Steve and Cliff discuss the many tax benefits and incentives available for real estate investments.

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Episode Transcript

Intro:

You're listening to the Practical Tax podcast with tax attorney Steve Moskowitz. The Practical Tax podcast is brought to you by Moskowitz LLP, a tax law firm.

Steve Moskowitz:

Welcome everyone. Thank you for joining our podcast. And we're looking forward to telling you a lot of tax savings in a very good area here, real estate. Traditional wealth has been built with real estate and there's all kinds of advantages to it. One of my favorites is OPM, other people's money. And there's all kinds of things here. For example, one of the things that Cliff is gonna tell you about, there's a government deal where the government will pay for 39% of the real property you choose to buy. You like that? I'll say it again. The government will pay 39% of the price and guess what? That's a gift. They just give it to you. It's not a loan. You don't have to pay it back. They just give it to you. And when somebody gives you something nice, what do you say? Well, most people say, thank you, but lawyers say more. I want more. Want to talk about all kinds of things like how you can make a real estate investment, a tremendous amount of money, profit and legally not pay any taxes on it. And this is the type of things that people look at and they say, look at the wealthy, look at the Fortune 500. They're making all this money, sometimes billions of dollars they'd be in profits and not paying any taxes legally, how can that be? And here's why. There's two purposes for the tax law. One we all know about is get money out of us, extracting taxes, but the other one is in democracy, the government can't order us to do things, even though it's good for the economy or it's good for society, they can't order us.

So, how's the government get you to do something they want you to do, but they can't order you? They give you a tax benefit. And that's what this is all about. And you know, a lot of people just grumble and cry about, oh they take so much taxes out of my earnings. And that's true. But what we're gonna talk to you about today, although the wealthy people do it, you don't have to be wealthy. This applies to any socioeconomic group. You can be a regular normal middle class person, do all these things, and our goal is to get you to be those people that other people point to and say, look at that wealthy guy, look at all the money he's making and he's not paying any taxes on it. And maybe some of that's because you listen to us on this webinar. Without further ado, I'm gonna introduce my friend and colleague, the head of our tax department, who's also an accountant as well as being an attorney, Cliff . Cliff, you want to take it away?

Cliff Capdevielle:

Sure, Steve, thanks. So, lot of wealth in America has been generated with real estate. And as you say, Steve, one of the key differentiators is the ability to leverage, use other people's money, take out loans and put down a fraction of the cost of a piece of real estate and then reap the rewards as the value of that real estate increases. I'm up in Incline Village. It is now the average, Steve, the average price for a home up here and this zip code, can you guess?

Steve Moskowitz:

That's a toughie. Coming from San Francisco, shacks go for millions.

Cliff Capdevielle:

It's five million dollars is the average house. So, that is skewed because you have Larry Ellison and the other Silicon Valley billionaires up here with properties in the 50 hundred million dollar range. But you can make a lot of money in real estate just by holding it for a long period of time. And you can purchase real estate, as you said, using other people's money, leveraging that and deducting the interest that you pay for real estate. Now, it's recently been limited on personal residences, but on investment property, you can still deduct a hundred percent of the mortgage interest.

Steve Moskowitz:

There's also some tricks to the trade. For example, what Cliff was talking about, under the tax cuts and jobs act, on your personal residence, you can only deduct the interest on $750,000. But that's per taxpayer, not per house. So if you have a very common situation, John and Mary, boyfriend and girlfriend, not husband and wife, buy the property together, they each get a deduction on 750. So the couple is deducting on one million, five. And the pioneer here was Mr. Voss, V-O-S-S. And he said, you know, IRS, we can each deduct it, and the IRS said, oh no, you can't Mr. Voss, that's just 750 for the whole house. And Mr. Voss said, oh no, IRS, you're wrong. Mr. Voss took it to tax court, tax court said, Mr. Voss, you're right. So that's one of the tricks of the trade. And of course, if you're getting a rental property, then that's a whole different story. We can deduct massive interest here.

Cliff Capdevielle:

Yeah. And interest deduction is only the beginning, Steve. On rental property, you're also entitled to depreciation and the typical straight line depreciation on residential rental property, 27 and a half years, commercial property, 39 years. But with a little planning, we can dramatically increase the depreciation deduction, can take advantage of the rules regarding accelerated depreciation and cost segregation, Steve and a cost segregation is worth it's weight in gold. And how does cost segregation work, Steve?

Steve Moskowitz:

So, what happens with cost segregation is normally when you have a rental property, you have to depreciate it over 39 years if it's commercial or 27 and a half if it's residential. But with , we send an engineer to your property and here she examines the properties. Well, this portion is 39 or 27 and a half year, but this portion is 15 year. This portion is 10 year. This portion is five year. And this portion you can write off on this year. And then what happens is you can have a massive deduction. This is the time value of money. This is how banks make their money. You would rather have a benefit today than 39 years from today because you write a smaller check to the IRS, the money you would've given to the IRS, you can invest and now you have earnings on money that had you not done the , you would've given it to the IRS instead, you're earning money on that money, you legally didn't have to pay to the IRS. So you can have, what I call are the sweetest words in the English language, a positive cash flow with a tax loss.

So, let's say that we had a parental building that took in 10 million dollars worth of rent and there were nine million dollars of cash expenses. We have a one million dollar cash profit. Well, suppose, now with cost , we can have an extra million and a half of depreciation. So, we say, well, now, instead of having a million dollars profit on the books, we have zero profit on the building. And again, we didn't write a check to depreciation, it's just an accounting entry. Cliff makes an accounting entry there. Now, we've got an extra half a million left over. And the question is, Cliff, if somebody says, hey, their spouse works and they make some money, could you offset this extra half a million loss on the rental property against the spouse's wages, dividends, interest or profit from business, what would you tell them?

Cliff Capdevielle:

And we would say if that spouse qualifies as a real estate professional, we very likely could take a much larger deduction and use that deduction to offset earned income. So we have spouses where one of the spouses is a physician or a dentist, they have a large number of rental properties. After cost segregation and after leveraging those properties, they have a large paper loss on those rentals, even though they're throwing off net income. We can use that loss against the ordinary income for that dentist or physician spouse, and guess what, Steve? Their tax bill evaporates.

Steve Moskowitz:

So folks, just imagine that. You have a situation where the building threw off a million dollars of profit in cash, but because , we have an extra depreciation of a mill and a half, so we wipe out the profit from the rental, so we pay zero tax on that million bucks. And then let's say that the wife was a brain surgeon and she made half a million bucks from her practice, we wipe out her income with the other half a mill, so this couple has earned a million and a half dollars and paid zero income taxes. That's why people that are aware of these things save so much in taxes and everybody else works so hard and grumbles how much they're paying. Remember, there's two purposes, never forget it. There's two purposes for the tax law. And one of the purposes is to encourage you to a certain thing, real estate is a very, very favored area, and you can do all these kind of things and a lot more. Cliff, I have a question for you. During the buying these properties, what if somebody says, you know, I heard that guy, Steve talking about out 39% and I only have to come up with 61% of the building and the government will give me 39%. What's that all about?

Cliff Capdevielle:

Yeah. So now we're getting into the area of credits. Credits are absolutely one of the most important areas. And one of the least understood areas by real estate investors. Most people are familiar with the idea of flipping houses and certainly can make money that way. The government incentives for certain types of properties can absolutely put money in your pocket, whether prices are going up or down. And we'll talk about a couple of real estate credits that are really worth looking at. First one is the rehabilitation credit or the historic rehabilitation credit. This is for historic buildings, Steve, and typically these are in downtown areas. They don't have to be, but certain historic buildings, the government will pay you essentially to fix them up.