The Mark Perlberg CPA Podcast
The Mark Perlberg CPA Podcast
EP 132 - Real Estate Tax Myths, Debunked
We break down the most common real estate tax myths, from REP status and short-term rentals to cost segregation timing and entity hype. We show how to time deductions, avoid recapture pain, and use non-asset strategies to cut taxes while building wealth.
• REP status based on hours and participation, not a license
• Cost segregation timing to match high-income years
• Excess business loss limits and why W-2s hit a wall
• Recapture planning with reinvestment or 1031 exchange
• Short-term rental rules and the 100-hour trap
• LLCs for asset protection, not deductions
• Holding company and management company myths debunked
• Cost segregation is accepted and improves accuracy
• Alternatives to buying assets for write-offs
• Real estate cash flow, depreciation, and tax-free refi benefits
• Holistic planning across business, wages, and investments
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When it comes to tax planning for real estate investing, the world is filled with so much misinformation and misunderstanding. And if you were to have some of these misunderstandings, it could cost you a fortune. So today we're gonna dive into the myths of real estate tax strategy and tax plan and what you need to know on some key items to be more aware of these myths and gain clarity on what real estate tax planning really is and what it should really be here. As we dispel these myths, you're gonna learn a ton whether you're just starting out or you're a seasoned real estate investor or even tax planner. So stay tuned, we're gonna gain clarity and we're gonna bust these myths as we go through this episode. Now, before I get started, if you feel a little overwhelmed by all this information and you know you need help, I will send you a free video illustrating what is possible with our tax strategies. Just go to prosperalcpa.com slash opportunity report, and I will provide for you an opportunity report illustrating what may be possible when we consider real estate tax planning or any of our other advanced tax reduction strategies to help you build wealth, reduce your taxes, and get faster to your goals? All right, now let's dive into the material here as we uncover the greatest misunderstandings and myths and gain clarity on this topic. First one I want to uncover for you is this question I get from so many of our clients. Does a real estate license help with real estate professional tax status? Do I need a real estate license to get rep status? And the answer is absolutely not. While it is a qualifying activity to be a real estate agent and have that real estate license gives you the opportunity to do it, there are so many other qualifying activities that you can do to get the real estate professional tax status. You could be renting homes, flipping homes, wholesaling homes, building homes, developing homes. There are so many other ways to do it. And just because you have that license, it doesn't give you many any more hours. What we care about is what's written in the law. We need to say that 50% of your working hours or more are in your real estate trader business, ideally more than 50%, and those hours equal at least 750 hours. That's how we get the real estate license. Sorry, the real estate professional tax status, not the license. Okay, there's the tax status and the license, they're entirely separate. We do not care whether or not you need a license. It is a tax status, it's an election we make on your return. Another myth I want to dispel here is most people assume that you will want to do a cost segregation study in year one, and usually that is the case. But oftentimes we can do cost segregation studies in the following years after we've purchased the property, where we see more of a bang for the buck for the tax havers. Some of the reasons why we may we may why we may wait on doing that cost segregation study, and maybe we won't do it in the year of purchase. One, we may not be able to use the loss, we don't have material participation or rep status. Two, you may not need the loss because you are in a lower tax bracket and you are already paying very little in taxes, and maybe next year you need the loss more. And there, so these are just some of the ways that we can say, hey, let's hold off on this cost segregation study into the following year. And that's where the strategy comes in. Sometimes we don't even know we need a cost seg until we've drafted the return, and we can then project the outcome of the cost segregation study if it were due to be performed this year versus a later year. Another misperception is that you can eliminate all of your taxes with real estate losses. Now, this may be true for some of you, but not for all of you. Here are some instances where you cannot eliminate all of your taxes with real estate losses. There's something called the excess business loss limitation. And that limitation in 25 is$630,000, and it is dropping, I believe, to$525,000. I might be a little bit off here, but it's in the low fives. But those are the limits of losses that you could take against non-business income, such as your W-2, capital gains, interest, and dividends. So if you have a high W 2, you may find that you are maxed out in the amount of deductions from real estate you could take against your income. Now, if you're a business owner, you can eliminate all your federal taxes derived from your K1 activity, your Schedule C activity. So you have a business and the profit is a million, you can create a million dollars of losses from real estate to offset the profits. That is possible. But if you're paying yourself a salary out of that business, if it exceeds that excess business loss of the 630 and 25 and around a little over 500,000 in 2026, and divide that in half if you're single, by the way. But if you ex if you're W-2 that you pay yourself or any non-business income exceeds that amount, you can't use the losses past that amount. Some other instances where you're gonna see that you're still paying taxes is you can't use the real estate losses to offset your FICA tax, so that's your social security and Medicare. And you also are gonna have a hard time using the real estate losses to offset your state taxes because most states will not conform to bonus depreciation. And most of your losses from real estate often come from that cost segregation study with the bonus depreciation. So you do a cost seg and you have the bonus depreciation. Uh it'll be you are gonna be far far, it's gonna be far more easy for you to offset your federal taxes and your state. Now you're still gonna see benefit on the state side, it's just gonna be more prolonged because they're not gonna give you that immediate deduction from the cost segregation study up front in year one. Now, let's dive into another common misperception that I see is you uh a lot of people will say do not do a cost segregation study if you plan on selling the real estate. Well, if you do sell the real estate, there is recapture, and it can be pretty painful because of the deductions you've created from the cost segregation study are then recaptured and taxed at your marginal rates. So that could be pretty painful if you don't do any planning. But you may find it's still worth doing the cost segregation study and creating that tax deduction, even if you're gonna see a sale in the future. Some ways that we can avoid the recapture is when we sell it, we redeploy into other expenses and other vehicles that will create additional tax deductions upon the receipt of the proceeds. So if we deployed it into other expenses in our business, we may find that we've mitigated or completely eliminated the taxation on the recapture. Also, we could do a 1031 exchange as a way to defer indefinitely the recapture taxes on that property. You may also find that you're in a high bracket this year and a low bracket next year. So you take the deduction this year and you offset your highest bracketed income. And next year you may find that the recapture is not so bad because you're in a lower bracket. So there are all these other instances to consider. Now, if you're planning on selling the property very soon, most likely you'll decide against the cost seg, but you never really know until we do a full look at your financial picture. Decide what's best for you here. Another scenario here is you another instance where I see a lot of misperception is people saying that you cannot reduce taxes without buying assets. Because a lot of the influencers are just telling you to create these fancy deductions, you know, turn your family vacation into a deduction. Or uh maybe that's not an asset, but for instance, buy a G-Wagon and gotta buy more real estate. There are so many ways to create write-offs and tax savings besides just buying assets like real estate and trucks and other heavy equipment and vehicles, etc. etc. So there are all sorts of charitable strategies, there are all sorts of tax credit strategies that are applicable and are gonna help you out with driving down your taxes. And you can even use real estate as a way to funnel money into a retirement account to reduce your taxes. So there are so many ways to do this. You don't have to rely on just buying more stuff to create a tax deduction. You really gotta look at the whole catalog of tax strategies you apply for and what is most applicable to you. And sometimes your strategies may be a little different than what you may think. So a lot of people say you use the real estate to drive down your taxes, but maybe we use alternative strategies to drive down your taxes to allow you to buy more real estate. You take your tax savings to buy more real estate, and then that real estate drives down your taxes. Another misperception I see here is that a little bit of an overemphasis on depreciation. So obviously, real estate is going to give you depreciation, and that's often seen as the best way to reduce your taxes. But especially for you, W-2 earners, and this is your first time to get deductions. There are so many other write-offs we can create when we have a business. So this may be the domino. So if you never owned a business before, you're high W-2, you try to do rep status, get your short-term rentals. Now it opens up the door to so many other strategies just because you're a business owner. Now let's talk about a lot of people promoting the short-term rental loophole and some misunderstandings here. And they will tell you you just need the average length of stay to be seven days or less and put in 100 hours, and then it'll offset your W 2. Well, hold on a second. While that may be possible, there we really want to make sure we understand the law before making these recommendations and that you're talking to an advisor that can make sure that you materially participate. Let me explain to you why that phrase can be very misleading here. And the reason why is because we need to say that you put in 100 hours and no one else put more time than you. Now, if you buy a multi-million dollar vacation rental and you're putting in 100 hours to oversee this rental, that sounds great. But you know how much time is it going to take the cleaner to come in and out of this property every week between all of your guests? If you only have a small handful of cleaners to clean an enormous property, there's a good chance that those cleaners are putting in more time than you, even though you're putting in those hundred hours. So there's a possibility that if you are scrutinized, the auditor, and we have been audited, the auditor is going to want to see evidence not only that you put in your 100 hours, but that no individual cleaner put in more time than you. And it's going to be very hard to substantiate that on these larger projects that require tons of manpower and cleaning efforts to maintain. Here's another misperception I see, and not just for real estate, but for all business owners, is that you need an LLC to create a tax deduction. That's completely false. You are entitled to a business write-off, whether or not it's in an LLC. You own a business as soon as you have that rental and it's available to the public, you can start recording your write-offs. You don't need the LLC. The only benefit as a real estate investor, you're typically gonna find in your LLC is it's gonna give you asset protection. It's gonna be from a tax perspective completely ignored and disregarded. So the only reason that we typically see our clients have LLCs for their real estate is purely for the tax sorry, purely for the asset protection and has absolutely nothing to do with the tax savings. Now let's talk about another, and this is some stupid stuff I see online by the way, um, overemphasis and all this encouragement to have holding companies, and you'll see these people have these diagrams with money going from here to here to here to here to here to here, and this is some they call this this sophisticated structure with a holding company and a management company, and you borrow from you, you know, your management company buys the asset and bills you, and then your holding company owns this and this, and this goes here, and this goes there, and you're like moving all these money to all these different places to give you a write-off, and it's a total BS. They're completely misleading you. You do not need a holding company at all to help you out one bit for your tax savings. And here's where the misunderstanding is they're saying that you need a holding company to say that you materially participated. And the reason why some of these charlatans online are going to emphasize this is because they don't understand the law. Now, the law says to materially participate, it's a facts and circumstances, uh, ability to see if you can group your rentals if you have more than one. And one of the factors they look at is common ownership. However, if you have real estate professional tax status and we want to group your rentals, it's an all-or-nothing election. You don't need them all rolling up into a holding company to group them at all. It doesn't even help your argument. When you group them, when you're a real estate professional, all of the rentals are treated as one activity, whether in one holding company or three holding companies, a partnership here and an LLC there, it doesn't matter at all. It will not save you anything, it will just cost you money and additional fees if it's not providing you asset protection. So all this fancy entity structuring you see a lot of people do, it may provide asset protection, but if it doesn't, you're just wasting your money on overly complex structures that you're going to be paying year after year to maintain, and it'll provide absolutely no value for you at all. You don't need a holding company or a management company to create any write-offs. You don't need to have a special entity to own your vehicle to write it off in your company. It is complete BS. So stay away from all of those people pushing these excessively complex, elaborate schemes of entity structures that really provide absolutely no value at all. Let's talk about some other things here where I see a lot of misleading information here. Some people will say that cost segregation is a red flag, and that is not true at all. Cost segregation is a high is a widely accepted practice, and it actually increases the accuracy of your depreciation schedules and how you're recording your write-offs on your return. So, and think about this. This is especially true when we have some sort of asset replacement. So let's say we're replacing our roof. So if we're gonna do a partial asset disposition, we're gonna remove our the roof on our property and replace it with a new roof. Well, what's the tax impact? Well, we're removing, we are right, we're we're eliminating part of the house that's a roof. We've been writing off this roof year after year as part of the property, and now we realize that it's completely obsolete and we're replacing it. Well, what's the value in the removal of that roof? Well, we don't know because we know we've never assigned a value until we do the cost seg that breaks out the value into the individual components. So, for in many ways, the cost egg increases our accuracy. Now, if you are under audit, they will review the cost segregation study to make sure it's reliable, but you will not get audited simply because you're doing a cost segregation study. You know, we've seen clients create millions and tens of millions of dollars of deductions. We've seen tax returns with literally$3 million of deductions from cost segregation on the return. And we haven't gotten audited. There is no discomfort in making the states because this is what the law says, and we're in compliance with the law. It's not an aggressive strategy, it's a smart strategy. And if you don't do it, you're leaving money on the table. You're putting a lot of money into this real estate, you're really investing and taking on the risk of acquiring it, and you deserve the tax savings associated with the depreciation of that property up front. Here's another uh misleading thought that I see from people, and that is that more depreciation always equals better tax planning. As I said earlier, uh, there's all these different ways that we can strategize and time the depreciation and depreciation elections. And essentially, at a high level, what we're typically doing here is we want to maximize our write-offs in the years where we have high income and we're at risk of high taxes, and we move the write-offs away from the years where we may be in a low bracket. And there's all different ways that we can do this and be strategic and resourceful in how we depreciate this property and when we depreciate, when we run the cost segregation studies, we can even elect out of bonus depreciation. There are so many ways to look at this when we are strategic. Some other things that we want to think about here is when we propose different strategies, some will say that an aggressive tax strategy may mean risky tax planning. Well, that's not always true. Sometimes being aggressive with your tax strategy doesn't mean taking aggressive stances with the IRS, and some may want to take an aggressive stance, they may want to invest in a strategy that hasn't been fully verified and tested in court cases yet, but is still legitimate. But you can also be aggressive with your tax strategies in the ways that you spend and reinvest, and the ways by which we outload capital into assets that we can legitimately write off, and the way that we structure our businesses, and the way that we hire our family, and the way that we go about setting up our activities so we can create these write-offs. It doesn't always mean we're taking huge risks to create the savings that you are entitled to. Now, a lot of people also will say If real estate doesn't reduce my taxes, then what's the point? Well, the beautiful thing about real estate, and this is why I like real estate probably more than any other form of tax reduction strategy, is even if you're not reducing your taxes, there's tremendous value to invest in real estate from a tax perspective and from a wealth building perspective. You see, you can still use the depreciate to offset the rents, the rental income. And you can do a cost egg to offset the rental income. So even if you're not driving down your taxes directly from the real estate investing and it's not offsetting your W-2 or your business income, the real estate investing could still be beneficial just simply because you can bring in money and cash flow without paying taxes on it. That's pretty awesome. And then you can also accumulate wealth. You're paying down the mortgage, and your the asset is growing in value and appreciating, and you're not paying taxes. You can do a cash out refi, you can refinance and take back some or all of your down payments tax-free, no taxes on that at all. So it's an incredible wealth-being building vehicle that is highly tax advantaged. Now, if you want to see, and actually, I want to drive this home a little more here. That real estate tax planning, if you really want to do this at the highest level and see the greatest return from an advisor or in a tax plan, you want to make sure you're looking at everything because we may not just want to rely on real estate to drive your taxes, but also see look at the full picture. What are we doing with our businesses and our W-2 and our investment income that may be creating additional taxation we don't need? We can eliminate the tax and have more money to put into the real estate that drives down your taxes, and that's something that's often ignored. People like to just drive straight into buying the assets and doing the cost eggs. There's so many other things we want to consider if we really want to drive down your taxes and build wealth in the most efficient manner to really create that wealth and give you the ability to grow your real estate empire as big as you can and do what you want to do with your overall goals, whether that's retire early, have more cash in the bank, etc. etc. Alright, I hope you found this informative and stay away from those stupid, crazy entity structures that make no sense online. Talk to me if you're if you're confused about this, by the way, and if if you've maybe already set up one of those things because you followed a fancy marketing company that calls themselves an accounting firm, we can help you undo the damage and make sense of it all. Uh so I hope you and you got something out of this conversation. And again, if you want to learn more about how any of these concepts or anything else we do with wealth building and tax reduction as it applies to you, go to prosperalcpa.com slash apply. That's prosper with an lcpa.com slash apply. Have a great day and happy tax savings.