Episode 4 – What Is Your Biggest Expense? This Episode Will CHANGE Your Answer
How to Pay Less Taxes
In this episode, Pancham interviews Brandon Hall, CEO & Founder, The Real Estate CPA. Brendon shares some effective and little-known ways to control your BIGGEST expense, taxes.
In the next segment of this show, we discuss land conservation easements. You will learn about this little-know investment strategy which can potentially save you thousands in tax dollars. How do you passively invest in a real estate syndication? What are some effective ways of vetting a real estate sponsor?
Finally, we discuss whether the newly introduced “Opportunity Zones” are a worthwhile investment. We wrap up this show with our “Taking the Leap” segment where Brendon reveals how he overcame challenges to successfully transition to Main Street Investing.
Disclaimer: None of the information from this podcast should be taken as tax, legal, or investment advice. Please consult qualified professionals before implementing anything discussed. In November 2019, the IRS released a statement saying that they intend to crack down on land conservation easements. As a result, recommend that you stay away from land conservation easements and consult qualified tax professionals on the matter before investing in them.
Subscribe to your favorite platform:
- 00:52 – What is your biggest expense?
- 02:58 – Pancham welcomes Brandon to the show
- 03:25 – Are you, as a highly paid professional doing enough to save your tax dollars?
- 5:232 – Brandon explains how real estate investing can help you lower your effective tax rate
- 9:10 – How to pay less taxes by accounting for depreciation in real estate investing
- 11:55 – Important nuances of bonus depreciation introduced in the new 2018 tax law
- 13:45 – What is cost segregation? How much does it cost?
- 16:18 – Brandon reveals another tax-saving instrument – Land Conservation Easements
- 18:06 – Can land conversation easements get you in trouble with the IRS?
- 20:03 – Should you always invest your hard earned money with a real estate sponsor who has a good track record?
- 20:53 – How do deductions work in a land conservation easement?
- 22:56 – Can a W-2 employee passively invest in real estate?
- 24:09 – Who is an accredited investor? What is the threshold for qualifying as one?
- 25:52 – Are 401 K’s and IRA’s good investment options?
- 30:35 – How to pay less taxes by investing in an oil and gas fund
- 33:07 – Do more tax saving opportunities open up once you walk away from your W-2 job?
- 34:25 – What are “Opportunity Zones” that were recently introduced by the Trump administration? How can you benefit?
- 37:25 – Ideally, what should be your investment horizon in an opportunity zone?
- 42:22 – Taking the Leap
- 42:22 – When was the first time you invested outside of the Wall Street?
- 43:18 – What fears had to overcome when you made your first investment property?
- 44:54 – Can you share one investment that did not go as expected?
- 47:15 – What is one piece of advice that you should give to people thinking of investing in the Wall Street?
- 48:30 – Brandon shares his contact information
- 49:20 – Discover SIX Solid Reasons for investing in Real Estate
4 Key Points:
- How real estate investing can lower your effective tax rate
- Pros & Cons or land conservation easement
- What are Opportunity Zones? Can you save your tax dollars by investing in them?
- Why investing in an oil and gas fund is a good tax-planning strategy
Welcome to The Gold Collar Investor podcast with your host Pancham Gupta. This podcast is dedicated to helping the high paid professionals to break out of the Wall Street investments and create multiple income streams.
Here’s your host, Pancham Gupta.
Pancham: Welcome to The Gold Collar Investor podcast show#4. This is Pancham.
If this is your first time listening, then thanks for coming. The Gold Collar Investor podcast is produced every week for your learning and enjoyment. Show Notes can be found at
thegoldcollarinvestor.com/show4. All links are in the show notes.
Now, let’s get into the show. Whenever I am discussing finances, and ask people, what is their biggest expense, 99% of the times people say that it’s their mortgage or rent. A few people mention that it’s their student loans. I have only got the right answer twice. For most people, the highest expense is their taxes, primarily their income taxes. You see, the government takes the 30% to 40% of your income. If you are a high paid professional like I was, this number can be even higher. And the kicker is that if you combine all of your taxes, that is property tax, income tax, sales tax, etc. then this number is a significant portion of your expenses. I’ve seen people spend hours finding a good deal of the latest electronics, flight tickets, vacations, etc. They will wait for a 20% sale to buy certain items. All that is fine, and there is nothing wrong with that but to me, that does not make sense if you consider the return on your time investment. If you consider your time to be worth let’s say $200 an hour, and you’re spending an hour to save $100, then it’s a negative return on investment. What if you spend that time in doing better tax planning? Imagine saving just 1% or 2% of your taxes a year? That savings alone can be more than all the savings combined. From all the deals that you look for in the whole year. All the wealthy people I know pay a lot of attention to tax planning. I personally have spent a lot of time on this topic. And that is why I have invited the person who has saved me thousands of dollars personally. Brandon, welcome to the show!
Brandon: Hey Pancham, thanks for having me!
Pancham: Are you ready to fire up my listeners break out of Wall Street investments?
Pancham: Great. Alright, so Brandon, I know most of my listeners are thinking that what can I do if both me and my wife are working W-2 jobs. Can we really do anything to save on taxes?
Brandon: Yeah, so we work with a lot of high net worth individuals, and this is often a question that we get if they are both still employed. And you know, people are always doing these standard things, like contributing to a 401k, they are maxing out their HSA, they are doing what they are supposed to be doing to minimize that tax blow coming in from your W2. We take this as a two-pronged approach. First, if your income is high enough, we might look at a land conservation easement, which I’ll talk about in a second. The second thing that we look at, is how are you building additional income streams that are tax-free or tax-deferred. We only work with real estate investors. So, a lot of our clients, they’ll come in, they’ll be building a real estate portfolio and while their W-2 income…you just can’t shelter it. It’s coming in, and you’ve got to pay taxes on it. It’s high, it’s there, and that’s always there. But the rental real estate income, they are able to build that out slowly and not pay tax, at least currently, on the income streams. So, we see a lot of clients that are high net worth, that earn a lot of money, that might be in the highest tax bracket but have actually has effective tax rates really low. Lower than somebody that’s earning $80,000 a year simply because they have one income stream that’s taxed at 37%, then they have another income stream that’s tax-deferred. So, it’s not taxed at all in the current year, and that’s that rental real estate income stream. You build that up high enough, your effective tax rate drops pretty significantly.
So, between land conservation easements, and just building out income streams that are tax-deferred that you don’t have to pay tax on this year via rental real estate, that’s the vehicle that we obviously want people to go into that those are the ways that you really reduce your “Tax”.
Pancham: Let me ask you a question on this particular topic. So, if I am starting out, and I have not done any real estate…I am not getting any passive income from real estate, and I am building that out. I buy one house, that is not going to decrease my effective rate, right? I mean, overall, the thing that you are talking about will work only if my portion of the income from this passive activity, passive income is much much higher than what I’m earning at my W-2 job, then my effective rate would be reduced. Is that right?
Brandon: Well, not necessarily. So, let’s say that you are at $90,000. You are at $90,000 through W-2. And let’s say that you pay an $18,000 tax. So, you pay 20%. That’s your tax rate. Let’s say you buy a piece of rental real estate, and you cash flow $10,000. So, $10,000 hits your pocket. But let’s say that rental real estate for tax purposes shows a passive loss due to the depreciation and different things that you can do there. So, Cash Flow – $10,000, hit your pocket, but you actually show a taxable loss. You don’t pay a tax on that cash flow. So really, what happens now is we have the $90,000 W2 plus the $10,000 in cash flow, but we are still only paying $18,000 in tax. So, my effective tax rate went from $20,000. So, 18 on 9 days, 20%. So, it went from 20% to 18% because my income went up, but my tax rate stayed the same. That’s what I mean by you invest in rental real estate to reduce your effective tax rate. It’s not going to reduce your tax. I’m sure given some of the stuff you can reduce your tax, but you’re not going to reduce your tax with this strategy, but you will reduce your effective tax rate.
So, a lot of people are always like, well, you quote the Warren Buffett thing where he pays less, the media always says he pays less tax than his secretary. What he does is he pays less effective tax than his secretary. His effective tax rate is 12% – 15%. The Secretary’s tax rate is 28%. But that’s because Warren Buffett has invested in these types of income streams where he’s just slowly chipped away at the main source. That W2 income that you can’t shelter, he’s just slowly added on income, and it ended up exceeding the income and then significantly exceeding the income the case.
Pancham: Right. I want to point out that it actually clarifies it completely. But I want to point out the very, very simple example that you gave over there from $90,000 to $100,000 and the way it reduced, not reduced, but kept your effective tax rate at 18%. Which in the traditional world, if you were to get $100,000, let’s say $10,000 raise in your W-2 job, you would pay $20,000 instead of $18,000. So you saved $2,000 in taxes. That could be your entire Thanksgiving shopping worth savings if you are waiting for the Black Friday.
Brandon: Exactly. And really, it’s just over time, let’s chip away at it. So, let’s just keep adding those income streams. Now, over time, your W-2 job is also going to go up. But if you’re really focused on building these passive tax-deferred income streams, eventually, you are not going to need a W-2 job. And that’s where it gets really fun.
Pancham: Yeah. The example that you gave that also applies to people who are earning $250,000, $300,000, $400,000, $500,000, right?
Pancham: It stays the same. It’s not right there, you know, it’s just that their effective rate is much higher than 20%.
Brandon: Yes. Much higher.
Pancham: Alright, so Brandon, I want to circle back to your example and discuss that even though I made $10,000 in income, but I paid no taxes on it. How is that possible? Can you explain?
Brandon: Yeah, sure Pancham. The way the real estate investing works is that you can have cash flow of…you asked about $10,000. So, I could have the cash flow of $10,000, but not actually pay tax on it, because my net taxable income is not necessarily going to be the $10,000 cash flow. They are not necessarily going to be equal. And one of the key reasons as to why this is the case is something that we call depreciation.
Depreciation was built into the tax code to monitor the wear and tear on business assets or your investment properties over time. Like I put a new property on today, it’s not going to be worth what it is today in 10 years because it’s going to have wear and tear. I might have to even make a couple of repairs. That’s what depreciation is supposed to measure. So, when I get a new roof on a property today, that new roof might cost me $7,000. I can’t write off the cost of the roof today, because that roof is going to benefit me for a long period of time. So, I’m not allowed to write it all off immediately. Instead, it becomes a capital expenditure, and then I depreciate it over the useful life of that component. Now, roofs have a useful life of 27 and a half years, regardless of what type of shingles you put on, the structure doesn’t matter. For the IRS guidelines, roofs have a useful life of 27 and a half years. So basically, I put a $7,000 roof on today, I can deduct a little bit of that $7,000 every year for 27 and a half years. So, depreciation is supposed to measure the amount of use per that component over the useful life. In this case, over 27 and a half years. So, if I have $10,000 in cash flow, I can have depreciation may be equal to $8,000. So, my net taxable income in this example is only $2,000. But when you get into the bonus depreciations, the cost segregations, all that stuff, you can have the net taxable income of say, $50,000, but then you could actually have a tax loss. So, the loss is reported on your tax returns of maybe $150,000. You have got this massive loss here. Even though you’ve made money from your rentals, on your tax return, you could report a big negative number. A big passive loss. Thanks to depreciation. Thanks to bonus depreciation. And how all that works.
Pancham: Very interesting. This gets even better in the new 2018 Trump tax law, right? Can you explain what the bonus depreciation is in more detail as it pertains to 2018 tax law?
Brandon: Yeah. Like I have mentioned, the bonus depreciation part… in the past you could bonus depreciate, but you could only take 50% bonus depreciation, and then you’d have to depreciate the remaining 50% over the component’s useful life. Now, any component with a useful life of less than 20 years, you can 100% bonus depreciate, which means I can write it all off in the current year. Now, when I use bonus depreciation, do not be confused with repairs and maintenance. It is a capital asset that we are adding to the balance sheet, and then we are writing it all off or expensing it via bonus depreciation. And the reason that I make that determination is because at some point, whenever you sell the property, you’re going to have to recapture a certain amount of that bonus depreciation. In most cases, when you write something off as repair or maintenance, you don’t have to recapture that expense, because it’s just a hard expense. But with bonus depreciation we added to the balance sheet, we have accumulated depreciation equal to the value of the property because we’ve 100% bonus depreciated it. Whenever we sell it, at some later point, we might have some recapture there that we’re going to have to pay some taxes on.
But with 2018 tax code, the key difference is that, 50% bonus depreciation moved to 100% bonus depreciation. So now, you can 100% bonus depreciate any component with a useful life of less than 20 years. Your carpeting for instance, it’s considered personal property. It has a useful life of 5 years. Land improvements, like the driveway, shrubs, trees, those all our land improvements. They have useful lives of 15 years. All of that stuff can now be 100% bonus depreciated. Now, the kicker is that you can’t go buy a property and then just randomly say, “Well, I think that the carpet is worth $1,000.” Instead, what you have to do is you have to get something called a cost segregation. What these guys are going to do is they are going to walk through your property, and they are going to assign a value to every component that has a useful life of 5, 7, 15 years and then they are also going to assign a value to the structure – the 27 and a half year property. The difference is that these guys are trained, they can do this, they have cost data that they can use, and then they pull to make sure that they are allocating some of that purchase price appropriately to components with a useful life of less than 20 years.
Cost segregation studies can often cost $2,000 to $5,000 to $7,000, depending on the size of the property, how many units you have. More bigger the units, the bigger the property, more expensive the cost segregation study is going to be. But as an example, you could buy a $1,000,000 multifamily property, get a cost segregation study done. The cost segregation guys are going to come in, and they’re probably going to say anywhere between 25% to 30% of that purchase price should be allocated to 5-year, 7-year and 15-year property. So, all less than 20 years. Which really means that you get to write off anywhere between $250,000 to $300,000 immediately in the first year, via 100% bonus depreciation.
You might be able to do a cost segregation study by yourself. There’s some survey-based purchasers out there. I don’t really recommend that. But you can use bonus depreciation if you don’t use a cost segregation study when you replace the components. So, I can’t buy a $100,000 property, and then walk through and say, “Oh, yeah, my carpets 1000 bucks.” So, I’m going to…I bought a property this year so I am going to use a 100% bonus depreciation, but I can buy the property and then let’s say next year, I replace the carpet. And let’s say I spend $3,000 replacing the carpet, I can bonus depreciate that. I can take 100% bonus depreciation on that $3,000. Anytime that I’m doing a big rehab, anytime that I’m doing any sort of repairs, I always want to get super itemized invoices, because my accountant, if they are good, they are going to be able to go through and itemize those components and figure out if we can use 100% bonus depreciation.
Pancham: Thanks for explaining that. Now, let’s move on. You mentioned something called Conservation Easement. I know that topic is something that might be new to a lot of people. But since you hit on it, we can talk about that. Are you going to talk real quick what that is?
Brandon: Yeah. I will try to give you a 30-second version which is going to be tough. Land conservation easements, this is the other kind of bulletproof option that people who have W-2 and earn a lot of money… This is your go-to option if you are looking for a significant tax deduction in the current year. So, the way that the land conservation easement works is you buy land, and then you get it appraised on development plans that you build out. Basically, you go and you say I am going to plan to develop this land, and the appraiser comes in, and he appraises those plans. And he basically says here’s what the land would be worth after you went through the development process. So, we bought the land, we get plans for it for development, then we get a value for post development of that land. The net difference between the post-development value and my basis can be written off as a charitable contribution on Schedule A. If I decide to instead of developing the land, I’m going to place a conservation easement on it and donate it to the government. The conservation easement means that nobody can ever develop on the land. So, you conserve the land. But in doing so you are allowed to write off a significant amount as a charitable contribution on Schedule A. Now generally, I think the IRS says that the median is 476% return. So if I invest $100,000, I get a $470,000 write off. That’s the median.
Brandon: We have a lot of clients that will invest $50,000 and give a $200,000 to $250,000 write off on Schedule A. There’s a couple of things that you have to watch out for like your charitable contribution can’t be more than 50% of your AGI. So, that’s something to consider. There are also risks involved. Everybody knows that whenever people hear land conservation easement, the next thing that they say is “Well, it sounds too good to be true. So, what are the risks?” And one of the big risks is that these are listed transactions with the IRS meaning that we basically are at the stake of flag or big red flag in tax return, and somebody’s going to look at it. There is a higher chance of audit there. But the deduction is totally legit. It’s totally legal. And the cool thing is you don’t have to do it yourself. There are syndications out there that…they find these families that have tons and tons and tons of land and they ask them to donate it and then they bring in investors that can place $50,000 or $100,000 and do syndication.
Pancham: Wow! A lot of value over there. You kind of answered my follow up question over there towards the end. The people who are working two W-2 jobs, they have not time. They have no time. They’re busy with family, friends, and the job, and all that stuff. So, how can they go about the conservation easements? Right? You mentioned that there are risks, Risk of the audit is number one, what are some of the other risks? And how can these guys use the benefit of conservation easements?
Brandon: Yah. You can do it yourself. You can buy your own land, and you can place a conservation easement on it. The process is tedious. So, we typically don’t recommend that you go out and do it yourself. The amount of due diligence that you have to get to substantiate the deduction is insane.
What we have done is we have slowly over time build out a network of syndicate sponsors who do this, who know exactly how to play in this space. They know exactly what documents they need to substantiate the deductions, and they just go out and they try to find people that have a land and want to donate it. And then they bring in the investor. So, if somebody has a big W-2 job, and they don’t have time, all you have to do is just this find somebody that is the sponsor, and that you can invest with on one of these things. Now, there’s a risk there too, though, right? Because you could be investing in a sponsor that is clueless, doesn’t know what they’re doing, and that that’s very risky.
Brandon: You want to make sure that you are investing in a good person. We have seen a lot of really sketchy people out there trying to do these things. We saw one a few months ago. He came across my desk, and I was like, “Oh, how many of these have you done?”
He’s like, “Oh, this is the first one.” I said “Okay”. We are not going to…push any clients your way because this is your first one. So, you want to look for somebody with a track record. You want to look for somebody that’s been in the space for a long time, and we’ve been lucky enough to build out those connections.
Pancham: Oh, great.
Brandon: We’ve seen the best and the worst.
Pancham: Okay, great. So people, like clients of yours, you recommend them to the people who actually are doing these and know what they’re doing, and that’s how you kind of educate those guys. Okay.
Brandon: Yeah, right. And one more thing on this, before we jump away. I want to explain how the deduction works or looks tax wise. So, if you invest $50,000, into a land conservation easement, you are going to take a $50,000 stake in LLC. I’m talking about syndication here. So, if you do the syndicated route, you’re going to take a 50k stake in an LLC. You will always have that stake but the LLC is donating the land to the government in the first year that you own it. So, you’re always going to get a K1. It might be a little annoying, but you invest $50,000 and in that first year in the 37% tax bracket, you get $200,000 – $225,000 write-off on Schedule A. So, that’s a deduction, multiply that by 37%, and I think it’s like, I don’t have a calculator on me right now. But I think it’s like $74,000, from the federal perspective, and then there’s always state benefits as well because most states go off of whatever your federal form is. So, right there, right on the federal side, I invest 50k, I get 74k back in tax savings. Almost a 50% return on my money. Not factoring in my state return as well, or my state tax decrease. So, that’s how that boils out math wise.
Pancham: Wow. That’s pretty amazing. Day one. I invest 50. I am getting almost 50% off that back.
Pancham: Not 50. Actually 100.
Brandon: You are getting all your money back.
Pancham: I am getting a 50% return on that.
Pancham: Exactly. Exactly. Wow, that’s a very, very powerful strategy. I know, a lot of my listeners probably have never even heard of conservation easements.
Alright, so let’s, you know, move on to the next topic, which is on the same lines that people who are working W-2 jobs, especially where the husband and wife are working, and they have kids, there is pretty much no time left to do anything else, and they want to really invest in properties and get the benefit of rental real estate. How can they leverage their time or their money that they have in savings to still get the benefit of real estate and the benefits, tax benefits without doing a lot of work? What suggestion would you have for them?
Brandon: If you’ve built up savings, and you don’t have time to go out and source your own rental real estate and trust me like this is a lot of people there. You’re not alone. If you don’t have time. I don’t have time. Pancham doesn’t have time. Nobody has time. You don’t have time, but you have the money. You have this vehicle giving you more money. You’ve got your savings building up, and you know that you need these tax-deferred income streams. You can still participate in real estate as long as you are for most cases an accredited investor. What would happen there is that you can invest in syndication. So, if somebody is going to go and buy a 400-unit apartment complex, for instance, they’ll need to raise, let’s say $5 million to close on that apartment complex. You can be the person that brings the money to the table, and as a result, you get a stake in the deal, and you get allocated a portion of the rents, all the expenses, and the tax benefits.
Pancham: Okay, great. So, no investor is left behind. Syndication is basically a group of people coming together and doing a project. In this case buying a multifamily building. Brandon, you hit on something called accredited investor .Can you explain what that is real quick?
Brandon: Sure. An accredited investor was originally set up to… the SEC wanted to protect people from getting into bad deals. And so they said, “Well, if you earn enough money, or if you have a high enough net worth, then you must be at some level of high sophistication.” So, they tried to create a threshold where only certain people could have access to certain deals. And that’s what the accredited investor is. So, an accredited investor, if you’re single, its 200k income over the last two years and reasonable expectations for that income to continue. Your marriage is 300k in the income of last two years and a reasonable expectation for that same amount of income to continue or you need a $1 million in net worth excluding the equity in your primary residence. If that’s you, then you are an accredited investor and you may not understand that you have access to these deals, but you do have access to these deals, because there are tons of people out there that are looking for accredited investors to come in and give them money so they can close on their properties.
Pancham: Absolutely. I was totally blindsided to these people 6-7 years ago, and now I am one of them. All right, one question that I always had myself when I was is it a good idea to keep putting money in 401k and IRA’s? What are your thoughts around that? People say that you’re saving on taxes. That IRS is giving you these so-called tax breaks by putting money at the Wall Street. What are your thoughts on 401k’s and the IRA’s?
Brandon: That’s a good question. So, the way I look at it is if your employer gives you any sort of match, you should contribute to at least get that match because that is built into your compensation plan. A lot of people just forget that they only have their W-2. They just look at the W2’s and they go, “Well, that’s my compensation.” But you really have all these other benefits as well that you need to factor in. So, if an employer is matching your 401k, you need to take advantage of that, because that is part of your total compensation plan.
Aside from that, though, it’s tough. And it’s tough, because when I first started, I was very anti 401k, and you can attest to this. We’ve had many conversations about it. But I’ve kind of shifted my gears, and I’ve shifted a little bit because I think it’s just a very personal thing. From a pure financial tax perspective, I do not think that contributing to your 401k maximizes your financial position. That said, I also don’t think that it’s necessarily a bad thing. There are a lot of our clients that invest in their 401k’s to gain the equity diversification rather than just ploughing everything in real estate. So, they get the tax benefits of contributing to their 401k’s, and then they’re gaining the diversification that their portfolio needs by only using the 401k’s to invest in equities. I think that’s an interesting strategy as well.
From a pure tax perspective, every model that I’ve run, even if you are not in a high tax bracket generally… I’m going to say generally, It always…It depends, right? Generally makes more sense to take the after tax dollar or the after tax 60 cents, and invest that into something like real estate because the returns over time, just compound significantly more in real estate then the after tax or the pre tax returns would in your 401k. That’s just my thoughts on that.
In terms of an IRA, some of the business owners have like an opportunity to do a self-directed IRA or a solo 401k. At that point, I’m a 100% on board. But traditional IRA’s, no I am not really a fan. If you can contribute to a Roth IRA though I’m a fan of that, and a lot of people even if they are phased out of the Roth contributions can still contribute to a Roth. If you structure the transaction correctly, and if your facts line up, you can still contribute to a Roth. You never actually max out. It’s a fun little strategy.
Pancham: Wow, what is that? Is that the back door?
Brandon: We try not to say back door. But yes, try to keep that door off of all the written communication. But it is coined that Backdoor Roth IRA contribution strategy. The way that works is [inaudible] income phases you are being able to contribute to the Roth IRA, you can still contribute. And the way that it works is you make a non-deductible contribution to your traditional IRA, a new traditional IRA, that you open. You cannot have a previous traditional IRA balance. If you have balances in your traditional IRAs, you have to get them out of traditional IRAs. Otherwise, this is not going to work. You can’t have any traditional IRA balances currently open. So, what you would do is you would open up a new traditional IRA, you would make a non-deductible contribution to that traditional IRA, and then, after 12 months, and that’s the key, you would roll it over into a Roth IRA. So, you’re making a non-deductible contribution, you’re not claiming the contribution on your tax returns, and then after 12 months, you roll it into a Roth IRA. Now why do I say 12 months? There is a little thing called the step transaction doctrines that the IRS can pull on you, if the sequential steps of a transaction occur very quickly in a process and what they would do is they would basically say, “Hey, you contributed money to a traditional IRA. You rolled it over into a Roth. Really, what you are just trying to do is put money into a Roth IRA.” If you do that too quickly, then they can pull that card on you theoretically, in an audit and disallow the transaction. You need to pay 6% penalty and all that stuff. A lot of our clients before they become our clients, they are doing this, they are setting up a traditional IRA making the contribution on Thursday, and then they are doing the rollover on Friday into a Roth IRA.
Pancham: I have done that.
Brandon: I say, “No, No, No. Wait for 12 months and then we can…” Just for audit protection, right? Nobody’s going to look at you right now but just for audit protection.
Pancham: Right. Okay. Great. Thanks for sharing all of that.
Pancham: A lot of value bombs over there as well. Other than, you know conservation easements and investing in real estate, either actively or passively through syndications and 401k’s and IRA’s, are there any other vehicles that the high paid professionals can leverage into to save on taxes?
Brandon: Yes, absolutely. If you are looking for an immediate tax write off kind of like the land conservation easement, you could go the oil and gas route. First year you can deduct up to I think 85% of the intangible drilling costs. So, if I invest $100,000, and let’s say that the actual oil and gas fund does allocate up to that 85%, they do allocate 85% of my investment to intangible drilling costs, then I invest 100k, and I can write 85k off on my tax returns basically on Schedule C. It’s not on Schedule C, but it’s basically the same thing.
I show a big loss from the business. But I have to have a working interest, and that’s the key. A lot of people that are investing in oil and gas, they forget to make that differentiation between the working interest and the royalty interest. The working interest carries more risk, but you also get the immediate tax benefit. Whereas if you invest in the royalty interest, you don’t. So, that’s one… we don’t see a lot of clients do that, though, and we often actually try to dissuade clients from doing that, because oil and gas is inherently very risky and unlike a land conservation easement, if I invest a 100k in oil and gas and I only get 85k write off. If I invest a 100k in land conservation easement, I get a 475k write off. So, very, very different in terms of power. But that said, the oil and gas are going to provide me benefits over time if it’s a good fund. It’s still something to consider, but kind of a back pocket thing.
Pancham: Right. So just to clarify, what Brandon is talking about here is not the oil and gas funds like go and buy the ETF’s. It’s actually the real funds which are doing the drilling. The actual companies which are doing the drilling of the wells and taking the oil out. And you have to invest with those companies. So, you’re at risk of actually not finding the oil in those wells, and they keep drilling for one year and you lose all of your money, but you will get 85% of that back right away as deductions. But still, it’s a risk.
Brandon: Yeah, absolutely. And that is a good differentiation to make. We’re not talking about some index that I can go and purchase. We are talking basically about syndications. The way these are set up, it’s very similar to real estate syndication. You have to go and find the sponsor, you have to get into their fund. Again, you got to be an accredited investor. In most cases, that stuff can be relatively risky.
Pancham: I have not seen any fund, especially for oil and gas without any accreditation. You have to be accredited.
Pancham: Okay, so that’s another one. Anything else, Brandon?
Brandon: So after those things, there are a few other things that we can look at that are not as hard hitting, but after those things, we really start to get creative. You really start to go and then say, “Okay, when we plan on retiring? What does that look like for you? How much money do we need to make so that you will walk away from your W2 job?” The second that you walk away from a W-2 job, the tax world opens up to you. You have so many additional things that you can do at that point. It is insane.
Brandon: You know this too. We start going down this route of planning for the future and sometimes it’s like 5 years off. It’s like, “Okay, well, what do we need to do between now and the five-year mark, to build the income streams, the tax-deferred income streams to get you to walk away from that W 2 jobs?” Trust me, when you walk away from that W-2 job, you will not pay much in taxes again?
Pancham: Exactly. That’s what I say. IRS actually gives incentive. Most of the IRS code is written to tell people on how to save taxes, not how to pay taxes. Really.
Pancham: There’s one thing that I want to hit on before we go to the next section of the show, which has come with the Trump tax plan, I believe, is the opportunity zones. What are those and can W-2 employers really benefit from it?
Brandon: Anybody with capital gains can benefit from it. So…
Pancham: Capital gains in real estate or anything?
Brandon: Anything. Any property that you own, that has a gain attached to it, which we’ll talk about in a second. So, opportunities zones, there are over 8700 opportunities zones across the United States. And these opportunity zones are areas that need some sort of economic stimulus. So, they are looking for investors to come in and invest money and bring the area up and out of economic distress. That’s what an opportunity zone is.
Opportunity funds are a group of people organized around doing just that, and injecting capital in an economically distressed area and bringing it out of that economic distress. Opportunity funds are probably… these 2018 tax code change… these opportunity funds are easily the best tax vehicles I think I have ever seen. I am a young guy, so I will also throw in there that I have ever heard of. They’re amazing, amazing tax vehicles. The kicker though is that you have to have capital gains. You can only invest capital gains.
Pancham: Oh, really. You cannot invest my raw income?
Brandon: Well, you can, but you don’t get any of the benefits. So, only the capital gains are eligible for all the tax benefits, and we’re going to run through those. The cool thing about this is that you can invest any property that you own. Basically, think about this as any asset that you own that has capital gains. You can sell that asset and roll the capital gains into an opportunity fund. You do not have to roll out your principles. The example that I’ve been giving people is if I own Apple stock, and I bought it when it was $50 and now its $150. I have $100 capital gain. I have $50 basis. I can sell Apple stock, get my $50 cash back now in my pocket and take $100 capital gains and put that into an opportunity fund and not have to pay tax today. I can defer my taxes. I also don’t have to reinvest the entire $100. I can pick how much I want to reinvest. So, if I have a lot of capital gains, I might just say I’m fine paying tax today on some of them, and I’m going to roll the rest into an opportunity fund. It’s really flexible. It’s awesome.
Pancham: Wow, this is pretty amazing.
Brandon: Investors gains within 180 days. That’s what you are looking for. That’s your timeline from the day of sale. You have got 180 days from the day of sale. But you can invest stock or you can invest capital gains from stock, you can invest capital gains from real estate, from partnership interests. Alright, so let’s say you are in syndication or a fund and you are like, “Okay, it’s time to get out.” Well, if you’ve got a capital gain attached to that then you can roll that into an opportunity fund. There are some questions on if I have got some sort of notes, and I sell the notes, and that has capital again attached to it. Can I roll that in? It’s a lot of questions out there that we’re still waiting on further guidance but some guidance did come out in the middle of October, which helped a lot. But there are still some questions out there that are lingering. So anyway, you roll your capital gains into this opportunity fund. Let’s take my $100 example. I’ve got $100 with capital gains, rolled into an opportunity fund. If I hold that stake for at least 5 years, I get a 10% step up in basis. My original rollover – I have a $100 in capital gains, but a $0 basis because they are capital gains, right. If I sell tomorrow, I still have to pay the capital gains tax. But if I hold for 5 years, my basis goes to $10. It’s 10% of my $100. If I hold for 7 years, it goes to $15. So, it goes to 15%. In year 7, I’m going to have to recognize my capital gains. I’m going to have to recognize that $85 of capital gains even if I still leave my money in the funds. So, that is something to keep in mind.
Basically, in the year 2026, everybody in the United States that is investing in opportunity funds will have to recognize their capital gains, even if they have not liquidated those capital gains from the funds. That’s definitely something to keep in mind.
Pancham: How would they figure out the value of that fund at that time if they’re not selling? So for instance, if the value of that area went down, for whatever reason, there was a hurricane or tornado and whatever, right? And that $100 total became $50 in value. If you were to get appraised, what happens then?
Brandon: If the value went down, we would just tell you to liquid it. Would tell you to call it a day in most cases, and in some cases, the value might actually go back up within the next 3 years, because there’s a 10 year rule. I will talk about it in a second. But that’s a good question. All the questions that I have seen is only been about earning more money. So in year 7, you have deferred $100 of capital gains, and in year 7, in 2026, you have to recognize the $85 of capital gains. I actually haven’t seen what happens if that $100 is no longer worth $100. It’s worthless.
Brandon: But that’s a good question. So, you have to recognize $85 of capital gains in 2026. The 2026 thing, by the way, the way that the code is written is it says in 2026, you have to recognize your capital gains. Basically, what that means is that you have to invest in opportunity funds by the end of 2019, to get full 7 years before 2026. So, that’s the investment horizon. That’s also why you probably have seen all these big companies just pop up out of nowhere with opportunity funds, because they know that the investment horizon is the end of 2019, and they are trying to get everybody in the door before that day.
Pancham: Oh my god, my emails are flooded! From this…
Brandon: If you invest in 2020, that’s fine. You will get 5 years before 2026 rolls around, but you won’t get 7 years. You will only get a 10% step up base. So, something to consider. If I hold for 10 years… I held for 7 years, I get a full 15% step up in my basis. So, my $100 is now an $85 capital gain. I have $15 basis. If I hold for a full 10 years, any appreciation on $100 that I invested is tax-free.
Brandon: Yeah, it’s phenomenal. It’s a 12% IRR. You double your money. It’s 7 years or something. So, my $100 turns into $230 and the additional $130 of appreciation that I don’t have to pay tax on, if I held for 10 years.
Pancham: This is amazing. It sounds like a lot of work, but the benefits are huge.
Brandon: Benefits are huge, and people have been asking about the risks. So again, very good to consider the risks. You’re investing in a sponsor or a company; you’re investing in economically distressed areas. Some of the investments are not going to pan out, and I think that some people are going to be haphazardly rolling over their capital gains and not really doing the due diligence because capital gains is not really my money anyway, right?
Pancham: It is house money.
Brandon: It’s all paper. But I think that it’s really important to make sure that you vet everything out. If you are looking for… there is the geo location risk. If I invest in one geographic area, that’s a risk. But there are these big funds out there that are investing in, in like almost every geographic location. So, you can get geographic diversification by investing in the bigger funds. Or you can put all your chips on the table and invest in one geographic area. It’s totally up to you, but obviously, that carries additional risk.
Pancham: Correct. All right. Great. Thanks Brandon for all of that. I am sure that a lot of listeners might be thinking that this is too much to take in.
Let’s move on to the next section of our show which I call Taking The Leap round.
Taking The Leap
I ask these 4 questions to every guest on my show.
My first question is when was the first time you invested outside of the Wall Street?
Brandon: Got it. I started my career at PWC in 2013, and in the first 3 months, I realized that it was not for me, and throughout my…
Pancham: You are so lucky, man.
Brandon: Yes. I knew real quick that it wasn’t for me. I immediately started looking for a way out, and I was heavily trading. I was trading volatility funds at the time, VIX and XIV and all that stuff when I was at PWC. Then I found real estate, and so I started saving up for real estate, and it took me about a year into my corporate career to purchase my first three in a property. I saved very, very rigorously and built up that cash stream. Once that thing started cash flowing, and I saw the light and pulled everything out and called the day.
Pancham: That’s great. What fears did you have to overcome when you first invested outside of the Wall Street?
Brandon: So for me, I was living in Washington DC, working for PWC, and I couldn’t buy anything in Washington DC. It was way too expensive. I’m a new kid, my measly 30k and some tax savings. $30,000 in regular savings, no tax savings at the time. $30,000 in regular savings doesn’t go very far in DC. I actually looked back to where I grew up – Hickory, North Carolina. My parents were living there. They were building out a real estate portfolio, and they still do live there. They were building out a real estate portfolio in Hickory, North Carolina. I decided that I would invest there because the properties were way cheaper. My $30,000 would go a lot further.
The big fear for me was how do you get over investing from a distance? For me, it was just I’m going to find somebody that I really trust to manage this thing, and I’m going to tell them that they have full authority to do whatever is necessary to manage this property and see it to success., and then you pay those people with incentives, right? So, it’s much smaller property manager. The big property management shops I wasn’t interested in. They tend to just kind of put you in the system and their systems, quite frankly stink. So, I went with a smaller property manager and we incentivized different things, and that’s how I kind of got over that fear of investing at a distance.
Pancham: Okay. All right. Can you share with us one investment that did not go as expected, if you have any?
Brandon: I actually have one right now. In Baltimore, Maryland, I am selling a three unit property. So, if anybody’s interested, let me know. It’s actually a solid deal. I bought a $500,000 property. I put 3% down because my owner occupied it. Three unit property and I rented out the other two. So this is my transition from the corporate world and into my business. I moved from DC to Baltimore and my wife was working at Under Armour at the time, and they were headquartered in Baltimore.
So me, going into my business, a virtual business, I was like, “Well, I don’t need to be in DC, and I don’t want you to have to commute back and forth. So I’ll just move up to Baltimore, and I’ll pick up a property and we can just live there for the time being.” So we did. We lived in one of the units and we rented out the other two. Our overhead went to basically zero. It was phenomenal. It gave me the confidence to fully pull the trigger and launch the business. Great, great property. Good returns. It cash flows well. It was probably returning anywhere between 10% to 12% depending on the year. The problem is that Baltimore is very anti-landlord. Very anti-landlord.
Pancham: Yes. I know that.
Brandon: It’s extremely anti-landlord. I’m probably shooting myself in the foot by telling everybody this because I really want to sell the property. Again, it’s not a bad deal. It does really well. I have been happy with it. But it’s so anti-landlord that I know that if the market turns I do not want to be in an anti-landlord city nor in an anti-landlord state. When you compare the rules between North Carolina and Baltimore, Maryland, it is insane. We spent a lot of money just on compliance on that property. My returns could be 18%. But they are not because I have spent so much money on compliance.
Pancham: Let me make you feel a little bit better.
Brandon: Please do.
Pancham: New York is, I would say even worse than Baltimore.
Brandon: Oh yeah. I know. You also would find me investing in New York.
Pancham: Okay. My last question, what one piece of advice would you give to people who are thinking of investing in the Main Street that is outside of the Wall Street?
Brandon: I would say surround yourself with smart people first. No question is a dumb question as long as it’s not asked twice. That’s kind of my motto. So, write it down and just be ready to learn and be hungry. If you decide to invest in syndications, make sure that you thoroughly vet the person that you are investing with. I like to tell my clients, it’s less about the asset, and more about the sponsor. A really bad sponsor can screw up the best deal. A really great sponsor can turn around the worst asset. So, make sure that you thoroughly vet your sponsors. We have had clients fly out and meet the sponsors before they will cut them a check. Make sure that you ask them all sorts of questions, test their knowledge, test their understanding of the market cycle, and make sure that they are sophisticated. One question that we encourage investors to ask is “What happens when you die?” A lot of people don’t like to go there. It’s more of it. But seriously, hey, you’re the sponsor? What happens if you die? And I’m investing in this deal? So, make sure that you pepper that sponsor with questions and get really, really comfortable before you pull the trigger.
Pancham: Great. Thank you so much Brandon for answering those four questions.
Pancham: How can the listeners reach you?
Brandon: I run The Real Estate CPA. You can go to www.therealestatecpa.com. You can email us at email@example.com. If you want to connect with me, you can definitely do so on LinkedIn. I am pretty active and post some things about taxes and business and just my philosophy on business ownership and things like that.
Pancham: Yeah. I would definitely subscribe to Brandon’s newsletter. He puts out so much content which you know even if you are not using him as your CPA you can learn quite a bit from that.
I would end up by saying this, “Taxes is your number one expense. Start thinking about strategic tax planning. It will go a long way in your financial success. And yes, everyone can do it.”
If you want to know the top six reasons on why you should consider diversifying outside of the Wall Street then you are in the right place. I have written a free report for you. It goes into not just the top six reasons why investing in stocks, 401k’s may not be the sound strategy, but also what are the alternatives. Get your free report today on thegoldcollarinvestor.com/download.
If you got value from the show, then please leave me a five-star review on iTunes. It will help me bring quality guests on the show. You can do that by going to thegoldcollarinvestor.com/review. It will take you to the iTunes page directly or you can go to the iTunes directly and find the show and leave a review. Thank you so much.
Thanks for listening. If you have questions? Email me at firstname.lastname@example.org. That’s p as in Paul @thegoldcollarinvestor.com. This is Pancham… Signing off… until next time… Take care!
Thank you for listening to The Gold Collar Investor podcast. If you love what you’ve heard and you want more of Pancham Gupta visit us at www.thegoldcollarinvestor.com and follow us on Facebook at @thegoldcollarinvestor. The information on this podcast or opinions. As always. Please consult with your own financial team before investing.