Announcer: Please note disclaimers at end of show. Welcome to Creating Wealth with Jason Hartman. During this program, Jason is going to tell you some really exciting things that you probably haven’t thought of before and a new slant on investing, fresh new approaches to America’s best investment that will enable you to create more wealth and happiness than you ever thought possible.
Jason is a genuine self-made multimillionaire, who not only talks the talk, but walks the walk. He’s been a successful investor for 20 years and currently owns properties in 11 states and 17 cities. This program will help you follow in Jason’s footsteps on the road to financial freedom. You really can do it. And now, here’s your host, Jason Hartman, with the Complete Solution for Real Estate Investors™.
Jason Hartman: Welcome to the Creating Wealth Show No. 145. This is Jason Hartman, your host, and thank you so much for listening today. Today, we are going to talk about taxes. Life’s single largest expense is taxes. How can we save money on taxes? It’s always amazing to me how we, as humans, have such a funny nature and it’s so illogical in so many ways. We will spend hours, maybe days, shopping around, surfing the internet, running around town to get a better deal on a new television set or a computer or a car or whatever it is, yet we will not spend much at all learning how to save money on life’s single largest expense. And so that’s what we’re going to talk about today, as we have on previous shows.
We’ve never had this guest before, Diane Kennedy. She is a very well known CPA and has a lot of expertise in the area of real estate and also business tax law. So we’re going to hear about some ways to save money on taxes there, and I think you’ll like it.
What I do want to mention to you also, and I noticed this with No. 143 when we had Lisa Bromma on, and we were talking about the IRA plans and so forth, these shows tend to stack up on us and we do record them in advance of publication. For example, we have 37 shows we’ve recorded in the pipeline that we have not yet released. So we have a lot of great shows coming up for you, and I know that because I’ve recorded them all. So sometimes, there is a lag time, so notice sometimes the speaker refers to next year and next year is really this year because they recorded at the end of 2009 on occasion. And that is also true with this one with Diane Kennedy, and it is now 2010. Just barely, but it did overlap into the next year technically.
So I wanted you to know that. Also, thank you to all of those who joined us for our Market Forecast call. We had lots and lots of people on that call. That was a very well attended call. And we do our annual market forecast. We have a whitepaper out. I know that a lot of you bought the whitepaper. It’s the best $25 you’ll ever spend, I think, and I hope you like that.
We did notice a typo in the whitepaper, by the way. Just a minor thing, but I wanted to point it out. It is on Page 28 and we will correct this, but Las Vegas, Nevada, we were predicting a ROI negative in Las Vegas, Nevada. Not a good place to invest yet. It will be in the future, but not right now. We were predicting a negative return on investment of 60.3 percent. Remember we are the only one that is doing a complete ROI Build, Return on Investment Build, including appreciation or depreciation, leverage and cash flow on these.
And Las Vegas, Nevada, it says the correct ROI when we have the narrative portion, but in the chart, there is a typo, where it says 2.4 percent positive ROI. So just disregard that. That was accidently copied from the Charlotte chart that is right above it on Page 28. A little typo I wanted you to know about.
Do get a copy of the whitepaper. Go to HYPERLINK "http://jasonhartman.webimpakt-green.com" www.JasonHartman.com. It’s $25. It’s the best $25 you’ll ever spend.
The conference call was a big success. We released our forecast for 2010 on that, and we’ll be talking about that more on future shows. But again, thank you for attending it. We have some really interesting opportunities in small, brand new apartments right now. In Columbus, Ohio, which is the only bright spot right now in Ohio, we think Ohio is largely a blighted market like Michigan that we really wouldn’t consider, but we’ve had some good deals in Columbus. And right now, I want to play for you a short call I had recently with a client, who purchased one of those apartment buildings, and we just talked for a couple of minutes recently and I want to play that call for you now. We had him on the show many, many months ago when he first purchased this property, but I wanted to kind of do a follow-up session to let you know that his experience is still going very well.
Let’s listen in to that and I will talk to you about another brand new apartment opportunity I have in just a moment.
Follow-Up Interview with John
Jason Hartman: It’s my pleasure to welcome our client, John, back on the line. And he was on prior show several months ago. John, was it a year ago now? It was a long time ago.
John: Well, it was probably somewhere in the podcasts in the lower 80s. Let’s put it that way. Yeah, it was maybe five months ago.
Jason Hartman: Yeah, that was a while ago. And we just wanted to check back in with you, John, on your experience in your apartment building that you purchased through our network in the Columbus market and see how it was all going. We had chatted a little bit and I said I think our listeners would love to hear this and know about your experiences, and let’s just have you back on the show real quick. So thank you for joining us and volunteering to share that with the listeners. What’s going on over there? How’s it been?
John: Oh, it’s been doing very well, Jason. It’s great to talk to you once again. And trust me, folks, when you deal with Platinum Properties, Jason Hartman and his people, they’re going to help you. They’re going to hold your hand. They’re going to help you 100 percent all of the way. I’m a perfect example of that because I live over 1,000 miles away from my property.
Jason Hartman: You’re in Minneapolis, right? We should say that.
John: I live up in snowy, northern Minnesota, and trust me; we have a little bit of snow on the ground. Not an awful lot. Last year was really bad. But as far as my property, everything has been going well. I had maybe a few vacancies throughout the year. I’ve had my property just almost an entire year about now.
Jason Hartman: And when you say a few vacancies, John, I just want you to clear that up for the listeners. This is an apartment building. And how many units do you have in it?
Jason Hartman: So 16 units, a small apartment building, and you’ve had a couple of vacancies here and there, but overall, what’s it been like? Has the revenue been good? Has the investment worked as well as you thought?
John: The investment has worked probably even better than what I thought. When I purchased this property, part of the deal – actually, I didn’t know about this until I got to Columbus – that this building was going to be 100 percent occupied. Now, I didn’t have to wait for a building to get built. I didn’t have to wait for tenants to get in. I didn’t have to wait all those months. It was already there. It was set up. It was done very well. The people in Columbus are absolutely great people. My property management company – five stars. The real estate people I dealt with – five stars. Just great people.
And also, this property, it’s a place that if I didn’t own my own and if there was any reason I would want to leave Minnesota – yep, Minnesota, I said, leave Minnesota; most people don’t like to come here. I don’t want to leave. I’m that kind of crazy. But if there was any reason I would want to leave Minnesota, that building, that complex is a beautiful place to live, and they attract lots of people. There is a good market of students, white-collar, hardworking folks. I would say the economic crisis has touched parts of that city, but the turnaround, the people who come right back in, it’s unbelievable.
And also, if you’re worried about vacancies, they fill up very quickly. I’ve even had two evictions. I was actually kind of surprised when I saw them, but the property management company there, they’re very quick and they dealt with everything very professionally. So you’re going to be taken care of very well.
Jason Hartman: Well, we should just explain a couple things for the benefit of the listeners that No. 1 is that we don’t particularly like the Ohio market. A lot of that state has been very badly hit by the economy. Columbus has been a bit of a bright spot within Ohio, where mostly, as of course, you know, John, and the regular listeners do, we like the Southeastern U.S., a little bit of the West. We just reopened Phoenix, as John, I’m sure you know because you listen to all the shows.
But this was a special deal. It was pretty unique in Columbus and that’s why we went after it and we’ve had a few clients buy there, and so far, what we’re hearing from people like you is that you’re quite happy with them, and we’re always glad to hear about good experiences. We’re probably in the worst economy in seven decades and so it’s just really nice when we hear from our clients that they’re having good experiences.
We’re telling people to buy in linear markets, markets that never really have the big run-up. They didn’t have a bubble, so the bubble really didn’t pop. Maybe they’ve softened just a little bit here and there, but it’s nothing major. And some of them actually have appreciated last year in the worst economy in seven decades, right? So it’s pretty amazing.
John: I think I agree with you with the Southeast, Texas, and Arizona. When I have the capital, I’ll be coming right back and I’ll be going to those hotter markets myself. So I’m going to be a returning customer.
Jason Hartman: Yeah, let’s get you into Georgia or Texas on your next purchase. How’s that sound, John?
John: Sounds fine to me. I need to go south for the winter sometime.
Jason Hartman: There you go, exactly. Well, thank you so much for sharing your experience with our listeners. We really appreciate having you on the show. Anything else you would like them to know?
John: Happy holidays to everybody.
Jason Hartman: Yes, we should say it is December 21. John, it’s the shortest day of the year today, and it must be really dark up in northern Minnesota.
John: It’s dark and it’s cold. We have about 15 degrees Fahrenheit right now.
Jason Hartman: Yeah, this has been a nasty winter in a lot of parts. California, we’ve been pretty lucky so far, but that’s why we overpay for housing and taxes and everything here in the People’s Republic of California. I don’t know if it’s worth it at some point. I think weather can only go so far, but that’s just my opinion. Anyway, thank you so much for joining us, John. We really appreciate it.
John: Thank you, Jason.
Jason Hartman: All right, so we not only have the Columbus apartments, and these are brand new, pre-leased apartment buildings, turnkey. It’s very rare to get brand new apartments. Usually apartments are older, so that’s something to consider. Also, we have a new opportunity in St. Robert, where some of you have purchased those brand new duplexes we have, where you can do that with low down payments. Well, we also have a small 16-unit apartment building there as well, kind of on a very similar arrangement. You can get in with a pretty low down payment and your cap rate is phenomenal for brand new apartments.
So we will be talking about that on future shows, but if you’d like more information now, contact any of our investment counselors through the HYPERLINK "http://jasonhartman.webimpakt-green.com" www.JasonHartman.com website, or just give us a call, (714) 820-4200.
Also, I am very happy to announce that we are moving our office. We’ve been in this office for two years now and we picked out a great new office. I have to tell you, the economy is doing funny things. Our office, when I signed the lease almost three years ago, this whole area was vibrant and there were lots of restaurants around, and the restaurants have gone out of business and it’s really, really changed. I mean it’s still a beautiful area, but the new area we’re in has so many great restaurants, and it has a huge auditorium. Actually, it has four auditoriums within the building.
So our new address we will announce on our next call when the lease is all signed. But our even on the 23rd, we’re planning to have that at the Marriott right across the street from our existing office, so I just wanted to let you know about that. And join us for that event, The Creating Wealth Bootcamp on the 23rd. And also the Masters Weekend this year is going to be a phenomenal Masters Weekend in March.
And we are about to release in audio – many of you have requested this – an audio of our prior Masters Weekend events. So what we’ve done is we’ve taken the last two Masters Weekends and we’ve blended together. The typical Masters Weekend usually has about 14 or 16 speakers, and this is a blend of two different Masters Weekends. Remember we only have this event twice a year. And the audio, we’ve blended them together, sort of the best of the best of both events, where we have 22 sessions, 22 different experts, that have flown in from around the country, that are experts on a whole bunch of different topics, where we will be having this audio downloadable. It will be about 15 hours of content for you and you can listen to it at your leisure over and over again.
Experts on everything from asset protection, tax planning, 1031 Exchanges, just the overall view of real estate. I do my session on organizational techniques, how to organize your real estate business. The best software to use, we have Joel from Property Tracker talking all about looking back at markets and timing markets. We have Doug, which a lot of you really liked at the last Masters Weekend, talking about protecting yourself from the three things you need to shield your wealth from and your future from, which is inflation and the government, and just a whole bunch of stuff. So a lot of great stuff. We will have that Masters Weekend audio available for you very shortly. It’s almost edited. I think you’ll really like that.
All right, let’s go to the interview with Diane Kennedy. Here it is.
Interview with Diane Kennedy, CPA
Jason Hartman: It’s my pleasure to welcome Diane Kennedy to the show. You may know her name in the real estate circles because she is a very well known tax advisor. And when it comes to real estate, this is the expert. So it’s great to have her on the show. Diane, welcome.
Diane Kennedy: Thank you, Jason. I’m glad to talk about real estate today. This is fun.
Jason Hartman: Well, we want to hear all about it. We all know it’s a fantastic investment. It’s a way to really be in control of your financial future rather than leaving it to some crooked Wall Street investment banker or CEO or mutual fund manager. I think the listeners are pretty convinced that real estate is the best investment in America today.
But there are tax implications and mostly, they benefit the real estate investor. I find that the tax laws are very favorable toward real estate. But what are some of the pitfalls and things that people want to watch out for to be a better investor and make sure they get all of their tax benefits?
Diane Kennedy: For years, I talked about the fact that you could take real estate and create cash flow with it, money you’re putting in your pocket, and yet, perfectly legally show on the tax returns a tax loss. It’s a paper loss. In other words, it doesn’t cost you any money to have that kind of a loss. But you still get the benefit of a tax write off.
Well, over the years, the IRS has made it tougher and tougher to take that loss, so where we are today, there are a couple of limitations now. For example, if you make less than $100,000 a year, you could take a loss of up to $25,000 against your other income. If you make over $150,000 a year, you can’t take any of the loss. Between $100,000 and $150,000, the amount of the allowable loss phases out. There is a little trick to this and the trick is something called the Real Estate Professional status.
What I think happened is a lot of people got really excited with this and there was some abuse of the system. Well, as a result, the IRS is after it pretty hard these days. We’re seeing a lot of audits. It started about two years ago in California, and unfortunately, if you have high other income and you’re showing a real estate loss with real estate professional status, you might be getting the IRS knocking at your door.
So this is one of those things. Don’t be afraid of taking the deduction, but if you do, just be prepared for an audit and make sure you have all your “I’s” dotted and your “T’s” crossed, and you’ll be able to get through without a problem.
Jason Hartman: Okay, fantastic. I have to mention that Diane is coming to us from Baja, Mexico, and so the sound is a little bit strange at times. I think there’s probably a satellite connection here on the phone. Just bear with us here, listeners, and we’ll try to improve that as much as possible in post-production.
So that’s with the real estate professional part of it. Tell us how the real estate professional law works, if you will, and then where the IRS is kind of picking at it, if you would.
Diane Kennedy: Sure. The real estate professional status, what the means, is that you set two criteria. No. 1 is spend more hours in real estate activities than you do any other business activity, and No. 2, you have at least 750 hours a year in that real estate activity. So in other words, if you have another job, you’re going to have to spend more hours in the real estate activities than you do your other job.
Now, if you’re working full time, that might be pretty hard to prove, so they’re going to want to see some kind of log to prove the hours you’re working at your other job versus the hours in your real estate activities. If you don’t work at all, then you have this minimum at least of 750 hours per year, which works out to about 15 hours per week. If you have a lot of property, that’s not a hard one to meet.
Okay, here’s the trick and what the IRS is after. They’re going to want to see a log of your hours that you spent in the real estate activities, and my suggestion is don’t walk in there with 750 hours if that’s what you need to meet. Instead walk in there with at least 1,500, so if they throw some out, you still have enough hours to be able to prove your case.
Some of the challenges that they’re making right now are related to how active are you really. For example, sitting at your computer and looking through MLS, looking at properties, they’re throwing that one out. They say that’s passive. It’s not really actively doing something. They want to see you out there.
For example, we had a case, an interesting one. It was an IRS audit on a real estate professional status. The client was in California and he had property up in Washington, and he was claiming that he was active in the management of that property – actually, it was construction and then management and they absolutely didn’t buy it. Even though he had the logs to prove it all, they said there’s no way from California he’s running something in Washington.
Well, the client came up with a picture that showed him at the jobsite with a hard hat on, and for whatever reason, the auditor just loved that and that was enough to win the audit. They said okay, well, if he’s showing up in a hard hat, obviously he’s doing some work and he’s active in it.
So you never know. Take lots of pictures. Show that you’re out there hammering a nail or picking up a board or meeting with somebody or putting the sign in the ground. Show that you’re actively managing these properties. That then qualifies you for real estate professional status.
The second part, though, is you have to materially participate in the management of these properties. In other words, you’re actually involved in the properties. That means not just that you’re spending hours as a real estate professional, but also specifically with the property. The rule here is that you need to spend 500 hours or more per property. Now, if you have ten properties, you might have just now had a mock heart attack, thinking 5,000 hours! How am I going to do that?
Well, the IRS lets you make an election. It’s called an “aggregation election.” Take it on your return. When you do that, you say I only have to meet the standard for one. In other words, all of these properties count as long as I get my 500 hours of material participation in the property. Usually, that one’s not so hard to do. You just have to prove that you were involved in something, meeting with the property manager, going out and inspecting the property, checking on background checks for the potential tenants, or inspecting to make sure the roof isn’t leaking, whatever. As long as you’re actively doing something with that property, or if you have multiple properties, in total 500 hours a year.
Jason Hartman: Okay, now, Diane, a lot of people that are listening happen to be in the real estate business, and when I say that, I just want to make a distinction here. They invest in real estate for their personal portfolio, and then they also might sell real estate either full time or part time, or they might be in some other part of the real estate business. They might be a mortgage rep. Like I mentioned before, they might be a real estate agent. And there’s sort of this overlap issue there, and I think this applies to yours truly as well, where their business and their whole life is real estate, but that does not necessarily mean real estate professional, right?
Diane Kennedy: Yeah, it kind of does. So Jason, maybe this will be good news for you. You get to count the hours if you’re involved in a real estate activity, like a real estate agent or a mortgage broker, that type of thing, as long as you own at least 5 percent of the company. So if you work for Coldwell Banker or somebody as a W2 employee and you don’t own any of Coldwell Banker, you don’t get to count all the hours you’re doing it.
But if you’re a sales agent, where you get a Form 1099 – in other words, you’re an independent contractor; that means you have your own business. So those hours would count then.
Jason Hartman: So that overlap can actually work to someone’s benefit, but we also want listeners to know that if they are not in the real estate business and they are purely a real estate investor, it is possible for them to qualify as a “real estate professional” as well, right?
Diane Kennedy: It is. In fact, I have that frequently. I have a client down in Florida where he’s a full time doctor, works a lot of hours, a cardiologist. His wife is a part time nurse. They had a lot of property, so what we did actually is have his wife cut down her hours in nursing so that we could get her to qualify as the real estate professional. They had a lot of properties and it was true she really was the one managing them, so that was an easy thing to prove. But the interesting thing is it does allow her to really concentrate on the real estate and she’s ended up making a ton of money in real estate, especially now in the down market, picking up properties and leasing them out and getting positive cash flow. I think she’s going to pass her husband’s salary pretty soon.
Jason Hartman: That’s interesting. Is there anything else we should talk about as far as the real estate professional category goes?
Diane Kennedy: The other downside and kind of to think about this is if you then have a property that goes bad, you have something that you need to – we call it “dumping bad real estate,” that you do a loan modification. A short sale primarily is the issue. If you sell something and you actually have a loss, here’s just a little note if anybody is in this spot, if you had previously aggregated your properties together – remember I talked about that aggregation so you can get through that 500-hour deal – if you previously aggregated, you need to de-aggregate the properties before you sell. Otherwise, any loss stays in that group and you have to sell all the properties in order to take the loss. It gets suspended.
Jason Hartman: Oh, so let me just ask you for some clarification here, if I may. So what you’re saying here is when someone becomes a real estate professional, they sort of notify the IRS of their intent to do this. Is that what you’re referring to?
Diane Kennedy: Yeah, you do that actually on your tax return. There is an election that’s made.
Jason Hartman: That’s an election.
Diane Kennedy: Yep, and the challenge is that you need to do something in the year before you do a short sale, as an example, or you sell property at a loss. Otherwise, you don’t lose the loss. It’s just suspended until you sell all the other properties. It’s a funny little tax rule that you have to be careful of.
Jason Hartman: Okay, now I remember when my CPA did this. I don’t remember it perfectly clearly, but it was something to the effect of it was just a little page attached to my return, and it says something along the lines of “taxpayer elects to treat all real estate as one activity” or something like that.
Diane Kennedy: Oh, you’ve got it. You can come to work for my firm. That’s it.
Jason Hartman: I don’t want to do taxes! But thank you. If things ever get tough in real estate, I’ll give you a call. But what that means is they’re aggregating this? Explain that to the listeners, if you would, and then explain the dis-aggregation because that’s how they get the benefit of a loss if they have to dump something, right?
Diane Kennedy: Exactly, yeah. So when you make this election, if you don’t – let’s talk about the downside. What if you don’t make this election? Well, remember that 500 hours per house of active participation or material participation I talked about. If you have ten properties and you have to do 500 hours each, that’s a lot of hours that you’re going to have to put in. Instead what you do is you say we’re going to call this all one activity, all these ten properties, so we’re electing to aggregate. In other words, combine them, and the only reason we’re doing this is just for purposes so we only have to meet one requirement of the 500 hours.
Now, the problem is that down the road, we’ve said this is all one activity, so if you have one activity and you sell off just a piece of it, you really haven’t sold the activity yet. And until you sell it all, you don’t get to take advantage of the loss. So you have to find – de-aggregate is the best way to put it – de-aggregate this one property that you’re going to sell out of there. So there’s something that you do that’s different. This is the kind of thing where you need to sit down with your CPA and strategize a little. How can we make this property different from the other properties, and then be able to say we pulled it as “out” first, before we did anything else.
Jason Hartman: Okay. And the reason is that they can – explain the difference. You still get to take advantage of the tax loss, but it’s different in the way it’s calculated, right?
Diane Kennedy: Right. Now, if you look at it this way, if you’re making over $150,000 a year, you’re not going to be able to take advantage of any real estate loss while you’re holding the property unless you go through this method. So by doing an aggregation, you get to take advantage of current losses, but there’s a little “gotcha” in there. If you stay in this aggregation and you sell, the loss itself or the sale becomes suspended. You have to sell all the other properties to take advantage of it.
Jason Hartman: And you don’t want the loss suspended because you want to take it right away.
Diane Kennedy: No, you want to take advantage of it. One of the rules is you take every expense and every loss you can immediately. That’s one of the tax rules. Defer your taxes as long as you can, hopefully to never.
Jason Hartman: Well, now, I do have to say, let me just make a little comment on that if I could right now. I met with my investment banker last week and he said that business is actually quite good. He buys and sells companies. And I was talking to him about a possible acquisition, and he said business is quite good because people are selling their companies now in anticipation of much higher taxes under the Obama regime. So sometimes, does it ever make sense to pay a tax early?
Diane Kennedy: No.
Jason Hartman: No? You don’t like that idea.
Diane Kennedy: Yeah, I totally agree with you. That’s an interesting comment. I said that and I thought, well, maybe not. And the reason is just simply because we have capital gains going up next year, the capital gains dividend. And if we want to get really concerned about it, it’s going from 15 percent to 20 percent on the cap. Additionally, the Senate proposal for the new healthcare bill, one of the ways they’re talking about paying for it is to further increase the capital gains tax. So we’re potentially looking at a 69 percent increase in the capital gains tax. That’s a lot.
Jason Hartman: I’m so glad you put it that way because so many people do not understand this very simple thing when it comes to taxes. In California here – I’m in the People’s Republic of California, and I say that with all due affection, sarcastically of course – when our sales tax went up, people thought it’s just a 1.25 percent increase. It was different depending on what city in which you live. And really, it was a much higher increase. It was like a 17 percent increase in tax. But people think it’s just 1.25 percent or something. This is much more significant. And you said that correctly. You said that’s a 69 percent increase in capital gains tax, so I thank you for saying it that way. That was the proper way to point it out.
Diane Kennedy: Well, yeah, and it adds up. That’s the other part of it. I have clients that maybe are in businesses where their margin is 3 – 5 percent to the bottom line. In other words, they’re saying that there’s a lot of cost and they have a lot of volume. But you start playing with numbers and you’re only making 3 – 5 percent on every dollar you make, it doesn’t take very long until you’re out of business. That’s a concern.
Jason Hartman: Yeah, that’s a very good point. Go on, though, with what you were saying.
Diane Kennedy: Okay, so that’s on the real estate. The point with the aggregation is it lets you take a current expense; you get to take advantage of that loss on your tax return. But when you sell it down the road, unless you unwind what you’ve done, it’s going to suspend that loss.
Jason Hartman: So if you unwind it, though, do you lose all the benefits of being a real estate professional in that year?
Diane Kennedy: No, no, just for that one property. You’re selling it anyway, so you don’t care.
Jason Hartman: Okay, got it. So that’s good.
Diane Kennedy: We leave everything else alone.
Jason Hartman: Okay. So we really talked about the real estate professional. We talked about selling on how – a short sale or a foreclosure, or how are they dumping this property?
Diane Kennedy: Well, in this case, if you’re selling it and you’ve got that loss, that’s where it is, so short sale or just even just a regular sale that you’re selling at a loss. If you have a loss, you want to be able to take it. Maybe I could just give you an example. This is the nightmare that I’m afraid some people are going to wake up to who have been doing short sales or foreclosures.
Let’s say you bought a property for $200,000 and it’s now worth $100,000. You’re able to talk the bank into letting you do a short sale for $100,000. So you think, okay, whew! I’m done with that. We’re done. But let’s say that what happened is you’ve actually gotten income because there was a loan on this for $200,000. I’m just going to say you bought it for $200,000, 100 percent loan. So you have $100,000 forgiveness that’s happened. That’s taxable income for you.
Now if this property was a real estate investment that you had, you’re also going to have a loss when you sell that property, and so, in fact, they probably zero each other out, or you actually might even have a little bit of a loss you’re going to take on your property. So the fact that you just got hit with this 1099 showing taxable income because of the forgiveness doesn’t matter.
But it starts to get tricky if that property has been in this group and the loss gets suspended. All of a sudden, now you’ve got a taxable income and you can’t take a loss against it. I’m afraid of that nightmare for a lot of people right now. Does that make sense?
Jason Hartman: I’m not sure it does. Can you just do that one more time, maybe another way?
Diane Kennedy: Absolutely. So we have a property that say you paid $200,000 for it, and it was all a loan of $200,000. Then probably with the properties down, it’s worth just $100,000. You’re able to get the bank to accept the short sale of $100,000, so they’re writing off the other $100,000.
Jason Hartman: And they’re giving you a 1099 for the debt relief.
Diane Kennedy: Right. They give you a 1099 for that. That’s taxable income to you. You’re going to have to pay taxes on the $100,000. But the benefit you’re going to get or the offset is you’ve got something with a basis of $200,000 because that’s what you paid for it, but you just sold for $100,000. So there’s taxable income of $100,000, but there’s also loss of $100,000. So it ends up zeroing each other out.
Jason Hartman: Now, Diane, I have to ask you about this. Wasn’t it Bush last year that said when all these short sales were occurring and people were getting this debt relief that they didn’t have to pay tax on that? Was that only on their personal residence, not investment properties?
Diane Kennedy: I’m so glad you asked that question. It was just the personal residence. Here’s a little other thing to be aware of. It’s only for federal tax. California did not adopt it, so for people who had that debt relief, for some their personal residence, they’re still going to pay California tax on it.
Jason Hartman: Yeah, that was the same with the Go Zone when we were really active in the Go Zone. People were buying properties there. It doesn’t get you out of the People’s Republic of California. You still have to pay the franchise tax board. And in whatever state you’re in, if they have a state tax, you have to pay state tax. So that’s a good distinction. What else should people know?
Diane Kennedy: I think the part with real estate when it comes to taxes is it’s really important to be strategic and think about what is the end game we want here with the taxes. For example, if you’re buying a lot of property and you’re picking up great cash flow – I have a friend that just bought two houses in Detroit for $500; had to put about $10,000 into them, got them both rented right away. I mean she’s going to make money on that without a doubt. So we need to look for all the write-offs you can get for that. The question then to look at is if we create a big paper loss for her, is it something she can even use? Is she going to qualify as a real estate professional and be able to take it?
If not, maybe it’s not worth it to take those extra steps. Maybe we just want to zero out income. So be strategic in what you’re thinking of with the real estate. It’s possible to do what’s called “front-end loading” with your depreciation and end up in the first 5 – 7 years creating huge paper losses on your real estate. If you can take advantage of them, that could be a great thing. But if you can’t, you’re just creating more of an audit risk and you’re just going to suspend losses anyway. It doesn’t make any sense.
And I think that if you have property that you’ve dumped through – you’ve had to do short sales, foreclosures, deed-in-lieu of, or you’ve done loan modifications on them, before the end of the year, talk to your tax planner about this. Make sure you have this planned for because there can be some tax consequences you haven’t thought of, and it’s not too late to do something about it as long as you do it before the end of the year.
Jason Hartman: Okay, good to know. Now, one of the great things about real estate and income properties is that if people followed a good prudent strategy and they were using debt properly – I don’t say to abuse it, but it’s a very powerful tool if you use it correctly – a lot of people are very fortunate, and now, again, they’re getting a whole other bonus. They’re getting loan modifications. And by the way, for our listeners, I’ll do a little shameless self-promotion here. We have a Do-It-Yourself Loan Modification Kit that you can purchase at HYPERLINK "http://jasonhartman.webimpakt-green.com" www.JasonHartman.com, so there you go. What are the tax implications, if any, on a loan modification? What should people be considering here, Diane?
Diane Kennedy: Well, it depends on the type of property they’ve got. For example, the loan modification on a principle residence isn’t going to have any federal tax implications at all, except on debt forgiveness, we’ve got forgiveness on that. In California, we have that. If you have an investment property, there can be some tax consequences on that. This could come in as cancellation of debt and it’s offset then by some basis adjustment. But you don’t have a sale to create a loss, possibly. This is where you need to get out your thinking cap and figure out how to avoid tax issues on that.
Jason Hartman: But we have to make the distinction. I think the type of loan modification you’re referring there to, Diane, is where they actually reduce the principle balance of the loan, right?
Diane Kennedy: Yes. That’s the kind we’re talking about, exactly.
Jason Hartman: So they might modify a loan and they might just make it zero interest for the first five years. They did that on one of mine, which I couldn’t believe. Or they might lower the interest rate. They might do forbearance on payments. There are different types of loan modifications. And I guess none of the others I wouldn’t think would have any tax implication, other than the principle reduction loan modification, is that correct?
Diane Kennedy: That’s exactly right. Very good distinction. So if they’re lowering your interest rate, if they’re saying you can miss a few payments, none of that has a tax consequence. That’s a great strategy. But if they’re lowering your principle, you could have a tax issue. But on the other hand, they’re lowering your principle actually, too.
Jason Hartman: Listen, Diane. I’ll just admit it to everybody. If I do on a game show and win a million bucks, I don’t mind paying taxes on that. That’s basically what a principle reduction loan modification is. You just won the game show, if you will, and got a big tax consequence. Anything else on the loan modification?
Diane Kennedy: I think, again, like you said, there are so many different possibilities out there. Just be aware of what’s going on and what you’re doing.
Jason Hartman: Now, you really specialize in your practice in the real estate field, right?
Diane Kennedy: Yes, real estate and small business. In fact, that’s the only clients we have are small businesses.
Jason Hartman: Do you want to take a few minutes and talk about anything in the business world? A lot of our listeners are home-based entrepreneurs. They own a small business. They might be what we call a solopreneur. Any tax things there that you want to bring up?
Diane Kennedy: I think there would be three little tips for this year. No. 1, if you’re in a sole proprietorship, which means it’s a scheduled fee, you have a one in three chance of being audited right now. We’re moving everybody we can into business structures of some kind, an LLC, an S Corp, a C Corp. It depends on what’s best for them. Sole proprietorship is just an audit red flag, so be aware of that one.
The second one, as we’re kind of getting ready for year-end and looking at what kind of deals can we write off, what should we be thinking about, a lot of times, people start thinking about buying some equipment, new computers, printers, that type of thing. For 2009, we actually have three different ways that you can take advantage of depreciation, which when you’re buying furniture and equipment, you don’t get an immediate write-off. You have to capitalize the assets.
No. 1, we’ve got Section 179, which lets you have the immediate write-off. You can take up to $250,000 off this year. It’s a huge number. That’s a lot of computers.
Jason Hartman: So the IRS wants people to buy capital equipment for their business. That’s what they’re incentivizing, right?
Diane Kennedy: Exactly. They’re trying to get the economy kick started, and so they want to help you do that, make that choice. Well, Section 179, one little piece in here – and this is going to lead into the third awesome thing that they’ve done for us – but Section 179 can’t take you to a net operating loss. In other words, you can use a Section 179 to the point that it takes you to zero. No. 2, you could have instead “bonus depreciation.” Bonus depreciation is you get to take a write-off of 50 percent of whatever you paid right off the top, and then do your regular depreciation.
So this could be a really cool thing because it can take you into a net operating loss. One part here, in order to get bonus depreciation, it has to be brand new. Now, this could wrap up with the third reason that I really like the net operating loss and why I’m mentioning that. In 2009, we have the ability to take the loss back five years. Now, this could be pretty huge. If people had businesses that are maybe not doing as well right now in this economy, but maybe five years ago, they had some banner years and were paying a lot of taxes. They can take that net operating loss, carry it back to those good years, and get a refund. The IRS is supposed to pay you within 45 days that refund. If they don’t, they’re going to pay you interest.
Jason Hartman: Wow. The IRS is going to pay us interest for a change? I love it.
Diane Kennedy: Yeah. I have to tell you I told this to a client. In 2008, we had the same rule as this five-year window. He was a guy who had made a ton of money five years before, and had a big loss in 2008. We took it back five years. He’s getting a refund of $200,000, and I said, well, the IRS is going to pay you within 45 days or they’re going to pay you interest. He didn’t believe me. He got his check within 45 days. What a difference that made!
Jason Hartman: Wow! Sure, it did. Now, what’s the benefit here? Was the prior rule, Diane, was it two years carry-back?
Diane Kennedy: It was; it was two years.
Jason Hartman: And now it’s five, so there are more years.
Diane Kennedy: Yeah, so it’s five years. And what’s happened is if it was only two years for this year, you’d be looking at 2007 and 2008, and for a lot of businesses, those have been tough years. They don’t have huge wins in those years. So going back five years, that’s back to the banner years. They have more income then.
Jason Hartman: Right, so that’s really good news. That’s great. I’m sure a lot of our listeners just love what you said, including myself. I am thinking I might have a deduction with one of my companies on there because I have a few different corporations. So when did that go into effect, in ’08?
Diane Kennedy: That was passed, oh, gosh, less than two weeks ago.
Jason Hartman: Oh, so that’s an ’09 rule, but that means –
Diane Kennedy: An ’09 rule for ’09, yep.
Jason Hartman: Okay, so ’09 and before, is that how it works?
Diane Kennedy: For 2009, you can take that back five years.
Jason Hartman: Okay. Wow, back to 2004! That’s fantastic. Good. What else?
Diane Kennedy: The strategy right now is to be thinking about that. If you have that, then this would be a great time to really maximize the loss of the company. You’re going to take it back and you’re taking it back to say 2004, where maybe you were at a higher tax bracket. You can really start playing these brackets. I had a strategy call with one of my clients this morning and we talked about buying a bunch of equipment and taking advantage of this bonus depreciation so we have a big loss to roll back.
Jason Hartman: That’s really good for people to know. Listeners, with my business, I’m constantly doing this in my head. Sometimes I will spend money intentionally, like a drunken sailor because I know that I can get a tax benefit out of that and turn that into income later. But I want to spend it now because I get the write-off now, or I can carry back a write-off, like Diane just mentioned. There are a lot of things you want to think about because remember the single largest expense in anybody’s life is almost always tax. So this is not a boring subject by any means. There is a real big, big upside to be made by being a good tax planner.
Diane Kennedy: And you know, it’s interesting when you were talking about spending money, and it’s not always about, “Oh, we’re going to go buy stuff we don’t need.” It’s just maximizing when it makes sense to buy it. And December often is the time to buy instead of January simply because you get the write-off now.
Jason Hartman: Right, so you want to bring write-offs forward as quick as possible, time value of money, that kind of discussion. Diane, anything else on the small business?
Diane Kennedy: No, other than it’s just been an interesting time right now. We’ll have to stay tuned to see what new laws are coming into play.
Jason Hartman: Okay, well, fantastic. What else would you like our listeners to know, just in wrapping things up here? And give out your website, please.
Diane Kennedy: My website is HYPERLINK "http://www.ustaxaide.com" www.ustaxaide.com. You’ll find I’ve got a blog there. I have a forum. There’s a lot of interesting – I call them the freebies. You can sign up for free teleseminars and listen to tax and asset protection items that you need to know. Additionally, I have a full service tax practice. Come through U.S. Tax Aide and you’ll see what we do and find out if that would be something of interest.
I think in general, though, for 2009, if I were summing up what all I have to say about tax planning for this year, it’s important to know that you have the most current information and to stay on top of things. A lot of changes are coming, not just from the federal government, but also from states as they get more and more aggressive, and we’ll have to watch how sales tax and income tax are playing into that.
Jason Hartman: You know, Diane, one thing in closing here. I remember reading an article about you a couple of years ago and it was an article in one of the business magazines, and I believe it was about – yeah, it was about how the number of millionaires is declining in California, especially in the Bay Area, because people are “moving” – and I’m going to say “moving” in quotes because we all know people play that game with where their residency is to some extent, either legitimately or sometimes illegitimately. I’ll just give you an example. There’s a wealthy area here in Newport Beach where it seems like every other car has a Nevada license plate. You know these people don’t live in Nevada, but of course, California has very high taxes. Nevada has none.
And then all the beautiful yachts in the harbor in Newport Beach are from Oregon, and there’s no sales tax there. People are always doing this stuff.
But is there anything as far as desirable states or obviously, states with no state income tax are very desirable, but anything you want to say there as far as thinking for listeners there? I don’t know. I just thought I’d ask.
Diane Kennedy: Yeah. I think that, depending on the kind of business that you have, it is important to think about where your business needs to locate. For example, I have a lot of website businesses besides the ones I’ve talked about. I have other sites doing things. I make money on the side on the internet. And I’m making sure that I have my nexus, which that’s the connection “where is the business located,” in Nevada, simply because the sales tax in Nevada helps internet companies better than some other states.
For example, if you go and buy a download of some product, some states are going to charge you sales tax on that. Nevada happens to be one that does not charge a sales tax on a digital download.
Jason Hartman: Wow, okay.
Diane Kennedy: Lots of new things coming down. The federal government has a printing press in the basement. The states don’t. You are their economic stimulus plan.
Jason Hartman: Yeah, exactly. The states can’t print money. They actually have to theoretically balance the budget, which California doesn’t do a very good job of at all.
Diane Kennedy: I guess they print out IOUs there, not dollars.
Jason Hartman: That’s true. So get your refund soon before it’s an IOU. That’s some good advice that you gave people today and I’m sure a lot of our listeners will start thinking about how they can save some money on taxes. I sure learned a lot. Thank you for joining us today. We really appreciate it.
Diane Kennedy: Thank you. I appreciated it.
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Duration: 49 minutes