I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox ð Also on YouTube at PlugAccountingandTax!
The Real Estate Client Avatar: 6ïļâĢ Six Strategies Only Real Estate Can Do
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Ten years ago, I met with my business development partner and shared with him this idea of documenting and sharing the tax strategies each client was using. ð It would make us intentional strategists - having to commit to strategies and execute on them. The idea floundered in that firm but it stuck with me. Fast forward to 4 years ago when I left Baker Tilly and shared the same idea with my now partner, Mitchell Baldridge. We doubled down into the idea and have built out work-up's and how-to's on dozens of strategies: ð who they're applicable to, when to use them, what to watch out for. This creates "client avatars" ðū that fit our expertise - rather than us saying yes to everything that walks and talks. One of the deepest expertise we have is in real estate. I spent time as a construction and real estate tax partner at Baker Tilly and lead the Houston tax team during my time there. This provided me insight and access to some of the smartest real estate CPAs I've ever met. ðĨļ Our real estate client avatar currently has 20 possible applicable strategies - but today I wanted to walk through six that are unique to real estate only: ââïļ
Real Estate Pro StatusIf you spend more than half your time and more than 750 hours per year working in real estate, you qualify for Real Estate Professional status. This is a classification on your tax return that signals to the IRS: this person is a professional real estate operator. ð This cracks open the passive activity rules. If you're not a Real Estate Professional, your rental losses get trapped behind Section 469 limitations. You can only use them against passive income. ð But if you have REP status, those losses are reclassified. Now they can (with the below election) offset W2 income or other active business income. That single reclassification is worth millions in tax over a lifetime when done right. 469-9: the Rental Real Estate AggregationHere's where it gets powerful. ðŠ Real estate professionals can make something called a 469-9 aggregation election. This is a simple statement that says all your rental real estate activities should be treated as one business for tax purposes. Why would you want that? Because if you have one property crushing it with strong cash flow and another property that's newer and generating losses from depreciation, an aggregation election lets you combine them. The losses offset the gains. ð You end up with a cleaner tax picture and way more flexibility on what losses you can claim and when. Add in a high-income earning spouse on W2 and these benefits add up quickly. ð° Qualified Nonrecourse Debt: Least Risky At Risk DebtNo one does debt like real estate - for tax purposes at least. When you borrow money to buy real estate from a lender who doesn't have recourse to your personal assets (among other criteria), that debt still counts as basis under Section 465. ðĶ That's code for: you can use that leverage to support bigger losses and distributions. Qualified nonrecourse debt gets added to your capital "at risk", which increases your basis in a partnership. And everyone likes basis. It's a huge reason real estate partnerships are so tax efficient. ð Section 163j RPTOB ElectionSection 163(j) limits how much interest businesses can deduct. It's brutal for unsuspecting highly leveraged businesses who generate losses and are owned by 35% or more LP capital. ðŦĻ But if you own real estate and make the Real Property Trade or Business election, you can bypass that limitation entirely. While it changes the rules on some bonus depreciation, if you're strategic about timing, this election can still be incredibly powerful. You get to deduct full interest expense year one, then plan your depreciation timing in future years. Many tax returns I see from other providers still miss this - exposing the property to audit rules that could cost the partnership real tax, penalties and interest. (Under new-ish audit rules, the partnership pays any underpayment of tax and chases down the partners to get reimbursed). ðĪ·ââïļ Opportunity Zones: All the benefit of dying, none of the inconvenienceI'm cheating a bit here. Opportunity Zones can be used by non-real estate. It's just that real estate has proven the main beneficiary. ðĒ Opportunity Zones can defer ultimate capital gains on an exit indefinitely. ðŠĶ Invest your gains into a qualified fund. Let it sit for 10 years. Pay zero tax on the growth inside that fund. That's not tax reduction. That's tax elimination. You'll still have to pay on the deferred capital gain, but the tax-free appreciation is where the real benefit is at. 1031s: the Real Estate Bro's 401(k)Section 1031 lets you sell an investment property, move the proceeds to another property, and pay zero capital gains tax. âĐïļ You can keep doing this forever. Sell property A, buy property B. Sell property B, buy property C. Keep compounding without ever writing a check to the IRS. No other industry gets this anymore after 2017 tax laws passed. Layer in Tenancy in Common (TIC) entity structuring and even syndicated properties can pull off one of the most lucrative compounding strategies in the tax code. ð° The TakeawayThese rules aren't random. Congress designed them because real estate builds community infrastructure, creates housing, and stabilizes local economies. ðĻâðĐâðĶâðĶ But knowing these advantages exist and actually using them are two different things. REP status that triggers the 469 aggregation. RPTOB elections that maximize interest deductions. 1031 exchanges that perpetually defer tax. If you're operating or investing in real estate, you should have these strategies in your arsenal and check that they are executed annually. ðŦĄ ðĨ Hottest Finance Posts This Week ðĨ
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I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox ð Also on YouTube at PlugAccountingandTax!
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