Topic: Member Workshop: Tax Secrets for Real Estate Investors
Host: dkennedycpa Date: Wednesday 04/09 Time: 10:00 a.m. to 11:00 a.m. Pacific time Location: Workshop Board
Description: Ever wonder why the nation's wealthiest people either made their money in real estate or hold their wealth in real estate? It's for the tax breaks! Here’s another tip: the wealthy understand that in order to succeed, you need to swim against the tide. Real estate is still a fantastic investment. Learn what the rich already know with the CPA to the rich and famous, Diane Kennedy, CPA.
Hello. My name is Diane Kennedy. I’ve been a CPA and Tax Strategist for over 25 years. My specialty is working with small business owners and real estate investors. My tax education company, TaxLoopholes, LLC, teaches people through books like Tax Loopholes for eBay Sellers, tapes and seminars on how to take advantage of the legal tax loopholes available to everyone. First though, the stuff that our lawyers make us say: Laws and practices vary from state to state and if tax, accounting, legal and other specific expert advice is required, the services of a professional should be obtained. Diane Kennedy, CPA www.taxloopholes.com
For this month's workshop I want to switch gears for a bit and talk about real estate investing, and the tax savings that become available to you as both a business owner and a real estate owner/investor. Diane Kennedy, CPA www.taxloopholes.com
We love your questions and appreciate your participation in each month's workshop. This month we've got a special treat for the first 10 people who ask a question. We'll give you a copy of my book, Real Estate Investing Loopholes. Diane Kennedy, CPA www.taxloopholes.com
I don’t normally talk about real estate and the tax savings it generates in my eBay workshops. We’re usually focused on the tax savings your business can generate. But there is a rare opportunity about to happen, and it’s something I don’t think anyone should ignore. Diane Kennedy, CPA www.taxloopholes.com
People have three survival needs: food, clothing and shelter. The government loves entrepreneurs and people who contribute to the economy, because they allow people to meet those basic survival needs (and a whole lot more). Entrepreneurs create businesses, which employ people. Employees receive income, and use that income to meet survival needs. Real estate investors provide shelter - one of the crucial survival needs. Real estate investors contribute to the economy in much the same way that business owners do. Diane Kennedy, CPA www.taxloopholes.com
Haven’t you ever wondered why business owners and real estate investors get all of the best tax loopholes and tax credits? It’s easy - because these are the people who make the economy work. Business owners and real estate investors take the pressure off of government to ensure its citizens have their basic survival needs met, by creating a situation where people can meet those needs. From the government’s perspective, there can’t be too many business owners or real estate investors, and it has some very powerful resources to encourage people to take up one or the other (or both). Diane Kennedy, CPA www.taxloopholes.com
Here’s another tip: smart investors know when to swim with the tide, and when to swim against it. Right now we’re in a position where the economy is faltering, house prices are falling, and people are getting worried. Mainstream opinion seems to be hunker down, and try to ride things out. But for smart investors, now is a great time to buy real estate and start new businesses. Diane Kennedy, CPA www.taxloopholes.com
Live in Your Home for Two of the Last Five Years. This loophole is probably the biggest gift that Congress has ever given to the American taxpayer. It’s simple – just live in your principal residence for two of the previous five years and you’ll get a tax-free exclusion when you sell your home. If you’re married, it’s $500,000 and if you’re single the exclusion amount is $250,000. Diane Kennedy, CPA www.taxloopholes.com
You don’t need to be a certain age to get it and you don’t need to buy another house or even move a certain distance away. All you need to do is live in your home for two of the previous five years. Diane Kennedy, CPA www.taxloopholes.com
Now here’s what makes this loophole so interesting and powerful. The IRS has a very loose definition of what “lived in” means. In fact, “lived in” can mean you spend as little as one month per year actually in residence at your house, yet still claim this deduction. Diane Kennedy, CPA www.taxloopholes.com
There are some rules around this: you need to be able to provide some evidence that you really do live here, even though you happen to be away from home – a lot. Things like having your mail sent there, having your driver’s license and voter registration cards set to that address, along with library cards, local gym or other social club memberships, etc. That’s why trying to use your home as a time-share, and renting it out the other eleven months of the year might not be a good idea. Talk to your tax advisor about ways to make this work to your advantage (and get a good set of luggage if you’re planning on doing a lot of traveling. As long as you’re looking at real estate along the way, you could claim the luggage as a deduction!). Diane Kennedy, CPA www.taxloopholes.com
How “Unforeseen Circumstances” Can Benefit You. Here’s another awesome loophole for homeowners. When Congress wrote the tax code provision for the gain exclusion, they also made allowances for having to leave a home without meeting the two of the past five years requirement. If you have to sell your home, under certain unforeseen circumstances, you can take a partial gain exclusion. For example, if you’re married and live in your home for only one year and qualify for this exception, you’ll be able to have a tax free gain of up to $250,000. That’s one year out of two, or half, of the full $500,000 gain exclusion. Diane Kennedy, CPA www.taxloopholes.com
Here’s what the IRS considers qualified “unforeseen circumstances”:
Death Disability Multiple births from the same pregnancy Change in employment Change in self-employment
Take a good look at the last two items on this list. If you have your own business, you know the one constant is change. That means that if your business has a change you can qualify for the unforeseen circumstances exception. Diane Kennedy, CPA www.taxloopholes.com
Write off Your Home Office. It used to be that having a home office and taking the home office deduction on your tax return was considered an audit red flag. And even though that changed over 10 years ago, I still get asked at least once a week whether or not someone should take the home office deduction … because they heard it was an audit risk. Diane Kennedy, CPA www.taxloopholes.com
Exclusive use means exactly that. You can’t use a part of your kitchen or living room, and claim the entire room. If you’re using a spare bedroom, you’re going to have a hard time claiming it’s a home office if you also have a king-size bed in there. Diane Kennedy, CPA www.taxloopholes.com
Once you have established a legitimate business space in your home, measure the room. Compare that square footage against the total square footage of your entire house. That is your business usage percentage. Now apply that percentage against all home related costs. Diane Kennedy, CPA www.taxloopholes.com
If you rent, that’s okay – you can take a percentage of your rent. If you own, on the other hand, you’ll be able to take a percentage of your mortgage interest, homeowner’s dues and property tax. You can also include a percentage of utilities, insurance, repairs … well, you get the picture. Diane Kennedy, CPA www.taxloopholes.com
And even better, once you have your home office set up, you can then deduct the things in it. The furniture you bring in is a deduction. The art you put on the wall is a deduction. And any improvements or changes you make to the room to accommodate your business is a deduction. In one of my houses I converted an ensuite bathroom into a recording studio, and was able to write off all of the construction costs. Diane Kennedy, CPA www.taxloopholes.com
The second rule, regular use, is pretty straightforward. For those of you working from your home, this is pretty easy. If you also have an outside office, then make sure you that you spend time on a regular, continuous basis. Once a month won’t do it here! Diane Kennedy, CPA www.taxloopholes.com
I often recommend to my clients that they take pictures of their home office space. Now you have some kind of pictorial evidence to show to the IRS if they ever ask – and they might, may years later when you may no longer own that home! Diane Kennedy, CPA www.taxloopholes.com
Write off Gain Apportioned to Your Home Office. One reason people still hesitated to take a home office deduction even after Congress changed the rules was because they were now required to pay tax on the gain realized by their home office, when the property was sold. If 25 percent of their home had been devoted to a home office, 25 percent of the gain was taxable when the home was sold. Diane Kennedy, CPA www.taxloopholes.com
Well, fortunately that’s all history! Congress changed the rules again back in 1997, and now, as long as your home office is part of the same structure as your home (be careful - a detached garage doesn’t count here), you don’t have to apportion any gain. Diane Kennedy, CPA www.taxloopholes.com
Write off Inventory Space. Here’s another way you can have your home make money for you. Inventory, unlike a home office, is deductible no matter where it happens to be. This is great because it means you can have your home office in one part of your house and your inventory in another part – and get an even bigger deduction! I remember one workshop where I was explaining this idea when a gentleman chimed in with a question. He asked if he took all his boxes stacked up along one wall in his garage, and laid them out across the floor, could he now write off his entire garage. The funny thing is, if his boxes took up all of the floor space, the answer was yes: he could! Of course where he’d park his car was another question. Diane Kennedy, CPA www.taxloopholes.com
Buy Investment Real Estate. If you own your home already and have a business, then one of the most ideal wealth-building plans is to invest all of the left-over cash from your business in real estate (after you’ve deducted all of your hidden business deductions). No matter how far wildly a market appreciates (and believe me, depending on where you lived things were pretty wild!), even when it reverses it never goes all the way back. Prices have certainly fallen in Phoenix, but housing still costs more than it did 6 or 7 years ago, when the market surge first began. People who bought property have still made money – maybe not as much as they had on paper 2 years ago – but they have still made money on their investment. Diane Kennedy, CPA www.taxloopholes.com
But it gets better. Even though real estate tends to go up in value over the long term, the government gives you a huge break when it comes to your real estate. In fact, the government says, “You poor thing! You have real estate. We think it’ll be worth nothing in 27 ½ years if it’s residential or 39 years if it’s commercial.” And there are tax strategies available to you that make this even better! Diane Kennedy, CPA www.taxloopholes.com
Depreciation. Depreciation is the number one reason why real estate is such a great tax reduction strategy. This is a deduction that you get to take and it doesn’t cost you a dime. In fact, depreciation is the reason why you can have a property making you money, month after month; money you put in your pocket … and yet still show a loss on your tax return. Diane Kennedy, CPA www.taxloopholes.com
Maximize Your Depreciation through Cost-Segregation. It’s possible to break out the value of personal property items within a property. These are things like refrigerators, ceiling fans, furnaces, water heaters, air conditioning units and the like. The depreciation life of these items is shorter – generally 5 or 7 years – than that of residential or commercial real estate, and this means more depreciation! Diane Kennedy, CPA www.taxloopholes.com
The method of separating personal property from real property is known as a cost segregation study. Now, here’s a warning. There has been a lot of abuse in this area. Despite the fact it is perfectly legal, there have been some bad guys who have taken advantage of this part of the law. I’m not saying don’t do it –just make sure you’re doing it correctly so that the IRS will support the work you do. The best way is to make sure your CPA understands this strategy and helps you with the cost segregation study. If your CPA is signing your tax return, he or she is putting his or her name on the line, and you can take confidence in the correctness of the work being done. Diane Kennedy, CPA www.taxloopholes.com
Time Your Depreciation Deduction. If you haven’t been maximizing (or even taking) the depreciation deduction, it’s possible to catch up all of your past depreciation in one year. But, you’ve got to know when to do it. Diane Kennedy, CPA www.taxloopholes.com
I remember talking with a client who was unhappy with his previous CPA. He had paid his CPA several thousand dollars to prepare a cost segregation study on his property and then to catch up his past depreciation. The problem was that his CPA didn’t take into account my client’s current tax situation when he took the depreciation deduction. My client had too much earned income to qualify for more than a $25,000 depreciation deduction. Diane Kennedy, CPA www.taxloopholes.com
The error meant that my client couldn’t take advantage of the huge loss the catch-up depreciation had generated. That past depreciation had been all caught up in a suspended loss that couldn’t be touched until my client sold the property. Diane Kennedy, CPA www.taxloopholes.com
Buy Your Own Office. One of my absolute favorite tax-savings strategies is to use the profits from a business to buy a piece of commercial property, such as a warehouse or office building. Your eBay business can then rent space from the entity holding the building, and you can earn money by renting out space in that building to other tenants. Diane Kennedy, CPA www.taxloopholes.com
Ideally, you should buy a building that has multiple tenants and not just your eBay business. You don’t want the IRS to get the idea that you’re playing a shell game with your income. However, it’s great to have your business be one of the tenants. Your business will pay a reasonable rent that is a deduction against business income. It’s income for the rental property, but that income is offset by rental expenses, including depreciation. Diane Kennedy, CPA www.taxloopholes.com
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The views expressed in this presentation are those of the presenter and not those of eBay Inc. The presentation of this information at an eBay event does not indicate endorsement or sponsorship by eBay Inc. Participants should consult with their accountants or tax specialists for professional advice.
I am in Ca. and am considering buying a reatal proprty in oregon and have a proprty management service take care of it. This would be an investment at this time as I own my home in Ca. How do you feel about this? Thank you
In reading your notes prior to this discussion, I was interested to learn anout being allowed inventory space as well as office space. Thank you for the tip!
I am in Ca. and am considering buying a reatal proprty in oregon and have a proprty management service take care of it. This would be an investment at this time as I own my home in Ca. How do you feel about this?
I'm from Oregon originally...so lots of thoughts pop into my head. (And at the risk of offending everyone from the Pacific Northwest, I moved to the driest place in the US as soon as I was old enough)
As far as a rental investment, what do the numbers look like? Diane Kennedy, CPA www.taxloopholes.com
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