Listen to me and Bernard Reisz of Resure Financial as we dive into a variety of tax and real estate investing topics. We discuss retirement accounts, capital gains planning, grouping elections, material participation, 1031 exchanges, capital gains planning and real estate syndications. Lots of great topics to geek out about!
A little about Bernard: Bernard Reisz, CPA founded ReSure to deliver real estate tax and financial tools based on professional expertise, going beyond execution of real estate tax tools to include expert and unbiased investor education. Prior to founding ReSure, Bernard served as Director of CoMetrics Partners, managing an array of engagements involving financial consulting and due diligence. Bernard advised owners of closely-held middle-market companies on advanced tax mitigation strategies. As a guest on numerous financial, tax, real estate, and legal forums Bernard delivers straight-talk and unique insight for real estate investors nationwide.
Transcript:
Mark Perlberg
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11:09
Let’s get into it. We’re going to start so the recording for the YouTube eventual and podcast of this. All right, guys, thanks for joining me today. I’m really excited to have a fellow real estate tax nerd for a geek out session on real estate tax strategies here. And we are joined by Bernard Race. Is that race?
Bernard Reisz
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11:43
Phonetically. It’s the reese.
Mark Perlberg
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11:49
Got you. Okay, that’s cool.
Bernard Reisz
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11:51
That happens, Mark, just, you know, that happens on almost every show. Reese rice, roast Oakle.
Mark Perlberg
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12:00
Okay, cool. You have a company that helps out advising people on all sorts of ideas with real estate here and giving all sorts of guidance on topics like retirement accounts and cost segregation, all that beautiful stuff. But tell me in your own words what you do.
Bernard Reisz
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12:22
Got it. I think this is a great context and a great place to have this because we’re both tax professionals and really we stepped into a void that exists. I think, in the tax service place, there are tax advisors like yourself. Obviously not all tax advisors are created equal, but there are tax professionals that are working with clients and being their tax advisors that are providing the tax guidance. Maybe a CPA that’s doing a tax return in addition to advising. And then there are tax services, cost segregation, 1031 exchange, self directed retirement accounts, to name the ones that we’re primarily involved in. But there are many of them, whether it’s trust and estates, a range of tools that are out there kind of that are called them arrows in the quiver that can be used for tax strategy.
Bernard Reisz
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13:26
So many of these other tax tools have, in a sense, been productized. And working with taxpayers, I’ve seen that there’s a gap there. Oftentimes a CPA will say, hey, get this thing done. Maybe this might be something to look into. But to provide as a tax service. They have the tax background. Number one, the background. But number two, their Mo is not really to provide any type of guidance. It’s like, okay, you want to sign up for the service? Hey, this is our fee. We’ll do it for you. Where the void is kind of connecting the tax profile to the tax tool. So to illustrate an email that I just sent today, people called me up, says he wants a solo 401.
Bernard Reisz
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14:18
And I explained to him it’s so easy for us to just sign you up here, click here, pay the fee, we’ll set it up for you. But we’d rather have a conversation with your CPA and ensure that this is really a good fit. And we talk the same language as CPAs to make sure that what’s actually being set up is optimal and compliant for your tax profile. So in a nutshell, we do 1031 exchange self directed retirement accounts cost segregation. The differentiating factor is we take it a professional approach that’s informed by a broader tax expertise.
Mark Perlberg
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14:56
Awesome. Great. And so, you know, let’s just so with all these topics here now, a lot of our clients, you know, we talk a lot about cost segregation studies and 1031 exchanges. We don’t talk a lot about retirement accounts with our clients. A lot of our clients don’t realize you can invest in real estate with their retirement accounts. Fill me in on some of the ideas that you’re sharing with your clients on what are they doing with their retirement accounts, what can they do? And also, where are some missed opportunities with using your retirement accounts, either for real estate or real estate investing or maybe even as a real estate investor for other endeavors?
Bernard Reisz
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15:41
Yeah, awesome question. There’s so much going on with retirement accounts, and what you see on the web, what so many of these things are, is typically oversimplification. So you’ll see some people saying, hey, this is the smartest thing in the world. Everybody uses retirement accounts for real estate or some other endeavor. And some folks that’s saying, no, never use retirement accounts for real estate or never use retirement accounts at all. And the truth is always a little more nuanced. And typically for most investors, there is a smart way to use these. So just at a high level, what are the rules? Just about every single asset class, there are very few things that are off the table. Self directed retirement accounts, which is a term that’s used it’s a marketing term, right? There’s no tax code for self directed retirement account.
Bernard Reisz
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16:37
You go, section 408 of the code is traditional IRAs. 408 a is world, IRAs. It’s not like 408 is self directed retirement accounts. Self directed retirement accounts are just retirement accounts that don’t have the artificial restrictions that are imposed by folks that have vested interests. So most IRAs are set up by people that are either a financial advisor that are making money on AUM, or even if you’re getting it directly from the brokerage, they’re in the business of making money on your investments, so they restrict you to investing in whatever is available through their platform. Same thing for qualified retirement plans. Qualified retirement plans are the group of plans that are employer sponsored. So those are the most well known as 401K plans, but you can also do defined benefit plans, cash balance plans, all sorts of combinations. That’s section 401 of the code.
Bernard Reisz
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17:42
The Secure Act 2.0 just gave us the Roth version of those, gave us a lot more flexibility and added a new section there. But again, there’s no separate section of the tax code that talks about using these accounts for real estate. Visa, Vistas. In fact, the code says nothing about investing in stocks or real estate. It’s kind of silent on that. It’s like, hey, use this stuff and you’ll get tax advantages. That’s really it. Now, what are the kind of the question that we get? So some of the questions I’m going to jump into some more nuanced stuff because you’re a CPA and we’re supposed to be geeking out over here.
Mark Perlberg
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18:25
Absolutely. Let’s do it.
Bernard Reisz
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18:27
All right. So one thing that I hear is from people can also pull it out. That really more of a financial thing. Some people will say, hey, I don’t want to put money in anything that doesn’t pay me. I have restrictions on it, right? I can’t use that money today. I find that is true to a certain extent, but the people that say that have a very narrow perspective because once you have a certain level of your needs being met, then it’s a question of what’s the smartest way to grow this, right? Yes, of course, if you need the money to pay the bills, don’t put it in your retirement account. Right?
Bernard Reisz
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19:10
But if you’re saying, hey, I don’t need this money to pay bills, now, is the benefit of sticking it into an account where you’re going to have tax free compounding for decades, which can be worth hundreds of thousands to millions of dollars. Alternatively, putting it in a Roth account where you may be able to turn that money double, triple, quadruple, ten, 100 exit, which we’ve seen, and not have to pay any taxes on that. So it’s really a financial move. And the folks that say, hey, don’t do this ever, because I want something that I can use today, are really failing to see the big picture to get into some more nuanced stuff. Something comes up. A lot is, I want depreciation. Deductions. Can I get that? Am I giving those up by investing in real estate through retirement account? I love that question.
Bernard Reisz
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20:05
That’s an awesome question. And it’s something that everybody should be thinking about. And it’s a great example of where this gets nuanced, but it’s also a great example of where folks on social media are saying, don’t ever do this for that reason. And they’re missing some of the details. So a couple of things, definitely the ROI is going to vary. So let’s say somebody is a real estate professional and they’re materially participating, right? So this is a real estate investment that they may benefit from getting depreciation passed through to them. That is definitely a factor. But what happens if somebody is not a real estate professional or this is an asset they’re not materially participating in?
Bernard Reisz
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20:57
This gets into the weeds of real estate professional with aggregation and all sorts of stuff like, hey, maybe you’re not getting you’re going to end up suspended passive losses, so maybe it’s not all that valuable. Alternatively, if it’s something that’s a limited partnership investment, which can actually totally mess up your aggregation elections, potentially on the real estate professional side, maybe you want that segregated, right? You may actually benefit. This is way into the weeds of taxes. But for folks that are not just to give you high level real estate losses are typically treated as passive. If you qualify as real estate professional, you can get real estate losses if you materially participate. However, you have to materially participate in every single asset. You got a lot of assets that gets to be difficult.
Bernard Reisz
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21:53
So there’s an aggregation election that you can make that would make it easier to meet your material participation. But if the aggregation election is an all or nothing deal now if your real estate rentals include a limited partnership, all your real estate rentals become subject to the rules that apply to limited partnerships. And so there’s actually a trap there for folks that are investing in syndications and making the aggregation election. So you may actually be very well served by taking your syndication investment and taking it out of your personal tax return and moving it into a retirement account. So I’ve spoken, I said a mouthful. There’s so many directions we keep going forward. Any commentary, questions that you would like.
Mark Perlberg
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22:52
When we think about because to aggregate the losses you’ll get from a syndication into your other activities here, but you’re saying that there are adverse consequences to the aggregation election. Can you tell me a little more about that?
Bernard Reisz
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23:10
Absolutely. So there are really there are two different aggregations. There are aggregations that apply to, that are not related to real estate professional. So that’s almost for any type of business can make him, you know, kind of an informal aggregation of activities that are economically related, but it’s not specifically related to rentals. And those are like under the, you know, in the regulations that’s 469 four. Then there’s the aggregation under 469 nine. And that’s specific to, for real estate professionals to aggregate their real estate rental activities. So it’s rental activities only. And that’s an all or nothing deal. Just to give listeners a little more context. So somebody wants to meet real estate professional status, tax status, that doesn’t mean that you can automatically claim all losses from any activity.
Mark Perlberg
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24:27
Forget about exactly.
Bernard Reisz
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24:29
It’s amazing. You go out there, people say like, oh, I use the Reps, like I’m a realtor professional, I can claim everything. Absolutely not. Reps is just overcomes the first hurdle and enables you to claim losses from rental activities in which you materially participate. Now, material participation give us like seven ways to meet material participation. So those will vary, but typically you can use all seven. However, if one of your activities is a limited partnership, then you’re restricted to three of those. Practically what that means is you’ve got to do 500 hours, which is not happening with a limited partnership.
Mark Perlberg
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25:26
Sorry for interrupting. Let’s talk about those three qualifications now that you have to have, not just so you have to now say that looking at you fit that three those three qualifications and not just you. It can also be the combination of activities between you and your spouse. So hopefully your spouse is chipping in on helping you get this qualification. But as you’re saying here, you may not be able to be one of these three even based on you and your spouse for your whole portfolio. But let’s talk a little more about what those are.
Bernard Reisz
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26:06
So when we talk about typically leaving limited partnerships out, you can be the fact that you are the only one participating, right, that you did substantially, all right, you did everything and then we don’t have to think about hours. Alternatively, what you can have is that you did the other extreme. You did 500 hours. And then again, it’s really straightforward. You had 500 hours in the activity and you’re treated as having materially participated. Now, outside of those two extremes, it gets a little tricky. So let’s call our sudden let’s call them like intermediate rules. So one is that you did 100 hours in the activity and nobody else spent more time in the activity than you. That’s not getting tricky because if you have a property manager, obviously that’s not happening.
Bernard Reisz
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27:08
But the moment you start bringing other people in, it gets very difficult to achieve material participation if you have a team because they may be spending more time on it than you also did.
Mark Perlberg
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27:23
That if you’re under scrutiny, it’s going to be very hard to substantiate that this will be hard to produce a log of everybody’s hours as well.
Bernard Reisz
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27:36
That’s an awesome point. Everybody talks about having their olog they don’t realize that in these cases you’ve got to have a log for other folks, which is impossible.
Mark Perlberg
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27:48
So so you have the 100 hours test that you now what are the other ones?
Bernard Reisz
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27:54
Then there are significant participation activities. So that’s a tricky one, but there’s something called having it’s a significant participation activity. This is geeky stuff. The tax code has active participation, significant participation, and material participation. Now, active participation is the lowest level of activity required. That’s all that’s needed. If your income is between 100 to 150K, then you can qualify, take up to estate losses so long as an activity that you actively participated in. Significant participation is not really we don’t get a hard and fast number. It’s not so easily defined what’s a significant participation activity, but if you meet that requirement, then you can claim some losses. But significant participation is something that is not well defined in tax code or regulations.
Bernard Reisz
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29:07
So typically what we’re looking at is the 100 hours, the 500 or the substantially all the rest of the tests are more about like, oh, if you participated for five out of the last ten years, right? Even if you fail this year, you can qualify because you participated in the last five years. But to initially qualify, we’re typically looking at either substantially all 100 hours and no less than anybody else, or 500 hours. And it’s based on each rental activity. Now, the moment you start hiring people, it gets tricky because you’re no longer doing substantially all. You may no longer be doing 100 hours per activity and more than anybody else. So here’s where the aggregation election comes in.
Bernard Reisz
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30:02
Now, the thing is, the moment you make the aggregation election, if one of your rental activities is in LP interest, the entire rental portfolio has to meet the material participation threshold that’s required for LP interests. And that’s the 500 hours. So you can no longer pass based on 100 hours. You have to be able to do 500 hours. Now, if you’re somebody that is investing kind of on the side, right, you don’t really do this. You have some other job, you have some other thing that’s taking your time. Now you’re an hour test, which could be a trap, because if you don’t meet that, all of a sudden you have just made all your other rentals passive. So occasionally making an aggregation election can actually take rental activities that you were otherwise materially participating in, right?
Bernard Reisz
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31:09
Say, hey, you’re the only one that does this. I do substantially, all right? Or I meet significant participate, or I meet the 100 hours test one of the other rentals. But now that I have aggregated it with my LP interest, I now fail matild participation for the entire asset, right?
Mark Perlberg
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31:28
And because when you aggregate, when you choose to aggregate all your rentals correct me if I’m wrong, but it’s my understanding once you choose that aggregation election, it incorporates all your rental activity, right?
Bernard Reisz
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31:41
That’s exactly it. It’s an all or nothing deal. And the conceptually, what it’s saying is it gets treated as a single activity. It becomes one big activity and we no longer see we don’t see the separate part. Essentially, we see one big new activity. And so you have to meet the material participation threshold for, let’s call it the highest or lowest common denominator within that new activity, which is the LP interest.
Mark Perlberg
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32:13
So some other things I’ve been thinking about with this is now a lot of people, they know the 100 hours, they know the 500 hours test, and they overlook the substantially all tests. When you look at that original documentation, you’re like, what does substantially all mean? And from what I found in professional guidance, because I was a little stuck on this as well, was I have found professional guidance that said, as long as you do at least 50% of the total activity, we could say that you did substantially all. What are your thoughts on that? Because I haven’t really found a very clear definition anywhere, but maybe there’s something I’m missing here. Have you seen anything?
Bernard Reisz
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32:53
I have not. And I would love to know what the source for the fifth greater than 50%? Yeah, I would love to see that would be super helpful.
Mark Perlberg
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33:04
Yeah, because they say substantially all, and then they don’t define it. If you hire a lawnmower, you’re not doing all the work on the house, and you’re no longer materially participating. So there’s some ambiguity here, and we’ll have to pull up some guidance. But what we have decided on was that if you do 50% or more of all the activities, we could pass that test based on some guys that I’ll pull up for, I’ll send it to you in a follow up email. But the cool thing about that, at least, is let’s say you get your first rental and it’s a long term rental. There’s not a whole lot of activity going on with that long term rental, and it won’t be too hard to pass that substantially all test, even if you’re not putting in a ton of hours.
Mark Perlberg
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33:50
So if you’re just getting started in and just got that first rental and have rep status, you should be all right. Now, the challenge here is when you want to do a short term rental, and let’s say you don’t have rep status, you’re doing the short term rental. Now you have all these cleaners coming in and out. It’s really hard to pass that substantially all tests. But what we have found is that the cleaners with the 100 hours test, because the short term rental takes so much work, if you could pass that 100 hours test, even though the cleaners are doing tons of work between each guest, you usually have a team of cleaners.
Mark Perlberg
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34:26
And we can say that we put in more time than any individual cleaner and 100 hours to pass a test, and then there’s additional hours getting the property set up to make sure we hit that threshold for material participation.
Bernard Reisz
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34:41
That’s an awesome tip. And I think this really highlights the value of true tax knowledge. I know it’s not as exciting for us to watch this as is to watch three minutes.
Mark Perlberg
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34:52
My cat just jumped up onto my laptop. He had to hear about this stuff right here. He was very excited.
Bernard Reisz
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35:01
A three minute video on YouTube or TikTok that says, hey, invest in real estate. Claim deductions probably is a lot more entertaining, but there’s huge value. And the real value is in this nuance we’re seeing, hey, how you can really qualify for this stuff. Do it in a way that’s not going to create any risks with the IRS, and know that you can kind of sleep well at night and know that you’re doing the most intelligent and smartest tax strategy, and you can see things are not black and white. And this is exactly why I got involved in delivering these tax tools, so I can have these kind of conversations and bridge the gap with a tax advisor that people are seeing on the Internet, hey, do this.
Bernard Reisz
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35:50
And sometimes there’s information that we can collaborate with your tax advisor, with your CPA, and together figure out, hey, is this worthwhile for you? Is this really going to give you the ROI that you’re looking for and working? Frankly, we love it when our clients have good tax advice. It makes us effective. It makes us efficient. It means that we can reach out, we can have a conversation with the CPA, and very quickly we speak the same language, figure out the optimal path for an investor or business owner to take.
Mark Perlberg
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36:31
And another thing here, let’s talk about syndications real quick, and retirement accounts. So with 100% bonus depreciation, let’s say you are able to use those non passive losses in the syndication. And that sounds wonderful, but most of these syndications have usually, what, five to seven year or shorter sometimes exit strategies. They’re eventually going to sell. And when they sell, there’s going to be capital gains tax and there’s going to be depreciation recapture. And not only is it hard to 1031 out of the syndication, you can’t 1031 out of the recapture on all those losses you took from the cost set. So what’s going to happen?
Mark Perlberg
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37:10
Now, you may think that you’ve won the tax game, you get all these wonderful losses from the syndications, but when that syndication exits and there’s gains, you’re going to get hit in the head with the recapture at your marginal rate, not the long term cap gains rate and the long term cap gains from the sale. And it’s going to be hard to offset with other cost segments because the 100% bonus depreciation is phasing down to now this year is 80 and 60, then 40 to 20. So it’s going to be hard to use other cost losses to offset that potential cap gain. So some of our syndicator clients may be sitting on a tax time bomb. Meanwhile, you put this into a retirement account is a good way of alleviating the tax burdens on these capital gains with the exit.
Bernard Reisz
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37:58
That’s an awesome point. Here’s what I’d say, here’s what I because it’s really, that’s why we think it was important for us to be able to provide, let’s call it this trifecta retirement account, cost irrigation, 1031, because they can work together or independently and they provide. What I like about it is they call it optionality. You know, you can, we don’t know what route you’re going to take, but investors can have options. So let’s talk about cost SEG for a moment. It is typically true that on cost SEG, bonus appreciation percentage is gradually decreasing over the next couple of years. But on a good exit, folks will be buying, assuming folks will have the equity to buy into a bigger asset.
Bernard Reisz
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38:53
So it is true that the percentage is dropping down, but they’re going to be able to buy into a much larger asset that will be able to deliver much higher depreciation deductions than what they just exited. We don’t have a crystal ball, but conceptually the question is to what extent these will offset each other or even provide excess deductions. Another factor is it may depend what kind of asset they’re exiting and getting into. Right. So different assets have different cost SEG profiles, right. So if you’re getting out of multifamily but going into a mobile home, right? Exactly. There are so many ways to approach this. There are so many ways to skim that cat, you know, not that one. Yeah, not the one. So many ways to just skid the cat. And it’s really about knowing a, how can we navigate this.
Bernard Reisz
·
40:05
Another thing, 1031 exchange. This is a, again, another area of, you know, a lot of discussion, but the rules for what qualifies for as real estate for 1031 purposes yeah, do not mirror what we call 1245 property for cost segregation purposes. So it’s certainly still possible that you can actually defer depreciation recapture using a 1031 exchange. So Congress, they issued while the IRS issued final regulations that kind of let investors have their cake and eat it too on the cost of creation and 1031 exchange side. So interestingly, Trump tax reform said no more 1031 exchange on personal property. So we had to figure out what’s personal property, what’s real property. And that got to be defined very much in taxpayer favor in terms of what qualifies as real property for 1031 exchange purposes.
Bernard Reisz
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41:16
And it does not mirror what we call for cost segregation purposes, 1245 property. So there certainly remains opportunity to avoid depreciation recapture. So what is it? What we like, really, we feel real estate investors have a lot of options that they have to be aware of and that there’s typically going to be different. We can’t guarantee it, but if you get into a deal, makes sense to be called surrogation, but it does make the consideration say, hey, should I do this in a retirement account or not? It definitely adds a lot of texture and color to that discussion, but an alternative to switch gears a bit. The truth is, what do I, you know, you want to use retirement accounts for the asset classes that need the most amount of shielding.
Bernard Reisz
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42:14
So what’s my favorite real estate asset class for retirement accounts is not equity investing, but debt investing. Right. So that means being the lender doing a hard money loan, a private loan or debt investments are syndicated just like equity investments are. Most folks have become very familiar with equity syndication, but there’s also debt syndication and debt doesn’t come along with any we can’t do a cost segregation on your debt investment. You’re the lender, but we can put in a retirement account. Right. And you can avoid getting that interest, which is taxed at ordinary income tax rates and does not have any debt, doesn’t have any depreciation shield, doesn’t have 1031 exchange. So it’s really about, I think this is like your main focus is like taking that holistic look at people and saying, hey, this is. What you got to do.
Bernard Reisz
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43:15
You have these different asset classes that you invest in. You got to mix and match and say, okay, this is where I do my retirement account. This is what I do my own aim. That’s really what it’s about, is bringing that big picture focus and integrate. I think that’s where the real value is because everything has its place. But you need your tax advisor to help you figure out what to put where for maximum ROI.
Mark Perlberg
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43:47
Yeah. When it comes to deferring taxes, I think of the most favorable ways to do this. We’ve explored a bunch of concepts. We’re also starting to explore doing this out of a trust, a complex trust that can serve as a tax deferred vehicle, and all sorts of creative strategies where you can take money out of those trust accounts without paying taxes as well, which is a really exciting area we’re dipping into. So lots of cool opportunities here. When you look at it from different angles.
Bernard Reisz
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44:20
Yeah, I’d say trusts are incredibly flexible. I do find that trust creates some more opportunity being the trust, but there’s.
Mark Perlberg
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44:33
Some scary tax rate through those trust. Exactly.
Bernard Reisz
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44:38
It trusts are incredibly flexible. But if somebody makes a wrong move, trust taxation, it’s amazing. Go on the Internet. I set up a trust that don’t pay any taxes. That’s like the first indication that it’s like something is not right. Trusts are very flexible with the right fancy footwork, can be very advantageous. But trusts in and of themselves are not magical because trusts are in fact taxed at much higher tax rates and are missing a lot of the exemptions and deductions. You may qualify personally right. But are not available for trust. But yes, that’s really the name of the game. You need a tax advisor in your corner. So we don’t provide trust as a product. We’re pretty well versed in them, and they’re out there and they have their place.
Bernard Reisz
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45:35
But that’s why I need somebody like Mars to tell you, hey, you need this trust that trust don’t do it for anybody.
Mark Perlberg
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45:43
Listen, do not DIY a trust tax strategy. You’re going to DIY anything because like Ian Bernard said, if you don’t know what you’re doing, those marginal trust tax rates will hit you in the head. So you’ve really got to be collaborative with the CPA and make sure that this would make sense for you and that you’re structuring it properly. So some of the things I’m curious about here what are some of the things and opportunities that you are most excited about right now in the current legislation and in the tax code and just things that you’re doing with your clients and the people you serve that you could maybe tell us some stories about and things that you glad to love.
Bernard Reisz
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46:27
Storytelling time. One thing that I love talking about is 1031 exchanges and partnerships and syndications. Very often the question gets to be with 1031 exchanges, folks want to go their separate ways. You know how to set that up. So there are options for dropping and swapping and dropping. But there actually is a lot of interesting detail that we can do to try to optimize the structure with regards to syndications. The key thing to be aware of, and I’ve put out some content here about this, when the folks will say, sure, 1031 into a synthetic, or you can’t the truth is always a little more, a little tricky. The reality is that when it comes to 1031 exchanges and ticks, we do not have a safe harbor.
Bernard Reisz
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47:31
Safe harbors are something that are really great for us as tax professionals and for taxpayers, a safe harbor, since the IRS telling you, if you do it the way we’ve outlined, we will leave you alone. And then there are many areas of taxation where there is no safe harbor. And so we structure it as optimally as possible, but there are no guarantees. So tenancy in commons is one of those examples. It’s commonly done, no pun intended, but it really comes down to trying to structure it as optimally as possible so that the IRS will respect it. The key thing that the IRS is looking at, what’s the major concern with ticks and 1031 exchanges?
Mark Perlberg
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48:24
I just want to jump in here for some of our non account listeners, although I have a feeling most of the people who listen to me are other tax accounts, which I’m fine with. You guys can take all the ideas, or you can refer them to me, or you can apply because we’re hiring, but with the tendency and comment to those of folks in there, because you have to exchange, the real estate has to go in your name when you exchange it eventually between the escrow and all that. So if you exchange the real estate, you have to own a new piece of real estate. It can’t be shares of that syndication partnership.
Mark Perlberg
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49:02
So when you do that exchange, you do what’s called you structure the new real estate as tenancy in common, meaning instead of owning shares in the stock, you’re exchanging it for a piece of that real estate to substantiate 1031 exchange. So that’s tenancy in common. That creates some challenges in what we’re talking about here.
Bernard Reisz
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49:24
Awesome. That’s exactly it. So you’ve got you can’t 1031 into a partnership. It’s got to be real estate, and you get that tenancy in common, which is an undivided interest in the underlying real estate. And most folks think it’s like, hey, all right, there’s no partnership because I’m not in the LLC as an LP, right? I’ve bought an interest in the real estate. But here’s the catch. Partnership for tax purposes in the IRS’s eyes is not necessarily what would be a partnership for legal purposes. So you may go to your attorney and they may say, do you have a partnership? Here. He’s like, no, we did the LLC documents, or we did the tick, we did the deed. There’s no partnership here. And a strictly legal perspective, that would be 100% correct response.
Bernard Reisz
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50:22
But a partnership for tax purposes doesn’t need the legal structure of a partnership. What it needs is any folks that are joint venturing that are collaborating in activity. Even if there’s no LLC, all of a sudden you’ve got a partnership for tax purposes. Now, near co ownership of real estate doesn’t create a partnership. So if you’re just the only real estate together and you’re distributing and collecting rents pro rata, if I own 50% of the real estate, I get 50% of the rent. That’s not a partnership. But what happens if you start operating this together right now, all of a sudden you’re doing improvements, there’s property management, and one of the co owners is doing all that and the other isn’t. The IRS would say, hey, maybe we’ve got a partnership here.
Bernard Reisz
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51:23
There may not be a legal structure of a partnership, but you guys are really functioning and running an operation together. You’re not just collecting rents. Are one of you guys getting paid by the other to run this? Are you getting an unequal share of the payout? Now, all of a sudden, we have something that the IRS would say is a partnership. And all of a sudden, the tick that the attorney says, and rightfully so, for the legal perspective is not a partnership, but the IRS’s eyes is a partnership. So the IRS did give us a revenue procedure where they list bullet points. Not bullet points, but about 20. You know, if you if I can screen my share, my screen, I can show you kind of the key ones are seeing it. Let’s see. Share that?
Mark Perlberg
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52:19
Yeah.
Bernard Reisz
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52:19
All right. Share screen. Let me know if you’re seeing this.
Mark Perlberg
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52:29
I see it.
Bernard Reisz
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52:31
1031 exchange. Let’s go to tick. Intro to 1031. Tick rules. So these are not all the rules, but we’ve kind of isolated the main ones. So to go through here, we’re getting how many did we highlight? And there are more, right? So there are about 15 factors that the IR there’s more than 1515 that we highlighted the main ones that the IRS is looking at to say, all right, did you guys create a partnership here even though you had tenancy and common interest? So this is where we see a lot of opportunity to optimize and structure things so that folks can have the highest level of confidence.
Bernard Reisz
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53:19
And as always, the case when we do this, we want to be working with your CPA, with your professional advisors that know there are judgment calls to be made, and those judgment calls are best made by an exchanger’s advisors that know that investors complete tax profile, we love to provide the support in the context. Judgment calls are really best made by an investor’s tax advisor, which is why our favorite clients are the ones good tax advice.
Mark Perlberg
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54:04
And with the tick structure, if you do it right, obviously it creates so much more flexibility. Now what I’ve seen is 30, 40, 50 could have a couple of hundred members now to restructure this as a tick on your exit or your entry. That could create all sorts of back and forth and lots of dialogue, I imagine. I imagine there are alsome challenges getting everybody on board and to understand what this means some of the parties can 1031. So definitely a lot of conversation here. Another thing that I’m actually talking to one of my clients about right now is we’re considering a 1031 as a tick into an oil and gas mining well. We haven’t finalized it, but we’ve heard of it being done.
Mark Perlberg
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55:01
But the advantages of the oil and gas mining well is ninety cents of every dollar contributed in capital can be deducted as ordered as non pass, really non passive ordinary losses for intangible drilling rights. What that’s going to look like on the current and future year tax returns and what kind of challenges and complexity it creates with the reduction in basis from the deferred gain of the 1031 exchange. So we’re having some interesting conversations on that.
Bernard Reisz
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55:35
Yeah, that’s fascinating. Mineral rights. So when you get to things that are not like what we would typically call real estate, there are a lot of things that be defined as real estate, you know, for 1031 purposes, and mineral rights can be on that list. A 30 year lease, for example, even though it’s a lease or any lease that has 30 years left on its term is real estate for 1031 purposes. The depreciation is interesting because the depletion right now, the thing is on a 1031 exchange basis, calculation gets a little tricky. So it’s interesting and I actually don’t know, you know, how that interacts. I think that’s something worth doing a little research on. Have you done that yet?
Mark Perlberg
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56:36
I am as much as I can during tax season. But it’s so rare that we see all of these concepts coming together to create new areas of complexity. So we’ll have to do a follow up web. I’ll tell you how it goes.
Bernard Reisz
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56:56
Okay. We do have something on the calendar so that might be a great up. That would be an interesting opportunity.
Mark Perlberg
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57:03
Yeah, very interesting. And oil and gas mining wells are something that we’re going to be exploring a little more with our clients who maybe can’t find deals as short term rail investors or find other opportunities. And they still want to reduce. Their taxes, and maybe they don’t want to manage any more properties and maybe they can’t materially participate as one of several vehicles and other ideas we’re bringing to our clients this year. So it’s going to be with having Donald Trump’s tax code phase out a former real estate investor, it’s harder sometimes it’ll be harder with the bonus depreciation phase out to reduce taxes and with other economic trends to find good deals for our clients. But it’s exciting for the new opportunities we’re going to introduce. So lots of interesting conversations to come.
Bernard Reisz
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57:54
I’d be intrigued. One thing that I’d say I toss out to people, though, is not to let the tax tail wag the dog.
Mark Perlberg
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58:03
The dog, yeah.
Bernard Reisz
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58:05
Because the oil and gas, I guess it’s interesting. I always tell people treat their tax tools the same way you treat an investment, right? You want to do due diligence and calculate your risk adjusted return. That means like, hey, how much money are you saving by implementing this tax tool? What’s the compounding return say? All right, now you have another one hundred K in your pocket. What can you turn that into? On a 1031 exchange, that’s almost like an infinite number. Because you can always the cool thing about real estate is the benefits of leverage. So folks, hey, you go into a property, you sell on the exit, you’re getting a million dollars. Now, some folks say, I don’t like country one exchange complicates my life. I just want to pay the tax and move on. All right, what’s the tax?
Bernard Reisz
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59:07
Depends where you live. But between if the gain is substantial, between state, federal, plus net investment income tax, even on a long term gain, it starts approaching 40%. Now, if you’re in a state that doesn’t have that kind of tax, you’re still looking at 24%. You know, between long term cap gains and, you know, when net investment income tax and if there’s depreciation recapture 25%, if there’s capture depreciation recapture in 1245, all of a sudden you get that your marginal income tax rates. That could be, you know, 30, 37%. Now suppose let’s just use a round number. You would have to give $300,000 in taxes. So now you walk it away with seven hundred K in your pocket and you want to redeploy that. In real estate, you have 300K less.
Now think about what you could earn on 300K that would have been invested in real estate or invested in anything. Now let’s take it a step further in real estate and I’m going to oversimplify. You benefit from leverage. So really every dollar that you give the IRS, you’re really giving up $4 in real estate. So by giving up $300,000 in taxes, you just gave away $1.2 million in real estate.
You know what, that’s also what’s interesting. Talking about leverage, it goes back to one of the great things about using real estate with your self directed 401 cases that you can now that you’re using leverage, you want to compare that to investing in mutual funds and stocks where you’re paying fees and this and that. You’re seeing the benefits of cash flow appreciation and leverage in these accounts as well. A lot of people may be overlooking that as well.
That’s absolutely huge. Now we talk about debt, something that I have toss out. One of the most misunderstood topics out there is Uvfi. Unrelated debt financed income. Unfortunately, this is the one topic that has some topics have good info, bad info.
That’s webinar right there.
Yes, but this is the one topic for which there is almost zero really? On target info on the web about the point is what I would say for purposes of today’s discussion. UDFI is not a reason not to use retirement accounts for real estate investing. When it’s properly understood, it’s a factor, but it should not intimidate folks. And when properly understood, it’s never a reason not to use retirement accounts for leveraged deals. Unfortunately, it’s something that’s used based on the misunderstanding of the topic, to talk people out of using self directed IRAs or using retirement accounts at all for real estate. Like everything else out there, the truth is a little more nuanced. And UDFI, you can say, is never a reason not to use self directed retirement accounts for real estate investing.
Yeah, I’ll have to do an episode of breaking down what that means and what the real impact is for our clients. Maybe another thing I’d like to talk to you about is exit strategies of these retirement accounts. Because you have it in a tax is deferred. Maybe when I come on as a guest in front of your audience, you can talk about some negative strategies and I’ll talk about some of the things we’re doing as well. So as we wrap things up, one of the things we didn’t get to talk about here is the community you have with research, financial. What do you do and how can people learn more about you and connect with you also?
Appreciate that question mark, really. I’ve got a bit of a mission, and I think we’re totally in alignment with that, which is a mission to benefit all real estate investors. It started from tax, which is getting good, reliable trustworthy info out to people and investors, because when the information that’s out there is not reliable, it harms the landscape for everybody eventually. But if folks take advantage of the rules the way they’re written and maximize the value real estate has so many powerful tax tools and Congress put them there for us to use, right? So these are not loopholes. These are totally above board. There are certain things out there, tax tools that, let’s call them, can be a little bit questionable, dubious. Those are tax tools that are created that Congress does not intend for.
And more often than not, those kind of tax dodges get shot down. It’s a matter of time. Cost segregation. 1031 exchange self retirement accounts. These are totally above board. However, they can still be misused and abused. And then what happens is folks get into trouble and the IRS says congress, hey, people are misusing these things. Right? We can see what happened with captive insurance conservation easements, right? Those are all things that were put in the tax code that had great tax incentives and they still have their place. But we can see how the IRS went ahead and is targeting those and is telling Congress, hey, maybe we should rewrite the rules here because folks are abusing this. We want to be able to keep using these powerful tools to accumulate wealth and benefit real estate investors.
And to do that, we’ve got to use them in a way that plays within the rules. Yet we can be aggressive, we can be creative, but the key is to use them expertly and knowledgeably. And that’s what this space is all about. It’s got education about, you see on the left hand side, 1031 exchange cost, segregation, self directed IRA, some financial products, not into these things, but as a financial geek, I can’t resist getting involved in it. And we’ve also got a meet up which is to give folks bring on true experts to do presentations and educate. There are a lot of true experts out there and no one expert knows everything about everything. And we want to really highlight and showcase true tax professionals so that the industry sees those professionals, uses their tools and engages with the tax code intelligently.
Awesome. So where can we find this? Because some people are going to be listening on our podcast.
Absolutely. So that’s Bernard Resurefinancial.com, free to join, easy to join. It’s designed to be a space for folks that have the same mentality that are looking for honest, unbiased, expert information deliberately kind of taken away from social media where you can get lost in the noise. This is supposed to be a zone where people can step aside and say, hey, I know I can come here. And what’s here is going to be it’s reliable straight talk on real estate taxes.
Fantastic. Bernard, thank you so much for your time. We’ll be having some more interesting conversations. I’ll be poking around there too and really appreciate your conversation. So hope you guys all enjoyed this. Subscribe for more and we’ll be keeping in touch.
Mark, thanks so much for hosting and looking forward to our future collaborations.
Absolutely. Have a good one. All right, Bernard, I’m going to jump into another podcast episode right now. Appreciate your time. We’ll talk soon.