As a real estate investor or property manager, it’s imperative that you have great representation regarding tax considerations. This is true, not only for running our own businesses, but also to provide the best possible advice if you have investment partners or investment property clients for your property management business. The key is planning to successfully and legally reduce tax liability in order to maximize after-tax income.
On this episode of Property Management Brainstorm, host Bob Preston is joined by Richard Hart, of Hart & Associates, a tax consulting firm providing guidance and services to property managers and investors. Richard is also a NARPM affiliate for those of us who are members of the National Association of Residential Property Managers. Richard and Bob explore tax related considerations that all property managers and investors will want to hear.
[2:40] Richard introduces himself, his tax accounting company Hart Associates, and how they can help you protect your hard earned money through legitimate and legal real estate tax planning.
[4:25] Reactionary vs. proactive: Richard explains the most common tax mistake he sees from real estate investors and property managers.
[7:25] From a tax and legal perspective, what is the best company structure is most favorable for real estate investors and property management companies?
[10:15] Many real estate companies received Payroll Protection Program loans during the peak of the Covid-19 pandemic. What is the proper accounting method for showing these loans on your company books once the loan has converted to a grant?
[13:10] Bob and Richard discuss the length of time real estate accounting and tax records should be retained in case of audit.
[15:05] Richard reviews the process for handling foreign investors who are seeking property management for their USA based real estate investment.
[20:45] IRS Forms 1099-misc and 1099-NEC, which one is right for reporting nonemployee income?
[22:05] The "2 out of 5" rule of rental properties to claim the tax exemption on capital gains when a property is sold.
[25:32] A quick overview of the concept of 1031 Exchange.
[29:55] Real estate tax decution fundamentals.
[33:10] Richard shares his closing thoughts and how you can reach him to learn more about tax considerations for real estate investors.
Connect with Richard Hart
Connect with Bob Preston
This episode is always available for listening, sharing, or download at Property Management Brainstorm. Subscribe to Property Management Brainstorm on Apple Podcasts, Google Podcasts, Stitcher, Spotify, TunedIn, iHeart Radio and YouTube.
Transcript of This Episode
Bob Preston (01:09):
Hello, brainstormers this is Bob Preston RMP, MPM regional vice president for the NARPM Southwestern region and your podcast host. Welcome to the show. As a property manager or a real estate investor, I'm sure you would all agree that it's imperative, that we have great representation regarding tax considerations, not only for running our own businesses, but also to provide the best possible advice for our investment property clients. The key is planning to successfully and legally reduce tax liability in order to maximize after tax income. I'm joined on the show today by Richard Hart, of Hart & Associates, a tax consulting firm who has been providing guidance and services to property managers and investors for nearly 20 years. He's also a NARPM affiliate for those of us who are members of the National Association of Residential Property Managers. Richard, and I plan to explore some tax related considerations, answer some really good questions and I'm sure we're all wondering about that. All property managers and investors will want to hear. Hey Richard, thanks for joining me today. Welcome to the show.
Richart Hart (02:29):
Thanks for having me glad to be here.
Bob Preston (02:31):
Yeah, absolutely. Hey, I always like to start our show by having my guests introduce themselves. Tell us a little bit about your company. And so Richard, why don't you kick us off with that today?
Richard Hart (02:40):
Okay. Well, my name's Richard Hart, I'm president of Hart & Associates. You can say we're a boutique tax accounting firm. We specialize in real estate taxation. So we serviced the property management, real estate brokerages, property investors, whether domestic or international throughout the entire United States. I've been doing tax accounting for over 20 years, but by realizing in real estate tax accounting for the past 13 years, basically we try to keep as much money in your pocket as possible because the IRS says, Hey, you can take as many deductions as you want, as long as they're legal. And that's what we try to do.
Bob Preston (03:14):
Perfect. I know it's a property management company and an investor that's always hugely important to me and the, you know, I'm in the state of California or tax codes for both the IRS and state codes, right. Hugely complex. And you know, I think that's why as property managers or investors, we need to be in lined with someone like you, right. So what I'd like to do today, if it's okay with you is we're going to discuss several areas related to common questions and concerns that I hear from fellow property managers and from my investor clients. And I know it's going to be tempting to do a super deep dive, right? Because each one could be discussed. I mean, you know, in length, but we're not gonna be able to do that today, but do just a summary of each of these questions and topics. And then maybe on a future episode, we can have you back. Does that sound good?
Richart Hart (03:59):
That sounds good. We're here to keep people up. I don't want people to fall asleep while they drive and listen to the attacks. Yeah.
Bob Preston (04:05):
Yeah. So, well, it's also going to be kind of a rapid fire, you know, a question and answer. So I think this is going to be good. But as a tax advisor and prepare, I mean, you specialize in real estate, property managers, investors, what would you say is the most common mistake or maybe a misconception that you encounter when working with these types of companies, you know, property managers, investors, or real estate,
Richart Hart (04:25):
The most common mistake is people tend to be reactionary as opposed to being proactive. What I mean by that is they wait until they're ready to file their taxes. And then they realize all the things of the options that they could have had during the prior year. So reactionary, they find out they owe X amount of dollars and now they're in a panic or they need to hit the bar. That's reactionary. Proactive is you make a plan for the upcoming year to align with your goals so that you can take advantage of a lot of tax deductions that are available to you. And also so that you can know exactly, okay, I'm going to owe X amount of dollars during tax time because that's another problem is by the time it's tax time, all the money has been spent and now you don't have the money to pay the taxes. And now you're behind the eight ball and it's extremely hard to get, get ahead of that once you can get to that position. So I would say that's the biggest problem that people are a reactionary as opposed to being proactive and a part of that too, is tax preparers and tax accountants. So why it feels so what do I mean by that? If you go to the doctor and you have a hard problem, you're not going to go to a podiatrist, right? They're both good, good, good doctors, maybe the best in their field, but you're going to go to the one who specializes in your issue. Likewise, with the accounting and tax preparers, there are a lot of good tax preparers out there, a lot of good accountants out there, but you need to find someone who specializes in real estate because otherwise you're going to miss a lot of, and again, a good tax preparer or accountant that specializes in real estate and is going to be proactive and helping to ask you the questions that you didn't even think about and setting up a strategy for the upcoming year for you and your business.
Bob Preston (06:13):
Then in the year, do you recommend property managers or investors do that? Like do you typically start that in January of the previous year? So you sort of, or the tax year? So at what point, I guess, is it too late to really have an impact.
Richart Hart (06:26):
It's too late to have an impact in fourth quarter. And in other words, October, November, December, you're going to be limited as far as what you can do. Usually like for myself, I like to strategize with my clients when I'm completing their tax return for the year, because then I understand exactly what's happened in the prior year. And then I get to start walking them through what they need to do for current year. For example, 2021, let's say you have to prepare your taxes in April. Then I give you a guidebook for the rest of the year. Most tax payers, January through April, it's going to be that's the busiest time of the year. So you're probably not going to get too much strategy for the upcoming year, but you should be able to talk to your accountant from minimum, starting in may to figure out what your plan is to the year.
Bob Preston (07:11):
Sure. Yeah. And then I suppose if you work with somebody on a long-term basis, then you already know a little bit about the strategy and the planning and it's more fine tuning right. Then starting from scratch, right?
Richart Hart (07:24):
Yeah. That's exactly.
Bob Preston (07:24):
Okay. Let's talk about company structure. As it's related to taxation, all of us in property management want our liability to be limited typically. So likely we have some sort of corporation in place, whether it's an LLC, an S Corp, a C Corp from a tax perspective, what are the differences of each of these kinds of entities and which corporate structure do you find is the most favorable for property management companies?
Richart Hart (07:48):
From a legal perspective, an LLC is probably your best structure. The reason I say that is because it's very simple to operate very low administrative costs with, with the state. If you're a corporation, you have to really follow a lot of corporate formalities to keep yourself legal and the LLC doesn't have all of that. And also a corporation tax higher. And especially in California, you got more taxes on top of a corporation. So legally speaking though, an LLC has all the protections that a corporation can ask. It's just easier to operate. Now there's a difference between an S corporation and a C corporation, a C corporation, very, really what a property manager wants to use a C corporation. You're going to take your public company public, or have lots of shares in that lots of investor. That's what a C corporation generally is mainly used for property managers. If they do have a corporation or elect to be taxed, as a corporation will want an S corporation. The difference with an S corporation is the S-corporation itself doesn't pay tax everything flows through to the individual owners, personal tax turns. And you get taxed at your personal rate, right? Historically a C corporation doesn't have the tax credits that your personal return would have. Historically, a C corporation is also taxed at a higher rate than your personal rate.
Bob Preston (09:10):
Double taxation, if you will, right?
Richart Hart (09:13):
Yes, but if you are wealthy the upper tax bracket, so let's say you're in the 35% tax bracket as a, on your personal return. That's the only time it would kind of make sense to use a C corporation because then you can keep most of the profits in the C corporation getting taxed at a lower rate as opposed to pulling everything into your personal return, getting taxed at a higher rate. But we're at a period of time where we know corporate taxes have got to go up because government's got to pay for the pay for stuff. So eventually the corporates are going to have to go up. So, you know, it all depends on strategy where you are as a company, what your goals are down the future that all comes into play as far as what structure you're going to use. But structure set up at the very, very beginning is very important because once you set up a structure, it's very difficult to make changes after the fact. Yeah.
Bob Preston (10:05):
A lot of people who listened to the show or new property managers are just starting out. So I think it'd be a very interesting conversation or, you know, very interesting topic for them, you know, 18 months ago when the COVID 19 pandemic erupted, many of us in the property management business were kind of freaking out. We had a lot of uncertainty on the ability just to collect rent. So that got a lot of us worried about the, the future of our companies. There were a lot of doom and gloom projections that, oh, people aren't going to be able to pay. And you know, many of us then of course obtain the payroll protection plan loans, which have since been forgiven and have converted to a grant. I think that's how it works. So I get a lot of questions from other property managers about where that money should go on the PNL, it converts from a loan to a grant. I think that's how it works. And then how has that money tax? Can you give us some insights on that?
Richart Hart (10:57):
Yeah. So PPP loans, if they're forgiven, they should appear on your profit and loss has other income. It should be a separate line item at the end of the P and L other income that's where should go. The reason being is your tax preparer will now be able to see this lump sum amount and segregate it out and say, okay, this let's say $50,000 as PPP loan. That's been forgiven now on the tax return, they won't include that as taxable income because it's tax rate, but on your P and L you want to show it as coming in as income. The only caveat to that is the majority of states follow the federal guidelines. And we'll say PPP loans are not taxable. There's only a handful of states that have their own laws where they will tax PPP money. California happens to be one of those states. So there's another step. If you have PPP for in California, you have to take your financials from 2019 and each quarter to 2020, as long as in 2020, one of those quarters, you received a twenty-five percent reduction in gross receipts compared to 2019, then California will allow you to have be forgiven of that PPP amount. But if you've made more money in 2020 than you did in 2019, then you have to pay tax to California. That peak,
Bob Preston (12:17):
That makes sense. I mean, they're kind of verifying that, okay, you needed this money to survive versus, okay, you got the money, but you actually did pretty well. Right. There are two different scenarios. Okay, perfect. What about the S corps? I think, you know, a lot of us are S Corps that issue a K one to the owners is that PPP then reflected as income on the K one or the owner, or again, is it not considered taxable?
Richart Hart (12:42):
It's not considered a taxable income. So it won't show up on the tax return, which should reflect an effect and only show up on the K one. However, again, if it's a for your California K ones, it will be on there if it is taxable to California. So short answer is if it's not taxable, it's not going to show up on your K ones. It's not going to show up on your personal return. You don't have to worry about it. If it is taxable, it'll only show up on your state tax return.
Bob Preston (13:07):
Gotcha. Wow. Super helpful. Most of us familiar with the common rule of thumb of keeping our personal tax returns for three hours, right? That's kind of the rule of thumb for us as individuals. Does that same rule of thumb apply to property management company for tax returns and keeping the records. And is it ever necessary to hold accounting and tax records longer?
Richart Hart (13:26):
So for businesses, businesses generally have to hold the returns for seven years because the IRS has a look back period of seven years for companies. And to answer your question, as far as holding them longer, it depends what's on your return for that year. So for example, if you purchase the property in 2000, you're selling it in 2021, you want to make sure you hold all the records from the purchase of that property in 2000, because now with your 2021 tax return, if you get audited, the IRS is going to want you to prove your basis in that property. So any, any records that can prove your purchase price, your capital improvements, etcetera, on that 2021 return would have to be kept. So short answer is as long as you're not selling anything that you have to prove basis, then you really keep records for personal for three years, businesses for seven years and find your current return. You you're selling an asset. You have to prove what you're putting down on a tax return. So you have to be able to prove your purchase price, capital equipment, anything that's gonna increase the basis of that asset so that the IRS knows how you're coming, computing your capital gains.
Bob Preston (14:35):
Sure. I'm guessing that's kind of tough for some, for some people to, you know, have records retained for that period of time. I know in today's day and age, we have cloud storage in 2000, we probably didn't. So some of the receipts from home improvements and things like that might no longer be laying around, but that's one way is just to make sure that obviously anything related to your company gets stored in the cloud, right? And then it's kind of there for perpetuity. You don't have to worry about like stacks of paper you know, taking up, taking up storage space. Okay. We came to you recently my company, north county property group with a scenario in which we had a foreign investor. I'm sure you remember this right. Who hired us to manage an investment property? And as we got into it and we reached the agreement, we realized that he didn't have a tax identification number. He was from a foreign country, but we had already started to collect the rent. We had rented it successfully. We wanted to keep him as a client, but this ITN as is known, kind of became an issue. So give us a low down on this, where our property managers needing to be cautious and what are the proper steps that they can follow to make sure they're in compliance with state and federal law when it comes to a foreign investor.
Richart Hart (15:41):
Okay. So property managers, they really don't have to worry about taking on foreign investors a lot of times, because of not knowing the procedures, they, they might turn away foreign investors. Once you get your systems in place, it's very simple. So basically your onboarding process find out what is the person, a country. I mean a citizen of the United States. They're not a citizen of the United States or a permanent resident of the United States. Then they are technically a foreign citizen. Foreign now become a foreign investor. And normally a foreign citizen cannot get a tax ID number unless they have a requirement for it. So it's kind of like the cart before the horse. So they're going to have, they might come in, buy a property, want to rent it out. Well, they've never filed a tax return before. So they have never had a need for a tax ID number. But now as a property manager, well, how do I handle this? How do I do the tax reporting for my foreign investor? What the IRS says is this. You can start take them on, start collecting the rents. All the IRS wants is 30% of gross rents deposited monthly via electronic taxpayer system. And that covers the property manager's responsibility. You take 30% of their gross friends. You send them that as a monthly tax deposit, you pay their bills and you send the, the owner, the net. Now the owner is going to probably going to freak out, saying 30% is a lot of money. Why am I even renting this place? If I'm not going to get this right? They're assuming it's a tax. It's a national tax. It's not a tax. It's simply a tax deposit. In other words, the IRS wants the foreign person to go ahead and file a non-resident tax returns and pay tax at their normal rate, which is usually 10%. What happens is this. Now that the property manager has a management agreement with a foreign citizen to collect rents. Now the foreign citizen has a basis for requesting a tax ID number from the IRS. They can work through a certified acceptance agents such as ourselves, or there's plenty of them nationwide, or even in their home country that they can go to apply for a tax ID number. It usually takes the IRS. These days, they're running for anywhere from 8 to 16 weeks to issue a number. In the meantime, the property manager is just collecting rents, taking 30% of that, sending it in as a monthly deposit to the IRS. Eventually when the foreign citizen gets a tax ID number, they will fill out a form called the W-8 ECI. They'll give that to what the property manager and now that property manager has that form on file basically in effect, that's a form of that exempts that foreign citizen from now having to pay 30% tax deposit in advance. At that point, you can just give them all their money. Now, what about all the money that's being collected in deposited? Does the foreign citizen ever get that back? Yes. As long as they filed their own non-resident tax return, they can apply for a refund on that money. So that covers the feds. Also, you have to look at your individual state. Each state might have a tax deposit requirement on just people who do not live in that state. They don't have to be foreign citizens that could just be non-residents of the state. Again, we'll touch on California, California requires a 7% deposit on non-residents. Again, you just take 7%. And in the case of California, I believe it's quarterly that you're submitting that 7% to them as a tax deposit difference with California is a non-resident has to file at least a minimum of two years worth of California tax return. It's before they can apply for an exemption from the California tax deposit. So each state will have its own rules and laws that you'd want to look into depending on what state you live in. But that's, that's the tag. As long as you're collecting the tax deposits and submitting them as a property manager, you're covered, don't get into the bad habit of listening to a foreign owner saying tax number. It's coming. Just give me my money. Because eventually that turns into two months, five months, one year, two years, it never comes.
Bob Preston (19:32):
What happened with us as you remember, right? Although we did collect the money, right? We had the money, we just weren't submitting it, which also caused us some problems. So I guess for us, that was the confusing part is how do we submit this money without a number for tracking, you know, by the IRS for this individual, right? So that's kind of where we got hung up. Now we know.
Richart Hart (19:50):
Just to clarify. So when you're submitting the tax deposit, the IRS doesn't know exactly who it's for. They'll just assign that deposit to the property manager EIN. So it goes into a pool for your property management company. IRS says, okay, we got a hundred thousand dollars from North County Property Group, who is this for at the end of the year, there's a tax form that you would have to file that basically reconciles who that money belongs to. And that's how the IRS determines, okay, 10 owners that have pulled a hundred thousand dollars. Let's see, who's going to file a tax return, but it kind of hope that no one does file a tax return because 30% is a high tax that's way more than the 10% that the owners will have to file. So it's, it's in the best interest of the owners to actually go ahead and get compliant.
Bob Preston (20:38):
Super helpful. I know that particular aspect is very, very common, especially here in California and is always confusing. Hey, many of us have in this business, contractors that work with us, right? Providing various services, such as maintenance vendors, oh, we have plumbers, you know, all these kinds of different types of people, electricians, maintenance providers. We also have in most cases, consultants who do things like marketing legal tax, right. Accounting guidance, and we're required to report the rental income earned by our clients, all these kinds of things. So the IRS now has two types of 1099 forms. I thought it might be helpful just to clarify, okay. What is reporting for non-employee income on the 1099 miscellaneous and what now is to be reported on? I think it's called the 1099 NEC.
Richart Hart (21:23):
Okay. Yeah. The IRS has a way of just making things more complicated. That's what they are, but that is the whole function. But 1099 miscellaneous will now just go for your owners rents. So all rental income is not reported on the 199. Everyone else is the 1099 NEC non-employee compensation. So all your vendors will get a 1099 and DC, all your owners will get a 1099 miscellaneous.
Bob Preston (21:51):
Yeah, that's super easy. So people that we've paid for services, that's the NDC for people where we've collected rents and we're just demonstrating, okay, this is the income that we've distributed to you. That would be the 1099 miscellaneous. Exactly. One of the most common questions I get from our real estate investor clients is about, I call it the two year rule, right? They come, oh, we got this two year rule we have to comply with. And that's for claiming the tax exemption on capital gains if they were to sell the property. And so I'm wondering if you can explain that requirement, how it works and of course, you know, the potential tax savings, if you can be in compliance with that.
Richart Hart (22:22):
Okay. So let's assume you purchase your primary residence as long as you live in your primary residence for a minimum of two years. And then let's say you sell it and you make a hundred thousand dollars, which in this market is easy to, to really see, right? Yeah. If you've lived in your primary residence for over two years, you get a $250,000 exemption. So in other words, the first $150,000 of capital gain on your primary residence is tax rate. If you're married, then it's double cause it's you and your spouse. So the first 500,000 of capital gain would be tax-free on your primary residence. What happens is sometimes you'll take your primary residence and turn it into a rental property, right. So can you still take advantage of that capital gain exemption? Yes. The thing is it's called to a five-year rule. So basically you look at the exact date, you sell your property and you look back five years to the day, don't go past it because the IRS has sticklers for time. So five years to the day, if you've lived in that property for at least two of those five years,
Bob Preston (23:31):
It doesn't have to be the most recent two years. It could be anywhere in that five years before you are selling.
Richart Hart (23:35):
Right. And it doesn't have to be you know, for example, it doesn't have to be 2020, 2021. It could be 2017. I lived there for a year, 2020 I for the air for years.
Bob Preston (23:46):
Oh, I see. So it doesn't have to be sequential.
Richart Hart (23:51):
As long as it's just, if I've lived in that property for two of the past five years from the date of sale, and I've not used that cap, that capital gain exclusion, I can now use that exclusion to shield if I'm single $250,000 worth of capital gain. And if I'm married 500,000 of capital gain, so that's what your investors are looking at. Obviously it's really practical, right? But again, you must look at the sale date and stick to that timeline. Don't go a day beyond that five-year mark because the IRS sticklers on that, then the clock resets, and then I get another primary property. And if I live in that front of the two years, then I can take advantage of that again, you know, two years. So it's not one and done it resets after your use it. Sure.
Bob Preston (24:37):
We have a lot of clients and this is not just our clients, but a lot of people are reaching a certain age, maybe it's retirement, and they're deciding to leave California. We're all hearing about this expensive place to live. So we've have a lot of clients who want to try lifts it living someplace else, Hawaii, Idaho you know, the, all these Midwest states are now flooded with people moving from California. So they come to us, they say, okay, we'd like to rent our property. They've been living in it and we're going to go try this. We think we're going to like it. And if we decide to stay, then we may want to sell. So I guess what you're saying, it's important then to make that decision within about three years, right? Because three plus the two you've lived there would equal five and then plan with enough time to make sure your home gets sold under that five-year bar.
Bob Preston (25:23):
So they bought the house in 2000 to use your previous example that you were saying, and they lived there for two years. And now it's 2021. Those two years don't count. All right, let's talk 1031 exchange. This is another thing that comes to me quite frequently from our clients. Common question, right? They don't really know how to work. I know this is complicated, right? And it might be worthy of its own individual episode, but as a high level explanation, how does the concept work and who can take advantage of it for tax deferment and savings?
Richart Hart (25:49):
Okay. So again, it's a complex subject, but high level, anyone who has investment property can take advantage of this. All right. So it can't be your primary residence. This must be investment property specifically. So let's assume I have an investment property that I'm selling now. And I am going to have a capital gain of about $200,000. I'm going to have a hefty tax bill on that. Well, I can do, what's called a 1031 exchange. What does that mean? That means the IRS says, go find a property that's an equal or greater value purchase it. And we'll basically defer the tax that's due on what you're selling now, until you sell this replacement property, there's a couple of caveats on that. The IRS says, okay, you have to identify your replacement property within 45 days after you sell the property, you're giving up and you have to close on that property within 180 days. So they give you a very tight window. And again, they're sticklers for those timelines and this market. It could be hard to find a property that fits your bill, because they're saying that within that 45 day window, they went through to identify at least three properties that you're going to replace. The one you're selling.
Bob Preston (26:59):
Yeah. By the time you identify them and submit them, they're already sold. You know?
Richart Hart (27:02):
Exactly. So that's the hard part, right? Because, so you have to identify and close on that within the occupation. So that's what makes it hard. And also you can never come in contact with the money. So in other words, you have to use an exchange agent facilitator, they'll take title, they'll close. The money will go to the exchange agent. And then when you find your replacement property exchange, agent will use the funds to purchase that property. So you can never come in contact personally, with the money. If you come in contact person with the money, then the exchanges is done and you can't take advantage of it. What's nice again, with the deferrals is you can upgrade into a property, maybe in a different location. You want, maybe you want to get into a higher level property. You can upgrade into, you can split your risk because you can take the property that you're selling and buy two or three properties, as long as it's the amount of those two or three properties that you're replacing is equal or greater value to the one you're giving up.
Richart Hart (27:54):
So there's a lot of strategic motives to also do it. And what's nice too, is it's a way to build wealth over time. Because again, instead of paying, you know, 50, $60,000 in taxes right now, it's deferred, right? So you're able to upgrade to an appreciating asset and what a lot of people do with the tax laws as they are currently is they keep deferring. They'll keep using the light kind exchange, keep deferring, keep deferring until they pass away. And then they pass it on to their children. And guess what? With the tax laws right now, the basis starts at the day you inherited. So in effect, all of that deferral that you've been accumulating is now wiped, clean your children, or whoever's inheriting the property. Doesn't have to pay any of that tax. Wow. So that's how people build wealth right now is they're trying to close that loophole. I don't know if they're going to be able to do it. That's one of the might be slipping into that new package that's going through, but as it stands now, it's, it's legal. And that's how people really build wealth and it's countries with appreciating assets like that.
Bob Preston (28:56):
Wow, you mentioned it's only for rental properties, is that true of the property that's being sold as well? Or just the properties that are being purchased? Because I get this question a lot, like, Hey, we'd like to leave California would like to sell our house and then that's their primary residence and we're going to downsize. We have the money to do that. We're going to use the proceeds from our property, sell here in California and buy some other rental properties. Is that qualify or does the property being sold? Also have to be considered a rental?
Richart Hart (29:20):
Right? The property being sold has to be considered a rental. So it cannot, the property being, being sold has to be an investment property. The property being purchased has to be an investment property. So to kind of get around that again, if the person's interested in doing a like-kind exchange and maybe they rent the property for a year before, you know, it was the primary. Now they rent it and now it becomes an investment property and then they can do an exchange.
Bob Preston (29:45):
Gotcha. Okay. And the time period for renting, it would be just a year.
Richart Hart (29:50):
I would suggest always there's nothing written, but it has to be a bottom line, right?
Bob Preston (29:54):
Hey, for the real estate investors that are listening out there, there's a long list of tax deductible expenses. That one incurs when they're renting a place or when they're a landlord, including property management fees, they might be paying. And those essentially can be subtracted from rental income, which helps reduce tax liability. Just to name a few, right? A mortgage and interest, property insurance, HOA, the management fees, appreciation all these kinds of things. How does this all get netted out? I mean, this may be simple and straightforward to you, but I think it's a good topic to cover here. As we close in on wrapping up the episode, how does that all get netted out and how can we help our clients as property managers consolidate that into reporting some of these items that appear on our property management statements to our investor clients, it's quite simple.
Richart Hart (30:38):
So you take your gross income and then any expense associated with that investment rental property is tax deductible. So basically every dime you put into that property, no matter what your, what the expense is, is allowed to be deducted. So if I make 20,000 for the year and I have 15,000 of expenses, then I'll have to pay $5,000. I only have $5,000 of taxable income. Now as a property manager with the PM, the cashflow statements that you provide to your owners, you can help them by segregating like major asset purchases. For example, their air conditioner goes out, that's a major purchase, segregate that out on the cashflow, you know, a new roof, anything that's basically a capital improvement, segregate that out because capital improvements or have a different tax treatment than just your regular ordinary expenses. So it saves the owner having lots of questions from their tax preparers, and then them coming back to you perhaps saying, okay, what is this $5,000 that's lumped into, you know, repairs I roof. Okay, well, on the tax return, we can't take the 5,000 as one hit. We have to read that over 27 years from a practical standpoint, everything on that cashflow statement is an expense it's deductible, but you might want to just have a section that's called capital improvements for, you know, anything that is a capital improvement.
Bob Preston (32:05):
Is there a dollar value if you send a plumber and he replaces the toilet, I mean, that would be not a capital approvement, right? The $250 to put in a new toilet.
Richart Hart (32:15):
Right. I generally say anything above $2,500. For example, I have a lot of clients that have properties in Florida that if their houses were Blitzer rated by the hurricanes, well, now those are not capital improvements. Doesn't really repair it because I got to get them back to, you know, operating if it's just things that are, you know, add more than one year of value to the life of the property, again, like a new roof, a new.
Bob Preston (32:40):
Yeah. But if you have a flood in your kitchen and you have to do remediation and as a result of your whole kitchen gets ripped out and replaced that's that is a, that's a maintenance aspect, right. You're doing it because you had to.
Richart Hart (32:50):
Okay. You're repairing it back to where it was originally. So you can write that all off.
Bob Preston (32:54):
Hey, Richard, this has been a great conversation packed with some really terrific information today. Thanks so much for coming on the show. I know we have barely scratched the surface on some of these topics. So, like I said earlier, maybe we can come back and do another episode and do deep dives on some of these specific topics, but in general, any last words for our listeners today. And also if someone wants to connect with you to discuss tax topics or have you do a plan for them tax plan for them in greater detail, what's the best way to get connected. So kind of summarize today's episode, any last tips, and then how, how can people connect with?
Richart Hart (33:24):
Okay, again, be proactive, not reactive. Talk to your tax preparer tax accountant now. So you can plan to save as much money on taxes in the future. If you'd like to get in contact with us, email me direct firstname.lastname@example.org. No S so it's email@example.com, or you can give us a call 7025894687. We're happy to answer your questions, no charge for a consult fee. The IRS says, take every deduction. That's legal. Why not do it keep more money in your pocket as opposed to.
Bob Preston (34:04):
Perfect. Hey, thanks so much, Richard. It's been a great episode. Thanks so much for coming on the show. Hey, thanks for having me, Bob. As we wrap up today, I'd like to make another quick plug to our listeners to please click on the subscribe button, give us a like, and also please pay it forward with a positive review to help encourage more great guests like Richard to come on our show. That concludes today's episode. Thank you so much for joining the property management brainstorm show. Until next time we will be working hard in the field to exceed the expectations of our clients, build their trust and confidence, maximize the value of their real estate assets. Our objective as always is to be the trusted advisor to protect rental property investments, achieve real estate financial goals for our clients and free them at the time involved in being a landlord. And we will catch you next time.