you would see maybe on stocks and bonds. 

In addition to that, if you take accelerated appreciation or bonus appreciation, which I’m sure we’ll discuss at some point here today. But when you do that, that actually creates ordinary income tax. When you sell the property, you’re going to have to pay ordinary income tax on that amount. It’s much more akin to getting invested – to running a business than it is to just a pure investment. 

I’d say one more thing, the biggest question that we get from investors is about the passive losses, right? Because most of the time, you’re not going to be paying tax on your rental income. People will say, “Well, why do I want to have a loss?” Well, the first thing there is the loss that you’re taking is usually due to the non-cash expense called depreciation. Depreciation is only an expense on paper. In other words, it’s very possible at real estate to have positive cash flow but have a loss on paper and pay nothing in taxes. 

And then people say, “Okay. Well, if I have to pay back the depreciation, why even take depreciation?” Well, first of all, you have to take depreciation. There’s no way around it. And then secondly, it’s about the time, value and money. Because you’re able to shelter your rental income from tax. And then there’s additional strategies you can use, like 1031 exchanges, and so on to shelter your capital gains and depreciation recapture from tax. It’s about taking the tax savings you’re saving now and reinvesting that for your future. If you just paid the government the taxes, that money’s gone. You’re never seeing it again. But if you could save some money, then you’re able to basically reinvest and return your money.

[00:19:56] NH: There’s so many good pieces in there. And this is exactly why, when I bought my first little property, one of the first things I did was I went and got a CPA, right? Because there’s so many pieces here that you can mess up. And it’s not as easy and cut and dry as like, “Oh, I bought this stock and I sold this stock. And I’m just going to put that into TurboTax. And here you go.” It’s exactly the time when you want to get a professional on your team. Make sure that you’re getting the right advice on how to actually do this the right way.

[00:20:20] TC: Yeah, for sure. And I forgot to mention bookkeeping, too, right? When you trade stocks, you get the 1099B. You throw in TurboTax a lot of times. The brokerage can integrate with TurboTax. You don’t have to do anything. You actually have to keep a profit and loss statement. You have to keep books and records. It’s a totally different ball game when you’re investing in real estate. 

Now, if you’re on the syndication side, the syndicator is going to take care of a lot of this for you and give you a K1. But if you’re actually investing in yourself, you’re going to actually buy a property, this is stuff that you would be responsible for as the investor. Just something you have to keep in mind. It’s more like running a business than it is making just a pure investment. 

[00:20:54] NH: I’m glad you mentioned that, because I was just going to ask. Is that a way to get – if that sounds overwhelming, right? If I’m listening to that, I’m like, “Whoa! Hold on. I don’t want to do any of that.” Is that a good reason to think about either like a partnership or some sort of syndication where you’re more of a passive partner? Is that one of the other advantages there?

[00:21:10] TC: Well, yeah. Well, the good thing about being a limited partner in syndication is you’re making a lot – you’re doing a lot of the due diligence up front to vet the sponsor, to vet maybe this he specific investment opportunity. But once you make that decision to invest, your responsibility in that transaction is essentially over. You don’t have to worry about the bookkeeping. You don’t have to worry about the tax file. You don’t have to actually make this stuff go, or running, or operating the property and finding tenants, and hiring property managers and doing all that fun stuff. That’s all for the sponsor. You just sit back and kind of collect the checks for lack of a better word. And you just don’t have to deal with any of that responsibility. That’s why being a limited partner could be really an attractive opportunity for a lot of people.

[00:21:52] DB: When you talk about the passive losses and the tax benefits there, I hear a lot of discussion about, “Well, I want to get into real estate for the tax benefits.” And particularly someone that’s a higher income earner is looking for tax deductions. We’ve all heard those kind of things. Should a pharmacist expect that the tax benefits of real estate will impact the taxes they pay for their W-2 salary? Or should a pharmacist expect that the tax benefits will impact the rental income that they receive from the real estate itself? 

[00:22:25] TC: Yeah. I would say, generally speaking, they should expect it not to really impact their income from their job. And more or less, you’re looking more at the real estate side. I could break that down a little bit. Back in the day, back in 1980s, they introduced this act called the Tax Reform Act of 1986 that made all rental activities passive by default. 

Before this, you used to be able to just go buy a property, depreciate it and take the losses to offset, say, your W-2 income. Let’s just say I’m just making up a number. Say you’re making $250,000 in W-2 income and you had a $50,000 loss from depreciation. Well, now you’re only paying tax on $200,000 of income. That could be really powerful. But that was really controversial at the time. That’s why they introduced this act. And they basically said that the losses, or the income and losses, basically from rental real estate are passive by default and they can only offset other passive sources. If you had that $50,000 loss from a rental property, it wouldn’t offset your income from your job. It would basically only offset other passive income that you have or be suspended and carried forward to future years when you do have passive income. 

Generally speaking, that’s what you can expect if you have a full-time job being a pharmacist, right? You can expect to be able to shelter your rental income from tax and even be able to shelter the capital gains and depreciation recapture. But you generally won’t be able to use that to offset the income from your job unless you can qualify as real estate professional, which I think we’ll discuss a little bit. Or you can use the short-term rental loophole, which is it’s known as. If you could use one of those strategies, you can actually turn your losses non-passive. But that requires definitely being active for the short-term rental loophole and for real estate professional working primarily in real estate. That’s usually not on the table for many people who have a full-time job.

[00:24:10] DB: Let’s go there for a minute, because I think that that’s another thing that I hear a lot about. I love that you’re attacking some of these misconceptions. And particularly as you’re jumping around social media, this may look like, “Oh, there’s these great amazing tax things.” Like, real estate professional status is another one. I think a common question could be could a full-time pharmacist be a real estate professional or achieve real estate professional status by, for instance, getting their real estate license? And would that generate these massive better tax benefits? 

[00:24:39] TC: Let me just start here. The real estate professional status, what that does is it allows you to take your losses from your rental property and turn them non-passive so you can offset your non-passive income. Like, income from a job, or an active trader business, or just other non-passive sources. That’s kind of the benefit of being a real estate professional. The problem is, to become a real estate professional, you need to do two things. You need to spend more than 750 hours in real property trades or businesses. And this is the harder part, more than half your total working time in these real property trades or businesses. 

And the IRS looks at a full-time job as 2080 hours, right? That means that if you had a full-time job and you were trying to qualify as a real estate professional, you would need to spend at least 2081 hours in a real property trader business. And that would equate to basically working 81 hours a week every week for the entire year. The IRS knows it’s not happening. And there’re dozens and dozens of tax court cases where people tried. And only one person under very unique circumstances was able to actually say that they had a full-time job and be able to qualify. That’s kind of the challenge of being able to qualify. And I wouldn’t expect if you have a full-time job or you’re running a full-time business to be able to do that. 

Now, it’s possible for your spouse to qualify. Maybe your spouse works part-time, or they don’t work, or they focus on your real estate. For them to qualify – and then you would both be technically real estate professionals when you file your joint tax return. That’s one avenue. 

But there’s something called the short-term rental loophole, where if you have a short-term rental property, which for all intents and purposes we’ll just say as an average stay of seven days or less, then it’s not a rental activity by default. And then all you have to do is what’s known as materially participate in that property, which is usually one of three tests, which is you spend more than 500 hours. Or you do substantially everything. You’re basically a one-person show. Or you spend more than 100 hours on activity and no one else spends more time than you. If you can meet one of those three tests and your property has an average stay of seven days or less, that will allow you to take the losses as non-passive. And that you can easily do that part-time. A lot of people who want to be actively involved in real estate but can’t quite make the real estate professional status work for them, they will go into short-term rental loophole. 

Now, one more thing kind of on that. If anybody is considering that, we have something at our firm called don’t let the tax tale wave the dog, which is don’t make decisions purely off the tax benefits. You have to ask yourself, “Is this in alignment with my goals? And does this make good business investment sense?” If you don’t want to be active in real estate, then don’t go use a short-term rental loophole, because you’re going to have to be active. And if that’s not in alignment with your goals, well then, you’re going to hate it and you’re going to wish you didn’t do it. Just something to kind of think about there. 

[00:27:19] [] NH: I think that’s huge, Tom. And I really like the series that you guys did on your podcast, the Real Estate CPA Podcast, about real estate professional status and about the short-term rental loophole. If anybody’s looking and you’re interested in what Tom’s talking about right now, I know I’m diving deep into the real estate professional status right now myself, definitely go check out that series, Real Estate CPA Podcast. Those are fantastic resources for going through the actual court cases. 

The episode you guys did that was just literally walking through court cases of people that got like totally beat up by the court and saying like, “No, you don’t qualify. And here’s why.” I love that. I thought that was great. You guys kill it with that.

[00:27:55] TC: And you know what’s really interesting? The reason why we put that out there was because a lot of the rumors on the internet that were telling people what the right thing was based on all the tax court cases and everything that we know. And they would say, “Oh, well, my CPA told me this. Or I heard this on some online form. You know what? We’re going to put these fires out right now.” We’re just going to go through a bunch – Not go through all. But we went through a lot of task court cases and just kind of demystified all these myths and rumor or what have you online and said, “This isn’t what we’re saying. This is what the IRS and task courts are going to say.” 

[00:28:26] NH: Yeah, I love that. Definitely encourage people to check that series out. Then, okay. We’ve talked about a lot of different ways to get some sort of tax advantages. Is there anything we’re missing, Tom? Anything that – again, if you’re looking at tax strategy as a high-income individual or a pharmacist, anything else we should be considering before diving into real estate investing? Like, things to be thinking about that maybe people miss? 

[00:28:47] TC: Yeah, yeah, I think this is one thing that I would say. I don’t think I made this point here yet, and I think it’s an important point, is when you’re investing in real estate, you want to look at it as a way to reduce your effective tax rate, right? When you’re a high-income earner, every dollar you earn, you’re getting taxed on that at your marginal tax bracket. If you’re at the highest tax bracket, let’s say 37%, or 35% or 32%, that’s the amount of federal income tax you’re paying on each dollar you earn from your job. 

If you’re investing in real estate, whether it’d be buying a property yourself or investing as a syndication, because of that non-cash expense call depreciation, you’re not paying tax on that income you’re generating. In other words, you’re generating more income but you’re still paying the same tax because you’re not paying tax on it. You’re basically reducing your effective tax rate. You’re reducing your tax rate that you’re paying, which is really the real power of investing in real estate that I think a lot of people could take advantage of. But sometimes when they hear, “Oh, I can’t use these losses or to offset my active income for my job,” they get all down about it. But no, I think you have to take a step back and look at the bigger picture and say, “Look, I have the opportunity to generate either cash flow or appreciation, capital gains and shelter this income from tax and not have to increase the taxes but still increase my income.” 

[00:30:00] NH: I think that’s a really good point. I like that a lot. All right, I want to jump into our last three questions, our final infusion questions. Three questions we ask every guest on the show. Get your take. The very first one is always, is what’s one tangible strategy that you use to make sure that you’re investing that works hand-in-hand with your career? 

[00:30:16] TC: Oh, yeah, absolutely. That’s investing as a limited partner, investing passively. Because my career right now is very demanding. It takes a lot of my time, attention and energy. And I know that going active just takes a tremendous amount of time and energy, too. And it’s just not the right time in my career to do that. By investing passively, I still get to build tax advantage income, everything I just discussed. Obviously, I’m not active. I can’t use the losses against my income. But I could still generate tax advantage income. Still get exposure to real estate without having to take on that responsibility and divert my time and attention to managing a real estate portfolio that I would have to do actively if I went that route.

[00:30:54] DB: I like it a lot. What’s one resource that’s been most helpful to you in your journey? Whether it’s a book, podcast, person, author, website. Whatever that would be. 

[00:31:02] TC: Can I give two? Because I have two that I – 

[00:31:04] DB: Sure. Go for it. Go for it. 

[00:31:05] TC: I’ll start with the book. There’s a book called The Hands-Off Investor by I think a gentleman named Brian Burke. He wrote the book. He published it on Bigger Pockets. It’s by far the best book I read on how to understand the world of investing as a limited partner. If you’re thinking about investing using that strategy, I would definitely suggest that book. It’s been a big eye-opener. I know I’ll probably reread it a handful of times. 

The second thing I would say, I think I kind of alluded to a little bit before, but you want to surround yourself by people who are doing the same thing as you are. There’s been a few groups out there that I’ve joined recently. One of them is called The Left Field Investors, where you can basically join a community of people who are investing in these types of deals so that you can learn from their experience and you can get comfortable doing it. So you’re not on this island by yourself and you’re making decisions with a group of people and not just yourself. I’d say the book. And then basically just surrounding yourself with people and not trying to go it alone. 

[00:32:02] NH: I like that. And that’s definitely not one that we’ve heard on the show before. I appreciate that new reference. That’s great. All right. And then the third question, what’s one piece of advice you’d give to a pharmacist contemplating a start in real estate investing? 

[00:32:14] TC: I would say you definitely want to know what your long-term goals are, and what your time commitment is and what your risk tolerance is to dedicating to. That’s going to all inform your strategy, right? If you don’t have a lot of time, investing passively is for you. If you do have time on your hands and you know you want to get actively involved, then, sure, definitely getting involved on the active side could work for you. But that would be my advice. Just know your long-term goals and make sure you know what your time commitment is, what your risk tolerances. And let that inform the strategy that you’re going to use to invest. That’s going to help, “Should I go passive or active?” That’s going to help you. You just got to know the goals.

[00:32:48] DB: I love it a lot. The strategy there, too. I think there’s really a lot there. And I think learning about all these different aspects of investing can help you put those pieces together and strategize better. And I know that a lot of pharmacists listening to this are probably not going to become CPAs. I know it to that great depth. But I think hearing a lot of these things hopefully will help people ask intelligent questions of their CPA and have really good brainstorming there. 

For people that want to dive in more and learn more about the tax side of real estate. I know Nate’s mentioned before, you have a podcast. Where can people find you and your podcast? 

[00:33:23] TC: Yeah, absolutely. Our podcast, I’m pretty sure, is on all major podcast platforms, Spotify, Apple, Google, all that stuff. It’s the Tax Smart Investors Podcast. It was formerly the Real Estate CPA Podcast. But we renamed it. There’s a wealth of knowledge and resources there on not only tax savings, but we also do interview a lot of experts on how they built their portfolios whether it’d be on the passive side or the active side. There’s a lot to sort through there. That’s definitely a great resource. 

And then if you just want to get in contact with me, probably the best way to do is through our Tax Smart Investors Facebook group. And that’s www.facebook.com/groups/taxsmart investors.

[00:33:58] DB: Very good. There’s one other topic that, before we hit record, we said we want to dive into this. We’ll throw in one bonus question here right at the end of, you know, there’s a lot of pharmacists out there that may jump from different jobs. Maybe they go from a hospital to a drugstore or vice versa. But they may have different jobs within the pharmacy world and they may have an old 401k sitting somewhere. Is there ever advantage to moving that 401k to like a self-directed IRA and using that to buy real estate? Or are the tax benefits of real estate so good you don’t need to worry about that? 

[00:34:34] TC: Yeah. That question definitely depends. I have a rather complex answer. I’m going to try to break it down in orderly fashion. Real estate is a tax shelter, right? You could hold real estate outside in your taxable account if you will, in your personal name, and shelter the income and the capital gains from tax using various strategies. When you put it into an IRA, you’re not really benefiting from those strategies because you’re already sheltering income in your IRA. You’re basically putting a tax shelter in a tax shelter. 

And there’s something else I’ll add on there, which is something called UBIT. The Unrelated Business Income Tax. If you use debt financing to acquire a property, whether you use your IRA to invest in a syndication or property that you buy yourself and then you have debt on, you’re basically going to be subject to tax on some of the income from that property. Usually not during the life you own it, but usually on the sale, you will be subject to the UBIT tax. And that could impact your returns. Usually not substantially. But it’s something to keep in mind. 

My philosophy on it is it depends on the individual person and what their total financial situation looks like. If a majority of your investable assets are in a self or in retirement accounts, I’d rather see someone put it in a self-directed IRA and go and invest through a self-directed IRA then liquidate your accounts. 

I’ve seen some people try to liquidate their accounts. And really, liquidating your 401k or your IRA, you’re paying income tax at your federal and – you’re paying federal and state income tax assuming you live in a state that has state income tax, which can – and then you’re paying a 10% early withdrawal penalty in many cases. I’ve seen people really rack up 30% to 50% – basically lose 35%, 50% of their account just by liquidating it. I’d say if you have a majority of your investable assets in an IRA or in retirement accounts, I’d rather see someone go and invest through the IRA despite the fact that you’re putting a tax shelter in tax shelter. I’d rather see that so you get the diversification. 

But if you have the investable capital outside of your retirement accounts, I prefer to see someone put stocks, bonds, mutual funds, ETFs within their IRA, which are very hard to shelter outside of a retirement account. But are very easily sheltered within the retirement account. And then take your investable funds you have outside of your IRA and go invest in real estate, which you can shelter from taxes outside of your account. I think it it definitely depends on the individual and what their financial picture looks like.

[00:36:59] NH: I love that. And again, a great reminder why it’s important to have a professional to talk to. I think it’s super easy to say, “Oh, I’ll just liquidate this. Or I’ll just buy this and it’ll be fine.” And then you figure it out with your tax professional next April. Talk to them in advance. Do the right thing. And ask them up front so they can help you figure out how to fix it before it becomes a problem or before you try to make a move. 

[00:37:20] TC: Right.

[00:37:20] NH: Well, Tom, thank you so much for joining us today. Again, as a big fan of the podcast that you’re on, it was great to have you on ours. And just appreciate you sharing your wealth of knowledge with us and the audience today.

[00:37:31] TC: Likewise. Nate, Dave, it was an honor to be here with you. And happy to do it. 

[00:37:36] DB: Wonderful. Thanks so much. 

[OUTRO]

[00:37:38] NH: Thanks for listening to the YFP Real Estate Investing podcast. If you like what you heard on today’s show, please leave us a review and subscribe to the show so you never miss an episode. If you have a question, know someone that would make a good guest, or want to connect with Nate or David, head on over to yfprealestate.com and join the growing YFP Real Estate Investing Facebook group.

As we conclude this week’s episode of the YFP Real Estate Investing podcast, an important reminder that the content in this podcast is provided to you for your informational purposes only and is not intended to provide and should not be relied on for investment or any other advice. Information in the podcast and corresponding materials should not be construed as a solicitation or offer to buy or sell any investment or related financial products. We urge listeners to consult with their financial advisor with respect to any investment. 

Furthermore, the information contained in our archived newsletters, blog posts and podcasts is not updated and may not be accurate at the time you listen to it on this podcast. Opinions and analyzes expressed herein are solely those of your financial pharmacist and must otherwise noted and constitute judgments as of the dates published. 

Such information may contain forward-looking statements which are not intended to be guarantees of future events. Actual results could differ materially from those anticipated in the forward-looking statements. For more information, please visit yourfinancialpharmacist.com/disclaimer. 

Thank you for your support of the YFP Real Estate Investing podcast. Have a great rest of your week.

[END]

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