Real Estate Business Tax Deductions- Q&A – Videos
Video 1 Transcript
Participant: Continuing the search in Florida. If I spend two days on my personal reasons and I spend three days looking at houses potentially to buy, I end up not buying.
John Hyre: All right, so five days in Florida, three days looking at houses. What we have to define again is was she looking at houses or was she looking at houses. All right, there is a difference.
Participant: If I really look at houses, as a result, I decided I’m not going to buy in Florida, can I write off that trip too?
John Hyre: Yes. You should be able to write off that trip. Now, if you actually buy, the cost of the trip gets added to the cost of the house. Actually, instead of a deduction, it’s added to the cost of the house and appreciated over time. You’re actually punished for buying, but you have to periodically buy to be credible.
Participant: If I didn’t buy, I can write it off all at once. Right?
John Hyre: I’m sorry?
Participant: If I didn’t buy —
John Hyre: Yes, if you didn’t buy — again it’s a reasonableness thing. You didn’t buy — but let’s say you can show me actual offers, and you can say, “No, I actually spent this much time with this realtor. Call her up and ask her.” Sometimes they will. Again, did you look at houses or did you look at houses? Wait for the mic, please.
Participant: Paying them periodically, so what is that like every month or every six months or every year?
John Hyre: What do you mean, periodically for what? You got to remind me.
Participant: For buying properties. Like you said, you have to make [inaudible 00:01:35].
John Hyre: Are you an engineer? You guys want a number. There isn’t a number.
Participant: It’s all gray, I don’t know.
John Hyre: Yes, it’s facts and circumstances, it’s gray. I think you have the idea that if you do buy periodically — if one of your trips actually results in to buy, and it’s credible, you have the evidence, you actually do it. You guys have a sense of what is and what isn’t.
Right. If you go on the trip, you show all the time you spend looking for the house. The meals, the time with the realtor, the gas, the rental car, the plane ticket, and you buy the house. You just add it to the basis of the house. It’s just like you paid extra for the house. Yes. Where are the gingers?
Participant: On the aggregation election. All my properties they don’t have any flaws or depreciation, they are all positive. Is there any reason —
John Hyre: Great, so your properties even after depreciation still show again?
Participant: That’s right.
John Hyre: Wonderful.
Participant: Yes, so it’s good.
John Hyre: We’re going to talk about actually this screen here in a minute. Let’s see if you’re doing the depreciation the best way you could.
Participant: Is there a reason to do an aggregation election in that case?
John Hyre: Is there a reason to do an aggregation election in that case — only if you’re paying the net investment income tax. In other words, real estate professional allows you to take rental losses against other income. The only time you would aggregate and be a real estate professional if it’s showing income is if you’re paying the net investment income task and you want to not pay it, and you don’t have any loses on them.
I don’t see a downside unless you change your plan down the road and start incurring losses. Remember that we talked about that each rental is considered an activity. If you dispose of one rental aka one activity, loses will free up. You don’t have any loses to free up. As long as you think you’re not going to create any, it’s okay.
You see how involved this can get? We have a lot of subjective questions that we have to know. Not just about what you’re doing now, but what are your future plans. That’s what we give into by the way. If your bookkeeping, for example, is lousy, you’re going to have a hard time answering some of these questions. It makes task planning a lot harder. I can’t emphasize enough clean books. Income statement, balance sheet, buy property.
Participant: Can that election be made year by year?
John Hyre: Can the election be made year by year? The problem is you can’t undo the aggregation. Once I make the election once, the properties I aggregated they stay aggregated even if you become not a real estate professional down the road except on Thursdays.
Participant: If you go on a trip and don’t buy anything for more than $2,000, but later decide to buy, can you still add it to your property?
John Hyre: Good question, I like it. I like it good question. You take the trip, you don’t buy anything and then a few months down the road you buy should you add the trip to the property? I would say if it’s before tax filing time, yes. Once the tax deadline goes by I would not go back and amend, it’s probably not worth it. Good question. You’re really thinking I like that.
Participant: Could we write off when we take a look at syndicated properties?
John Hyre: When you take a look at syndicated properties could you write it off? Yes and no. That’s an investment first of all. In tax parlance, there’s a difference between a trade or business which requires more activity and is more hands on.
When it’s syndicated, it’s an investment and what’s the problem? Investment gets written off on schedule A and for most of you that’s a problem because miscellaneous itemized deductions on schedule A only apply to the extent they exceed 2% of adjusted gross income. What does that mean? If you have $300,000 adjusted gross income, 2% of that $6,000, you can only take deductions on investments after they exceed $6,000. If you have $7,000 investment expense you get to take a thousand of it.
Schedule A is a lousy place for deductions. Unfortunately, you may be trapped into it because sometimes time doesn’t allow you to have a trade or business on the side. I have that issue, my practice keeps me so busy and I’m such a horrible property manager I don’t manage my properties. My activity on my rentals cannot rise to the level of a trade or business. It’s an investment activity. The deduction framework for that is different.
By the way, what do a lot of people try to do in that circumstance? Add it to the basis. That’s way better and in that case you could take the deduction on schedule A that you’re probably not going to get. You could fill it out but it still comes out zero or you add it to the basis of a property at least you get more depreciation and when you sell less gain. There are some gainsmanship where something that’s normally bad not being able to deduct is normally considered bad, you take the alternate and you capitalize it add it to the property given your probable tax circumstance, that’s probably a better answer.
Now, what does that lead us to? I will be thinking of other expenses related to your investing that we could add to the basis of the property instead of deducting it. That’s the larger lesson from your question. Good question.
No pressure three in a row? No, you guys all had good questions so far but those are some really thoughtful questions.
Participant: Going back to the question about bumping up the basis, on the gentleman’s question over here that had the research question. Can you do that though when you’re doing a 1031 exchange? Can you bump that up?.
John Hyre: Yes you can. It depends what you mean by doing a 1031 exchange. Bottom line is this, the costs of investigating the property, anything that would normally be a capitalizable expense is still capitalizable in the context of a 1031.
When you do a 1031, you’re still buying a property, you’re just using money from some other property plus potentially some outside money — extra cash, extra expenses to research, extra debt. All that counts so you want to track and I have to emphasize you want to track all of that. Why do I say that? Entrepreneur bookkeeping is almost a contradiction in terms.
Participant: I’m hearing you emphasize trade or business. Can you define those two?
John Hyre: I like you guys. What’s a trade or business? Totally! There’s a ton of case law. There are hundreds of cases and it’s going to be — remember this because it’s going to be real relevant in the context of your IRA and 401K.
You see, outside of the IRA and 401K normally because the deductions are better, we want to trade or business. Inside the IRA and 401K because of something called U-bit, which we’ll explain what that is, you don’t want to trade or business. Just like the IRS, we’re going to talk out of both sides of our mouth, we’re just going to flip-flop when we do it.
What’s a trade or business? Depends on the level of involvement and the level of activity, right? It’s the contrast between an investment that’s totally passive and a business that you’re totally into and running everyday, lots of work and time, and of course, we’re getting into these gray areas right in the middle where is it a trade or business? Or is it an investment? It has to do with the level of activity. How much time do you spend, how much activity, how much of it is managed for you?
There are some patterns, for example, interest and rents on residential properties are usually presumed to be investment not a trade or business. If you are buying and selling something a lot, or you are providing a service, that’s usually presumed to be a trade or business as long as there’s enough activity to get you there, but what’s enough utterly, utterly gray. What happens when the law is gray? We play.
There are exceptions, but most of the time the tax system rewards you, but if the law is gray, you take the position that favors you. The penalties for doing so if you get caught are typically anywhere from non-existent to not enough to discourage you from doing it as long as you have a good batting average. For example, outside of the IRA I have and activity that maybe a trade or maybe a business, maybe it’s not. I’m going to argue with this, because the mathematics favor me greatly in that respect.
Can you be both an investor and a trade or business? Not typically with regard to the same activity, but if there are separate activities, yes sure.
It can even be a separate activity — IRA is definitely a separate activity from everything else you do plus I can have a set of rentals here that I directly manage and I can have stuff in Florida I don’t manage. One’s an investment, the other one’s sort of a trade or business. Rentals are special in terms of defining them as a trade or business, that’s something that I don’t know that I want to get into right now.
Participant: Question about the syndication if you bought that, you said you could write it off into scheduled A. Now if you buy that in your business, wouldn’t you be able to write that off in your Schedule C as a business expense?
John Hyre: Not necessarily. The question is if you bought the syndication in your business, could it be written off as trade or business not necessarily because a business can buy an investment and then we have bifurcated treatment, part of what comes out on Schedule C is business and part of the other I’ll be forced to Schedule A because it was not business. Even though it was in a business, that doesn’t necessarily make it business except on Thursdays.
Video 2 Transcript
Participant: Do educational expenses relate?
John Hyre: Great question. Educational expenses. Can you write today off? You should know when I’m fishing for the trick question.
It depends. If you are in a trader business to do what real estate, rentals can be a trader business if you’re fairly actively involved which for a lot of you, you won’t be. You don’t find in California, no cash flow, you buy through our host, they manage or have a manager, you’re not in a trader business, you don’t have enough activity.
But, if you are self-managing and you’re managing a fairly extensive number, you’re busy on them, then you could have a trader business with the rentals and it’s deductible. If you don’t have a trader business, this is just an investment activity, guess where it goes, schedule A, you’re still deducted but in a place that does you’re no good.
Let’s say you took real estate courses and you screwed up? You didn’t take it from our hosts. You heard Ben Merrell on TV and you paid crazy money for something you could have gotten somewhere else that was just as good a lot less. Can you write that off once you’re in the trader business?
Let’s say you took the foreclosure course, you paid $20,000, are you in a business of buying foreclosed properties and reselling them? Are you in the business of buying them and renting them out? If the answer is, “No.” You can’t write that expense off until when? When you get on the trader business.
That’s called a startup cost. It wasn’t a cost to do in business because you weren’t doing business at a time. It’s a cost of investigating a business and it sits out in the ether and it floats there until what? You start a trader business and it goes on the book as an asset.
It’s a special kind of asset called a startup cost. First $5,000 deductible, after that it is depreciated over 15 years, 7% a year, just like land improvements.
You see how much grey there is and how much criteria and rules and hoops. Let me tell you something the Besanteen’s got nothing on us. You’re all familiar with the term when we say something’s horridly complex or bureaucratic. It’s Besanteen. If they could have seen our system, they would just call everything complex American.