Peter DeGregori, CPA and Jason Hartman get into the details about IRS / Treasury Department real estate professional status, material participation, passive vs. active investing, real estate tax benefits and in-depth discussions into the Go Zone (Gulf Opportunity Zone). Platinum Investment Counselor, Gia Jurevich, hosts a Q&A. Jason and Peter also answer some common investor tax questions.

Vertical Advisors, LLP
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Announcer: Welcome to Creating Wealth with Jason Hartman, President of Platinum Properties Investor Network in Newport Beach, California.  During this weekly program, Jason is going to tell you some really exciting things that you probably haven’t thought of before, or a new slant on real estate, 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 nine states.  This program will help you follow in Jason’s footsteps on the road to financial freedom through real estate.  You really can do it.  And now, here’s your host, Jason Hartman.

Jason Hartman: Welcome to Podcast No. 28.  This is Jason Hartman with Platinum Properties Investor Network broadcasting today from the OC, Orange County, and today is part of our complete solution for real estate investors.  We have a special guest for you, Peter DeGregori, a CPA and an MST with Vertical Advisors, LLP, here in Newport Beach, California.  And he is going to be advising us on some of the details we are going to drill down today on what it takes to qualify as a real estate professional.  There are some tremendous tax benefits related to that.

Also, we are going to be talking again about the GO Zone, as we did on a prior podcast, which I know many of you listened to because we got some great feedback on that.  So let’s get into it.  Let’s talk about real estate taxation.  Let’s get some reminders on some of the tax laws.  It is now September 2007, so you’ve really got to start planning on doing tax planning for the end of the year, and make it a point to get some benefits from the GO Zone if you can qualify, so today we’re going to talk a lot about qualifying for them.

Before we start, I would like our audience to get an understanding, Peter, of what exactly you do, so welcome.

Peter DeGregori: Okay.  Thanks, Jason.  Thanks for the opportunity; appreciate it.  Well, we’re a CPA firm, and like you said, we’re located in Newport Beach, California.  We’re a little bit different.  Our firm focuses on specifically real estate investors and small to midsize companies and their owners.

Jason Hartman: Excellent.  One of the things I have noticed over the years, and Peter, I know we’ve talked about this, is that it’s really important to have an advisor when it comes to taxes.  Taxes are so complex and such a big subject that specializes in real estate or in business or whatever you need in particular, so that’s excellent.  Go ahead; tell me more.

Peter DeGregori: Right.  Actually, a lot of people when they come to us will say they think all CPAs are the same, but they’re actually different.  You have the big, big firms for Fortune 5000 companies and you’ve got the small guys for just your wage earners.  Real estate professionals and small to midsize business owners need a CPA that knows what’s going on in that specific industry.

A couple things as I’ve been in the real estate industry for a while.  I’ve spoken at some Robert Kiyosaki Rich Dad events, Diane Kennedy events, and those two authors, which I’m sure the majority of all of your listeners know them, have some great resources, so go to those books and look at them, some great resources.  I have also spoken at a couple different events tailored to business owners, eBay Live, et cetera.

Jason Hartman: Excellent.  Well, what does MST stand for?  That’s one of the six letters after your name.

Peter DeGregori: Yeah.  MST stands for Masters of Science and Taxation, and what that means is it’s a graduate degree in tax law.  It’s like carving out law school just on tax law.

Jason Hartman: Excellent.  What makes Vertical Advisors different from other CPAs?

Peter DeGregori: Like I said, we have our own special niche.  We focus on the problems and the issues that small to midsize business owners deal with and real estate investors deal with, and real estate tax law is actually pretty complex.  It’s pretty deep and we’re going to get into some of those topics today.

Jason Hartman: Absolutely.  Well, give us a refresher on real estate tax law and let’s just jump into the topic here.

Peter DeGregori: Sure.  First off, real estate by definition is what the IRS or the Internal Revenue code calls a passive activity.  And as one of your previous podcast specialist’s interview went over – I think her name was Carla.  She did a great job.

Jason Hartman: Yep.

Peter DeGregori: She said that real estate by definition is a passive activity, and what that means is there is a totally different area of tax law that deals with real estate.  And we’re not going to get into the specifics, and I want to remind everyone that we are going to talk about general tax law and you need to go see your own tax advisor because every taxpayer has specific issues.

Jason Hartman: Yeah, that’s important actually.  I’m sorry I didn’t say that right up front like I have on other podcasts.  Just remember that Peter is an expert in taxation, but again, here on a podcast, there are many specifics that apply to individual listeners.  Everybody has a different tax situation, so what the purpose of this is is to educate and inform you and give you concepts and ideas that are somewhat general in nature and conceptual in nature and go back and take them to your own tax advisor, or call Peter or call Carla and get specific advice for your specific situation.  So again, in a format like this it can always only be general, so please bear that in mind.  Go ahead, so passive activity.

Peter DeGregori: Right.  So let’s jump back.  Real estate by definition is considered a passive activity.  And what does that mean?  In a general term, it means that passive losses, which is the real issue, can only offset passive income.  So if you have passive income, no big deal.  It just goes; you pay some tax.  But most real estate investors know one of the beauties of investing in real estate is that if they find the right property with your help, that they will be able to have a tax loss.  So the next step is, “How can I get those tax losses to reduce my taxes of all my other income, wages, flow through from businesses, stuff like that?”  And there’s really two loopholes.

Jason Hartman: Okay.

Peter DeGregori: Loophole 1 is called material participation, and as Carla spoke in the previous podcast, pretty much anyone can qualify.  It’s pretty much a give me.  The IRS gives it to you.  However, it’s limited and most real estate investors aren’t able to use this.  And the quick down and dirty of this is it allows you to take $25,000.00 of passive losses to offset non‑passive income.

Jason Hartman: Okay.  Now, does this depend on your income level here?  Are we talking about that yet or is that something we talk about later?

Peter DeGregori: No, it does.  And it’s probably hit you, Jason, I’m guessing.  So the general rule, passive losses can only offset passive income.

Jason Hartman: Okay.

Peter DeGregori: Two loopholes.  Loophole one, material participation.  Let’s just say it’s a give me.  It allows you to write off $25,000.00 against non-passive income, and like you said, there’s some limits.  So with tax law there’s always all these little hurdles that you’ve got to get over, and we’re going to talk about more of them today.  If you have more than $150,000.00 of AGI, and that’s the number on the bottom –

Jason Hartman: Adjusted gross income.

Peter DeGregori: That’s right.  That’s the number on the bottom typically of Page 1 of your federal tax return.

Jason Hartman: Okay.

Peter DeGregori: You can’t use this, so most real estate investors will accumulate wealth and their AGI is going to be over $150,000.00 and they’re not going to be able to take this.  So if they can’t take this –

Jason Hartman: By the way, just out of curiosity, Peter, can you clarify what – if you’re filing jointly for married people or separately, how does it play into that?  Is that $150,000.00 AGI for each spouse?

Peter DeGregori: Well, it’s not.  It’s a good question.  Here’s the issue is let’s say you’re filing joint.  Most of my taxpayers or actually most of my clients are joint or they’re single, so this law is going to look at $150,000.00 on the joint tax return or it’s going to look at a single tax return.  If you’re married filing joint, then you have to look at different issues.  It’s going to start changing the law, so rather than $150,000.00, it might cut it down to $75,000.00.

Jason Hartman: Okay.

Peter DeGregori: Okay.  So the big thing here for people that are single or for married, if your AGI is over $150,000.00, you’re not going to be able to take $25,000.00 of loss against ordinary income.  Now, a $25,000.00 loss isn’t that big for big real estate investors, but it can help out for the right taxpayer.

Jason Hartman: Sure, okay.

Peter DeGregori: The next loophole is the one that we’re going to get into more detail today, and that’s the one, Jason, that you told me your listeners have been a little bit confused about.

Jason Hartman: And it is confusing, let me tell you.  This next one is a wonderful benefit for those who can qualify, but there is a lot confusion surrounding it, so we’re glad you’re here to clear it up, Peter.

Peter DeGregori: Thanks.  I’m going to try.

Jason Hartman: Okay.

Peter DeGregori: The next one is called real estate professional, and Carla touched on it.  Real estate professional status doesn’t mean you have to have your real estate broker’s license, although it can help.  It’s a definition within the Internal Revenue code.

Jason Hartman: Okay.  So it’s not related to whether you’re in the real estate business in the sense that you sell real estate to people.  You’re like a realtor, a real estate broker, real estate agent.  It doesn’t relate to that then.  It relates to the way you invest?

Peter DeGregori: Well, it will indirectly relate – it could indirectly relate to those items, and we’re going to talk about what sort of activities allow a person to qualify for real estate professional status, but let’s kind of step back, talk about general and then we’ll dive down to those specific questions.

Jason Hartman: Sure.  And the reason I mentioned that is because when people come to our live events and they’re in our office and we’re working with them and counseling them on their investments, they always ask, “Well, I don’t want to get into the real estate business.  I already know 5,000 realtors.”  Everybody does.

Peter DeGregori: Right.

Jason Hartman: Kind of a California joke.

Peter DeGregori: Right.

Jason Hartman: “And so does that mean I can’t do this?”

Peter DeGregori: Absolutely not.

Jason Hartman: Yeah, good.  Good news.  So that’s good news.

Peter DeGregori: Absolutely not.

Jason Hartman: So keep listening, everybody, okay?

Peter DeGregori: So we’re going to go into real estate professional status, and this is that really great loophole, to be able to take passive losses and offset them against non-passive income.

Jason Hartman: Excellent.

Peter DeGregori: So let me give you a quick example.  Let’s say you make $250,000.00 in wages, and one of the taxpayers, husband or spouse, becomes a real estate professional status.  You get some great property, maybe some in the GO Zone, which we’re going to talk about earlier.  There are some great advantages over there.

Jason Hartman: Okay.

Peter DeGregori: You could take $250,000.00 of real estate losses and offset your wages and have zero taxable income.

Jason Hartman: That is so awesome.  I tell you, I always say that taxes are life’s largest expense, and if there is anything we want to learn to be savvy about, it is saving money on taxes and doing what the government is trying to motivate us to do which is provide rental housing to people.  And they give us such great rewards for it, so keep going.  That’s great.

Peter DeGregori: Okay.  So on real estate professional status, everyone should really listen to this if they want to use this strategy.  The real estate professional status can really increase your ROI on real estate also because it’s going to save you some taxes.

Jason Hartman: Yeah.

Peter DeGregori: So listen up.  First off, I just want to tell everyone that the IRS is looking at real estate professional status.

Jason Hartman: I’ve seen some stuff recently in the media that they’re cracking down on this a bit because I guess a lot of people are abusing it or have been abusing it.

Peter DeGregori: Yeah.

Jason Hartman: So you want to really make sure you qualify ironclad for this.  It’s a great thing, but again make sure you qualify.

Peter DeGregori: Right.  So real estate professional status, we’re going to jump into it, and just a little bit of a refresher as Carla mentioned last time.  You need to work on or in real estate 750 hours or more – and that’s the big kicker – and more hours than you spend on all of your jobs, and it’s typically all of your jobs that you earn income.

Jason Hartman: Okay.

Peter DeGregori: So a quick example is let’s say you work part time.  You work 1,500 at a part-time job.  You’re a W-2 or maybe you’re a sole proprietor.  You have your own gig.

Jason Hartman: Okay.  So now let’s just clarify that for the listeners.  The typical American work here is considered to be 2,000 hours a year, 50 weeks, two weeks vacation theoretically.  If you’re a European, you probably work a lot less than that, so 1,500 hours a year?

Peter DeGregori: No, no, no.  You – 1,500 hours, Jason, was just an example.

Jason Hartman: Oh, okay.

Peter DeGregori: So let’s take a more realistic example of some of the real estate investors that you’re dealing with.

Jason Hartman: Sure.

Peter DeGregori: You have a full-time job, and let’s say you’re just working the minimum of 2,000 hours.

Jason Hartman: Okay.

Peter DeGregori: Okay.  You would have to spend 2,001 hours in real estate activities.

Jason Hartman: So more than your regular day job, if you will, as the expression goes.

Peter DeGregori: That’s right.

Jason Hartman: Okay.

Peter DeGregori: So most of the people that are coming to me have already kind of shifted out of their W-2 job.  Maybe they’re part time or they run their own business or one spouse stays at home.

Jason Hartman: Right.

Peter DeGregori: And you’ve got to strategize the right timing and the right person, who’s going to focus to be on that real estate professional status?

Jason Hartman: Now, what I’ve noticed, Peter, in talking about this at seminars and having questions answered by the tax expert we had at the seminar is that it’s a pretty good deal for married people really with one spouse not working, so if one is staying home with the kids, that’s the person that usually gets qualified as the real estate professional because the other spouse is working 50 hours a week.  So that kind of is a benefit to married people, right?

Peter DeGregori: I would say so.

Jason Hartman: Yeah.

Peter DeGregori: And one of the hurdles which is non-tax is the husband has to talk the spouse – or maybe it’s the wife that’s bringing in the money.  One of them has to talk the other one into doing this.

Jason Hartman: Okay.

Peter DeGregori: And if they have a large family, it might not be practical but it’s definitely easier.  I would say it’s a great strategy.  A lot of my clients also will say, “Hey, now the kids are out.  My wife wants to get back into work.”

Jason Hartman: Right.

Peter DeGregori: “We own real estate, she sees it, she likes it, she can work out of the house.”

Jason Hartman: Yeah.

Peter DeGregori: So she can focus on being that real estate professional status, so 750 hours and more hours than your normal job.  That’s what you need to meet for a real estate professional.

Jason Hartman: Okay.  So let’s just recap that.  It’s 750 hours a year and – or is that, “or?”

Peter DeGregori: “And.”

Jason Hartman: “And,” good.  And more hours than your day job –

Peter DeGregori: That’s right.

Jason Hartman: – as the expression goes.  So if you work 750 hours a year and just have a part-time job, then you’ve got to work 751 hours a year to become a real estate professional in the real estate business.  Define that.

Peter DeGregori: Yeah, great question.  First, I would really like more of my clients not to say 751 hours, so maybe it’s 50, 100, 200 more hours than they work another job.

Jason Hartman: Okay.

Peter DeGregori: Just so you have a little bit of a hedge if you get audited.

Jason Hartman: Sure, yeah.  And you always want to have multiple strategies in case of an audit and have multiple defenses and go above and beyond what the IRS expects so that if they kick something out or say no to something, you’ve got a little something more to fall back on.  You don’t want to just be one hour over in your example, right?

Peter DeGregori: Right, right.

Jason Hartman: Okay.

Peter DeGregori: So let’s go a little bit deeper into the real estate professional.  We have to focus on the activities.  What qualifies?  And this is a question that comes up all the time by the new people that are coming into my firm.

Jason Hartman: Great.

Peter DeGregori: The IRS defines a real estate activity as follows:  A trade or business in real property development, so your developers qualify; redevelopment, construction, reconstruction, acquisition, conversion, going from like an apartment to a condo.

Jason Hartman: To condos, yeah.

Peter DeGregori: Rental, which we’re going to hit back.

Jason Hartman: And that’s pretty much what our clients are engaged in, rental or operations I guess.

Peter DeGregori: Right.  And we’ll touch on that in more detail.

Jason Hartman: Management, okay.

Peter DeGregori: Operations, management, leasing, brokerage, trade or business like you guys.

Jason Hartman: Right.  So it doesn’t hurt to be in the real estate business as a broker as an agent, in the trade if you will, but you’ve got to do some of these other things probably to – as well.

Peter DeGregori: Yeah.  If you own a development company or you’re a real estate broker or a real estate agent, you have a big leg up from someone that is not already in the industry where they’re earning their revenue.

Jason Hartman: We’ve noticed, Peter, since we started talking about the GO Zone over a year ago and our clients started investing in it, some of our clients have actually decided to join the very unexclusive ranks of getting their real estate license because they just thought that was one more thing that they could use to be involved and engaged in real estate and qualify with that number of hours.

Peter DeGregori: I think that would be a great point.  That would just add on to the side of making them become a real estate professional, but it’s clearly not going to get them over the top.  They’ve got to focus on the hours.

Jason Hartman: Right.  So in other words, let’s just talk about that for one moment because I’ve had this question asked at live seminars.  Someone, they own one rental property and they have a real estate license and they sell real estate for a living.  That person’s not going to qualify, are they, as a real estate professional?

Peter DeGregori: Well, they might.

Jason Hartman: They might?  Okay.

Peter DeGregori: They might.  It depends.  When you start getting into someone’s a real estate agent or a real estate sales person, it makes things a little bit more complicated because it gets into looking at, “Are you an employee versus you own your own business?  Are you an independent contractor?”

Jason Hartman: And in California, the vast majority, or really around the country – we’re talking US now if you’re out of the country listening.  Of course, we’re referring to US stuff.  Our independent contractors are receiving a 1099 for their activity as a real estate agent, so any comment there on who’s better off?

Peter DeGregori: I would say someone that’s a real estate broker or a real estate sales person or someone in the construction or development business, or even maybe someone that does plumbing on new companies or something.

Jason Hartman: Okay.

Peter DeGregori: Or excuse me, new housing.

Jason Hartman: New housing?  So contractors and things like that that are involved in actually building, getting their hands dirty, they can qualify?

Peter DeGregori: Yeah.

Jason Hartman: Oh, that’s really nice.

Peter DeGregori: Yeah, because if we could touch back on it, construction, reconstruction, redevelopment, so we have some plumbing clients that the time that they spend because they are the owner can qualify.

Jason Hartman: Right.

Peter DeGregori: Now, if you’re an employee, if you’re a plumber or some other construction worker, then there’s different rules that you can either talk to your advisor, which we don’t have enough time to go over, but –

Jason Hartman: Okay.

Peter DeGregori: – but let’s focus on the final piece.

Jason Hartman: But that’s good.  It does let another group in a little more, so that’s fantastic.

Peter DeGregori: Right.

Jason Hartman: That’s excellent.

Peter DeGregori: Yeah.  So let’s focus maybe on the rental piece since it hits a lot of my clients and your customers.

Jason Hartman: Okay.

Peter DeGregori: Okay.  So rental, here’s the big issue that the IRS is looking at.  They want to separate between who’s a real estate investor versus someone that actively participates in real estate.  So to be a true real estate professional, and there’s gray area and stuff in here too, but just to kind of get my point across, you need to do some things to get your hours.  So obviously the more properties you have, the more support you have for real estate professional status.

Jason Hartman: In other words because I’ve definitely noticed that one, it kind of dovetails on the question I asked before.  If we’re talking single-family homes, for example, not apartment complexes or shopping centers or big things, but when we say property, if we’re just talking about a single property, if they own two or three properties, they’re just unlikely to be able to justify that full 750 hours a year, right?

Peter DeGregori: It’s going to be hard.

Jason Hartman: Yeah.

Peter DeGregori: But I’m not saying it can’t be done.

Jason Hartman: Okay.  All right.  Go ahead.

Peter DeGregori: So you want to get real estate professional status.  We’re focusing on the rental piece.  What sort of things do you need to look at to really solidify and build a case so if you do get audited for real estate professional status, you can win.  So having more properties is better.

Jason Hartman: Okay.

Peter DeGregori: And then doing certain things.  Most of my clients, and I’m sure your clients, have property managers because they’re going to have property throughout the whole US.

Jason Hartman: Um hm.

Peter DeGregori: Set up some sort of relationship with the property manager to where they look at all the applications for your tenants and you review them and approve them.  That puts you into more of a management role.

Jason Hartman: Okay.  So it makes you more active is what you’re saying?

Peter DeGregori: That’s right.

Jason Hartman: Okay.

Peter DeGregori: That’s right.  It makes you more into the business of being in real estate.

Jason Hartman: Excellent.  That’s very good advice.

Peter DeGregori: Some other good comments that we share with our clients, or good strategies, is on expenses.  Most property managers will pay the normal monthly utility expenses and everything right out of their accounts, right?  Well, let’s say there’s some big ticket expenses, so maybe something we tell our clients is, “Any expense over $1,000.00 has to be paid by you.”  So you’re going to look at it and really justify, “Do I need it?  I’m going to cut the check.  I’m going to look for vendors,” things like that.

Jason Hartman: On the small properties that we are involved in helping clients buy, those are typically – the management agreements look something like if the expense is over $200.00, then the property manager needs to get approval from the owner.

Peter DeGregori: That’s good.

Jason Hartman: If it’s under $200.00, the property manager can make their own decision and just fix it.

Peter DeGregori: Um hm.

Jason Hartman: Right.

Peter DeGregori: Great idea.

Jason Hartman: Okay.

Peter DeGregori: The other thing is they need to get out and look at the property, so I always talk to my clients and if they’re looking at properties, I’ll say, “God and buy a property where it makes sense from a financial perspective, but also where you like to go and visit.”

Jason Hartman: Yeah.

Peter DeGregori: So go look at the property, go meet with the tenants, do drive-bys.  Here’s the issue – you do not want the IRS to view you sitting on a porch sipping lemonade and just getting rent checks.

Jason Hartman: Right.

Peter DeGregori: Okay.  If you do that, it’s going to be very hard to justify that you have the real estate professional status.

Jason Hartman: Okay.  So a couple things on that one, Peter.  No. 1 thing is a lot of the markets that we specialize in, we’re in 33 markets around the US and currently recommend about a dozen of them because those are the right places right now, and that’s always changing; it’s always dynamic.  But go to some of these areas after you buy properties there because they’re really nice places to visit, some of them.  And I’ll give you an example, like Austin, Texas.  That’s just a great hip little town and it’s a nice place to visit.  There are a lot of great places right around the US that are just neat places to go for a little weekend trip, no big deal, not expensive.  And I’m talking to a taxman here.  Can you deduct the trip?

Peter DeGregori: Sure.  If the trip has a business purpose like you’re going out to see your piece of real estate, absolutely.

Jason Hartman: Okay.  Now, a distinction on that one is I heard that if you don’t own there, if you just go on a scouting trip you can’t deduct it, but if you own there or when you scout you actually buy, you can take the deduction.  Gray area or –

Peter DeGregori: I’d say a gray area, and here’s my –

Jason Hartman: I think if you go on a lot of trips and don’t ever buy anything, the IRS is probably going to say no.

Peter DeGregori: Here’s a bad fact.  Let’s say you go to Hawaii and write it off five times and you never bought a piece of property in Hawaii.

Jason Hartman: Yeah.

Peter DeGregori: Probably a bad fact, so my statement is do things that you can justify and be supportive and don’t get too aggressive.

Jason Hartman: Okay.  All right, good.  Now, one thing I want to also make the distinction of is that I am getting a little confused, and I know that some of the listeners probably are too because we’ve had this question asked about 100 times at live seminars.  The stuff you’re saying to do here, you’re saying, Peter, to be active, to be somewhat active in the management of your properties in order to qualify for real estate professional, but doesn’t that go back to the other issue we talked about at the very beginning of this podcast, which is material participation?  The lines are blurring for me between material participation which is what we were just talking about doing, it sounds like, and real estate professional.  What’s the distinction there?  Can you clear that up?

Peter DeGregori: Well, there are two different subsections within passive activities, and material participation is stated in the passive activities section, which we’ve just spoken about.

Jason Hartman: Okay.

Peter DeGregori: But also material participation is looked at as other investments maybe in businesses other than real estate, so that’s why some practitioners and taxpayers get a little bit confused, material participation.  Here’s the way that I look at it.

Jason Hartman: Okay.

Peter DeGregori: Is in order to be a real estate professional, you have to be not in real estate just as an investor.  And what does that mean?  You have to materially participate, use the word loosely, actively participate.  And what does that mean?  That means you have to spend over 750 hours, and more hours than your job if you have one.

Jason Hartman: Right.

Peter DeGregori: And participate how?  We talked about it, construction, rental, management, leasing, brokerage, real estate.  Those are the issues.  And a lot of people out there are going in and buying properties specifically in the GO Zone, which we are going to talk about a little bit more, thinking that they’re going to get this big write-off.  And they need to know if they’re going to qualify or not, and we’re going to get into that in a minute.

Jason Hartman: Okay.

Peter DeGregori: Because the GO Zone area can be a great tax benefit for someone that can qualify for the benefit.

Jason Hartman: Okay.  Before we leave the subject of number of hours per year, 750 hours per year to become a real estate professional or more hours than your regular job.

Peter DeGregori: “And.”

Jason Hartman: “And,” sorry.  Not “or,” that’s “and.”  Thank you.  Okay.  Now, one of the challenges we’ve had is that clients will come to one of our events or they’ll call us on the phone or email us and they’ll say, “This GO Zone thing sounds fantastic.  I want to buy – I want to identify and buy six, seven, ten properties in the GO Zone, get these tremendous tax benefits,” and we’ll talk more about that in a moment.  But it’s October and I work 2,000 hours a year at my regular job and the person’s not married, or they’re married and their spouse works also full time.  Can I qualify?  And the answer is probably not going to be real good I think here because they don’t prorate it, right?

Peter DeGregori: No.  They don’t prorate it.

Jason Hartman: Yeah.

Peter DeGregori: I would agree with you.  It’s going to probably be very difficult, so that’s something that we start having a discussion with them and say, “Well, does it blend into your strategy that one of you qualify as a real estate professional in ’08?”  And then trigger the property purchase in ’08.

Jason Hartman: So you might want to concentrate on regular non-GO Zone properties this year in ’07, take the traditional benefits of real estate investing, a good return, leverage, paying your loans back in depreciating dollars.  And God knows the dollar is going down the tubes at the time of this recording, at least.

Peter DeGregori: Right.

Jason Hartman: Which is good for real estate investors that borrow money, and we’ve talked about that on other podcasts.  And then do the GO Zone properties in January maybe because you can only receive the benefit of that accelerated GO Zone depreciation in the year you buy/place it into service, right?

Peter DeGregori: Correct.

Jason Hartman: Could you buy it this year and then not place it into service until January?  Because we’re almost in real estate time we’re at the end of the year now basically.

Peter DeGregori: Hypothetically, yes.

Jason Hartman: Yeah.

Peter DeGregori: Some quick examples is maybe it’s not rent-ready.

Jason Hartman: Right.

Peter DeGregori: There’s a lot of new construction there and maybe it’s not fully finished yet.

Jason Hartman: Okay.

Peter DeGregori: So that’s not even just a specific GO Zone issue.  That’s a specific tax issue on any property.

Jason Hartman: Okay, good.

Peter DeGregori: So if it’s not rent-ready, then of course you could buy it, close on it in ’07, and not place it into service until ’08.

Jason Hartman: Until ’08, yeah.

Peter DeGregori: And then you get to the issue, do you qualify to be able to take the benefits?

Jason Hartman: In ’08.

Peter DeGregori: That’s right.

Jason Hartman: Yeah, in 2008.  Okay, good.

Peter DeGregori: And Jason, one thing I want to mention is even though my passion is reducing taxes for my clients, the taxpayers out there need to first look at, is this a good deal even before the tax benefit?

Jason Hartman: Right.

Peter DeGregori: Okay.  And I think some of the information packages that you have for your client is very informative because you show them their return before taxes –

Jason Hartman: And after tax, yeah.

Peter DeGregori: – which is positive.

Jason Hartman: Right.

Peter DeGregori: Which is good.

Jason Hartman: Yeah.

Peter DeGregori: That’s a big leap right there.

Jason Hartman: Sure.

Peter DeGregori: And then how it even increases if they get the tax benefit.

Jason Hartman: Thank you for mentioning that because you just reminded me, we had our team meeting here for our staff in-house, and we were talking about how with the mortgage meltdown issue, it’s getting harder to qualify to buy properties, which is good and bad.  Bad in some ways but very good in others.  It’s definitely causing rents to increase all around the country, but that happens kind of slowly over the course of a year or so.  But we were talking about how we used to say on pretty much any property we sold, if you’ve got it rented and you followed our advice and you put 5 percent down, you could get a 40 percent annualized return on investment before tax benefits.

Now, nothing is guaranteed, of course, but if A-B-C-D happen, that will happen, right?  And it was terrific, and a lot of our clients benefited from 40-percent or even better returns, but the problem is now with more money down, you can’t use as much leverage.  And when you use less leverage, the investment doesn’t perform quite as well as it did.  It performs well, but not quite as well.  And so I was saying I think we’re going to have to start redoing our pro formas, and now the rates of return are around 30 percent, 28 percent.

And someone in our meeting says, “Why are you concerned about that, Jason?  That is a phenomenal rate of return.  I mean, where else can you get 25, 30 percent on an investment every year?”  And that’s before tax benefits, and then of course with tax benefits, that’s individual to each taxpayer so it varies quite a bit, but there are definitely tax benefits there.

Peter DeGregori: Yeah, it’s still a great return.

Jason Hartman: Yeah, it’s phenomenal.  Okay.  What we’d like to do now is take a little bit of a break and invite in one of our investment counselors, Gia Jurevich, who has some questions and case studies from specific clients of ours and wants to ask Peter about them.  So Peter, you’re the answer man, and Gia, you’ve got some great questions, so welcome Gia and Peter.

Gia Jurevich: Thank you.  Peter, I have several clients who are in the situation where the husband works a full-time job.  He’s a W-2 employee, the wife is a stay-at-home mom, doesn’t have a job on the side, and they want to qualify for GO Zone, so starting here in September or October, what would they need to do to get themselves qualified for this year?  Is it even possible or should they just work on 2008?

Jason Hartman: If I can just make a distinction on that one, Peter.  She says, “qualify for GO Zone,” but do we want to really say, “qualify for unlimited passive losses”?

Peter DeGregori: I think really what the investor is looking at is qualify for the GO Zone tax benefit.

Jason Hartman: Okay.

Peter DeGregori: Common question.  Hear it often so it’s a great question.  I’m going to go over it quickly because Jason and I covered it just a little bit.

Gia Jurevich: Okay.

Peter DeGregori: But I think it’s good for Q&A.  Perfect situation, the wife would need to qualify as a real estate professional because I’m going to assume husband and wife have combined income over $150,000.00.  So if they don’t have any passive income.  Let’s assume they don’t have any passive income, or even if they do, in order to get the benefit of the GO Zone, they’re going to have to qualify as a real estate professional.  Okay.  So first off, does your client – do we want to assume that your client has other rental income, passive income or not?

Gia Jurevich: No.  They’re coming in without any other rental income.

Peter DeGregori: Oh, okay.  So no other rental income, and this might be their first or second investment, so in order to get that big tax benefit, wife is going to have to qualify for real estate professional status, which means over 750 hours in real estate activities which we discussed, and more hours than any jobs that she works on and you said that she doesn’t have another job.  So this is a perfect situation to where a wife can get involved doing some things if she has a desire to get back working, do it from home, and save the family some big tax dollars.

Gia Jurevich: Okay, great.  All right.  So how many properties would it take the couple to qualify for the 750 hours?

Peter DeGregori: Well, there’s nowhere in the Internal Revenue code that it says you have to have a certain amount of properties, so that’s first.  I would say that you’re going to really need to have more than one.  That’s 15 hours a week to get to 750 hours, and you really want to be able to support it if you get audited.  You want to be able to sleep at night, so whether it’s three, six, it really depends, and that’s something that you have to work with your real estate investor on, understand the property and work with your tax preparer.

Gia Jurevich: Okay.  Is it required to have a real estate license?  Does it help?

Peter DeGregori: It’s not required, so real estate professional is a status definition within the Internal Revenue code.  It doesn’t say you need to have a real estate license.

Gia Jurevich: Okay.

Peter DeGregori: I would say that it helps in a couple ways.  One, it’s going to help when you’re buying and selling properties because you as a real estate sales person should be able to pay less commission or get some commission, so that’s going to help in a financial aspect, but also it’s going to be a helping factor but purely not win it to be qualified as a real estate professional status.

Gia Jurevich: Okay.  And another issue we have come up is we have a lot of clients who have passive income from rental income.  And so what can they use the GO Zone write-offs for?

Peter DeGregori: That’s a great question.  So as I said earlier, generally passive income is just passive income.  You pay tax on it.  But what happens if you have passive losses?  Passive losses in excess of passive income, you have to get to those two loopholes, which I talked about.  And we’ve been spending a lot of time on real estate professional status, but let’s say, as you just said, your investor is not in that situation.

Let’s say your investor has $300,000.00 of passive income, has had some properties for a while, doesn’t really have any more depreciation.  They have good rent rolls.  They’re making the money, and that was the reason why they got into it.  They might want to look at diversifying and buying some property into the GO Zone because then they can take that accelerated bonus depreciation and hopefully get that loss, not a cash loss hopefully but a taxable loss with that bonus depreciation of around $350,000.00, and then it zeros it out.  If they hit the numbers right, that’s a great answer.

Gia Jurevich: Okay.  So just to clarify, they do not have to be a real estate professional to take advantage of the GO Zone in this situation if they have passive income.

Peter DeGregori: No, they do not.  The real estate professional status only comes into play when your passive losses exceed your passive income, so then the real estate professional status allows you to take passive losses against non-passive income.  And what it really does is it converts it to be non-passive losses, and that’s how you can write it off to wages and other income.  But in your example, that’s a great strategy.  Wipe out the passive income that you got on the older properties.

Gia Jurevich: Okay, great.  Thank you.

Peter DeGregori: You’re welcome.  Great questions.

Jason Hartman: Excellent.  Okay.  Let’s talk about the GO Zone now specifically.  Now, for those of you who may be listening to our podcast for the first time, the GO Zone is an area in the Southeastern United States that – like another area that was known as the “Liberty Zone” up in the Northeast New York area – provides some tremendous, tremendous tax benefits, probably the biggest gift the IRS has ever given us in terms of tax benefits.  And basically what qualifying investors can get is a 50 percent accelerated depreciation.

Remember, one of the wonderful things about real estate is it gives you these phantom write-offs called depreciation.  In other words, they’re what’s known as non-cash write‑offs.  When we want a write-off, if we own our own business, we have to spend money.  If we’re not in our own business but we just want a write-off and we donate money to charity, we donate the money and take a deduction.  Well, one of the wonderful things about real estate, just to recap on this, is that we get a write-off without actually paying for it, these non-cash or phantom write-offs known as depreciation.

And there is a publication about the GO Zone.  If you have trouble sleeping, you can take a look at our website at www.jasonhartman.com and we have posted their IRS publication 4492, and it’s also on the IRS website which talks about the GO Zone, but an expert like Peter can really help you with the details of this, and his contact information is in the show notes for this show.

Now, Peter, with the wonderful GO Zone benefits, is there anything our listeners need to know that is particular, unusual or special about 1031 tax deferred exchanges?  Now, maybe you want to just quickly explain what a tax deferred exchange is and then talk about them as they relate specifically to the GO Zone.

Peter DeGregori: Okay.  It’s a great question.  It popped up just with a client of mine last week.  First, let’s talk about 1031 exchanges, which are also called like kind exchange.  It’s when you take one investment property and exchange it for another property.  So let’s say you have a house in Newport Beach and you bought it ten years ago when it was much more affordable.  You’ve made a boatload of money on it and you want to get out.  Hopefully you actually got out before, but let’s say you want to get out now, and you want to go into maybe let’s say the GO Zone.

So the issue is let’s say you have, oh, I don’t know, $300,000.00 built-in gain in there, so from when you bought it from what it’s worth that you’re selling it, you do a like-kind exchange.  You hire a 1031 exchange qualified intermediary.  You can’t touch the money.  It goes into escrow.  It stays in the escrow and you use – you exchange Property A for Property B.  And the advantages of that like-kind exchange is that you can get a new property, use that built-up appreciation in there to buy a bigger property and not have to pay any tax.  You’re deferring your tax to some future year.  Now, when you’re dealing with the GO Zone, one of my clients called up and said –

Jason Hartman: One comment on that.

Peter DeGregori: Sure.

Jason Hartman: Isn’t that wonderful, though, compared to stocks?

Peter DeGregori: It is.

Jason Hartman: Because every time you sell a stock you get taxed.  There’s no like kind or 1031 tax deferred exchange on stocks, is there?

Peter DeGregori: That’s correct.

Jason Hartman: So if you make money in your own business or you own stock and you sell it, you pay capital gains tax no matter what.  But on real estate, not only do we get preferential tax treatment when we own the property through this benefit of depreciation, but we also can trade it all our lives and never pay tax if we do it properly.  Isn’t that just great?  I love that.

Peter DeGregori: It is.  It’s a great strategy, and congress has put it out there, and also with the GO Zone, congress has put it out there because they want to incentivize taxpayers to get into real estate.

Jason Hartman: Yep.

Peter DeGregori: The government can’t do it.  They already have enough stuff that they’re going to do.

Jason Hartman: Right.

Peter DeGregori: But let’s talk about like-kind exchange and the GO Zone.

Jason Hartman: Good.

Peter DeGregori: Here’s the issue.  If you take a property that’s outside the GO Zone and you exchange it for a property in the GO Zone, what happens?  And the real issue is you’re going to have a carryover tax basis.  So let’s say you bought the property for $500,000.00, you’ve depreciated it, and now the property has a tax basis of $200,000.00.  Okay.  You’re going to take that $200,000.00, and that’s your what they call carryover tax basis.  That carries over into the next property, and what’s important about that in the GO Zone is that that $200,000.00, as long as it’s applied to qualified GO Zone property, now that $200,000.00 is available to get the 50 percent bonus depreciation, so you can exchange out of a non‑GO Zone, get into a GO Zone, and be able to utilize your tax basis on a non-GO Zone property to get that bonus depreciation.

Jason Hartman: So that’s a really good thing, right?

Peter DeGregori: It is.  It’s another advantage for people that are looking at getting into the GO Zone.  Now, this area right here is not specifically identified into the IRS pub.  It’s an issue that requires more tax planning, but this is the position that we’re working with and we feel comfortable with with our client.

Jason Hartman: Excellent.  What are some other benefits of the GO Zone?

Peter DeGregori: There’s a couple other benefits which people are not focusing on as much as the 50 percent depreciation, but this might be something for other real estate investors.  I think Carla touched on it last time, and I want to just bring it up again.  Let’s say you go into the GO Zone, you get some big losses, you qualify and you can use them, i.e., you’re a real estate professional status.  You create a big loss.  You can carry it back up to five years.  Okay.  You go year five, four, three, two, and you get a refund, and you talked about that on one of your last podcasts.  A great way to get cash back in, and then you can parlay that and put it into more property.

Jason Hartman: So isn’t that wonderful?  Basically, we’re sitting here in 2007, and qualifying investors that buy qualified GO Zone properties can go back and get a refund of the federal taxes they paid in 2002?

Peter DeGregori: Yes.

Jason Hartman: Wow.  Is that cool or what?

Peter DeGregori: That’s great.

Jason Hartman: I mean, 2002, 2003, the last five years you can get that money back.

Peter DeGregori: That’s right.  Oh, and you know, Jason, one important fact that we haven’t really discussed is we’re really talking about federal tax law.

Jason Hartman: Yeah.

Peter DeGregori: State taxes are totally different.  For example, real estate professional status does not exist in California, so the California residents cannot lower their California state tax by using real estate professional status.

Jason Hartman: But California residents can lower their federal tax.

Peter DeGregori: That’s right.

Jason Hartman: Excellent.

Peter DeGregori: That’s right.

Jason Hartman: Okay, yeah.  So it’s a federal tax thing.  The state’s going to get their money either way.

Peter DeGregori: That’s right.  And each state is a little bit different so you’ve got to talk with your tax preparer in each state.  Another issue that I thought was interesting is if there’s any individual real estate investors out there that like to invest in older properties, historical properties, what the GO Zone did was is it has increased tax credits for historical properties.  And a tax credit is a dollar-for-dollar reduction against taxes.  If you get bonus depreciation that lowers your taxable income and then you apply your tax rate, but a tax credit subtracts dollar for dollar against your tax, so it’s a much stronger deduction.  And what they did, and I won’t get into it too much, but there’s some good properties that might be out there that are historical that you can go in, gut it and refurbish it and you can apply for some really great credit.

Jason Hartman: Okay.  So that’s the difference between a tax deduction and a tax credit.

Peter DeGregori: Right.

Jason Hartman: Important to know.

Peter DeGregori: Right.

Jason Hartman: Good.  What else?

Peter DeGregori: The last thing I’m going to just say, which Carla touched on last time, is that this is not an AMT issue.  So AMT is hitting more and more people every year.

Jason Hartman: Okay.  So that’s alternative minimum tax, AMT.

Peter DeGregori: That’s right.

Jason Hartman: That’s really a big issue so I’m glad you brought that one up.

Peter DeGregori: And most people know what AMT is because they’ve got stung by it, but here’s the issue.  You get bonus depreciation if you qualify.  That’s the same depreciation you get for the AMT calculations, so there’s not a difference.  Big deal if you’re getting hit with AMT.  So my overall comments for the listeners out here are is when you’re going into real estate property, and specifically the GO Zone, is make sure you talk to your real estate investor guidance guy and also your tax professional to make sure the numbers are working out and make sure you’re not buying a property without understanding everything.

Jason Hartman: Excellent.  Well, Peter, thank you so much for being with us.  If our listeners have questions, you can contact Peter DeGregori or any of the people at his team at Vertical Advisors, LLP at 866-756-8868.  That’s 886-756-8868, and that contact information is on our website at www.jasonhartman.com.  Thank you so much for listening and stay tuned for a couple of announcements.

I’m here with Senior Area Manager, Karam, and we wanted to talk to you quickly about his recent trip.  He just returned yesterday from Jackson, Mississippi.  Karam, what did you find there?

Karam: Well, Jason, it was a very interesting trip.  Unlike other areas, this is a very unique area in the sense that we live here in California, and we go to all these markets and every market is different.  Jackson, Mississippi, on the other hand, the way it is different from the other areas is they don’t have the apartment complexes like we have in most of our metro areas.

Jason Hartman: Yeah.  So you don’t have that high-density attached housing, huh?

Karam: That’s correct.  So what happens is all these houses have high demand of rental, and on the rental side there is not too many houses available for rental so there is a quick rental and you get the high rents, so the cash flow is better.  But you have to drill it down to the micro area, the communities that we want to invest in, buy the investment properties.  First thing we look at is the school system.  Now, if you look at any particular city and suburb, it may have a good school system or it may not be in the good school system.  Now, one particular city may be half in one county and the other half is in a different county.

Jason Hartman: So that was true of Hattiesburg, right?

Karam: That’s correct, yes.

Jason Hartman: So if you look at Hattiesburg, you can’t choose by just Hattiesburg.  Some of the area is not so good –

Karam: No so good.

Jason Hartman: – and some is a desirable investment area.

Karam: Right.

Jason Hartman: You were telling me about how they gave you a list of 131 properties that the broker thought would be good for our investors, and the process of you narrowing it down and what you narrowed it down to.  Why don’t you tell everybody about it?

Karam: Well, I just narrowed it down to 21 properties.

Jason Hartman: Out of 131?

Karam: Out of 131, and that’s all I would sell from, 21 properties, and they are in a good school system, a good, quality product, looking at the communities, the location of the communities, location of the properties, and that’s all I came up with.

Jason Hartman: Excellent.  So Karam, talk to us about this specific property you’ve got in front of me.  This one is $179,760.00, so we’ll call it $180,000.00.  It’s almost 1,700 square feet.  Projected rent is $1,500.00 a month, and return on investment, Karam?

Karam: Yes, 42 percent, believe it or not.

Jason Hartman: Forty-two percent projected ROI, and if you qualify for all the GO Zone tax benefits, projected first-year ROI is 128 percent.  Don’t try that in the stock market, huh?

Karam: That’s correct.  The reason is these areas, not only the high rent but the property tax is very, very low.

Jason Hartman: Only $195.00 a month on that property, wow.

Karam: Right.

Jason Hartman: Good stuff.  Okay, Karam.  Anything else you want to talk to us about?  Let’s – you’ve got one more property.  Maybe this one in Indianapolis.  That looks kind of interesting.  There’s some big discounts on this.

Karam: Yes.  Indianapolis really surprised us, that market, and we are getting great deals.

Jason Hartman: Yeah.  We weren’t’ expecting this one to be so good.

Karam: Yes, great deals.  And I’ll give you an example of the property that I saw yesterday, 2,101 square feet, four-bedroom, two and a half bath, brand new, single-family house, comes with the rent-ready package, meaning washer, dryer, refrigerator, blinds, garage door opener, front and back yard sodded; for only $127,000.00.  Do you know what that means, Jason, per square-feet price?

 

Jason Hartman: Yeah, that’s amazing.  You’re buying like very close to the cost of actual construction here.  How much?

Karam: Yeah, $60.00 per square feet only.

Jason Hartman: Sixty dollars per square foot?

Karam: Yeah.

Jason Hartman: That is unbelievable.  It’s like the downside risk is almost nothing.  Go back and listen to our podcast on risk evaluation.

Karam: And, again, return on investment is 41 percent.

Jason Hartman: So 41 percent projected return on investment, and these are some good properties.  Give us a call or check out our website for more properties, and all the details are listed there, and we will look forward to talking to you on the next podcast.  Thanks.

Hey, I just wanted to announce a couple of quick things for you.  If you are able to come to one of our live events, we would love to see you and meet you in person.  We’ve had people fly in from all over the US for them.  Be sure to join us for our core event, our main event that thousands of people have attended, that’s Creating Wealth 101, on Saturday, November 10.

Join us for the GO Zone Tax Benefit event, the biggest gift the IRS has ever given the American people.  There is still a chance to recoup the taxes you paid in the last five years, so if you paid federal income taxes in 2002, do not miss the GO Zone event.  It’ll be the last one of the year, on Tuesday evening, November 13.  This event is at our office in Newport Beach, California.  Join us, and don’t miss this one.  It’s a very important event, so hopefully you can join us for some of those events.

Also, remember our rental coordinator is here to help with your rental properties.  If you need assistance with your rentals, your property managers, your advertising, remember we’re here to help, and we stay with you through the life of the investment, so feel free to call our office anytime and ask for the rental coordinator for assistance on your rentals.

Also, want to remind you, listen to our old podcasts.  At least go back to Podcast No. 13 forward and listen to all the podcasts after that.  You’re welcome to listen to all of them.  The ones before No. 13 are older, but they’re also good, but the newer ones, No. 13 and forward, which are really good ones to listen to, so please take advantage of that.

And remember, the overall market commentary right now, due to the mortgage meltdown and the sub-prime issues that are going on out there in the market, is that rents are going up all across the nation.  When people cannot qualify as easily to buy a property, they are forced to rent, so let that work in your favor by accumulating more rental property assets.  And don’t be afraid to ask for more rent and raise your rents.  That’s a good thing to do.

Also, if you are interested in career opportunities with us, our company is growing quickly and we would love to talk with you about career opportunities.  We’re in the process of getting approved for franchising.  If you’re interested in a Platinum Properties Investor Network franchise, we’d be happy to talk with you about that and get you set up there once we are finished with our approval process.

Be sure to see appropriate disclaimers and disclosures on our website at www.jasonhartman.com.  Remember that we are not tax or legal advisors.  So give us a call on any of these issues, and remember, we are here to help, and we will look forward to talking to you on the next podcast.

This material is the copyrighted creative work of either Jason Hartman, the Hartman Media Company, Platinum Properties Investor Network, Incorporated or the J. Hartman Company, all rights reserved.

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Duration:  52 minutes