CW 455 – Diane Kennedy – LLC’s, Asset Protection & Tax Savings with Tax Strategist, Financial Educator & Renown CPA

Today’s Creating Wealth Show is here to give you another taste of what to expect from the upcoming Meet the Masters event in January 2015. Speaking with Jason Hartman is renowned CPA Diane Kennedy, who is full of ideas and advice on topics ranging from international investing and its tax benefits, the ins and outs of LLCs and what your self-managing options are for your real estate investments, to name just a few issues covered.

 

Key Takeaways

07.25 – When you get involved in the issues that Diane Kennedy does, you know all about taxes and the IRS

08.30 – On a more international note, Puerto Rico is a destination that seems to offer everything to some people, and nothing to others.

09.53 – An LLC is a great and conventional way of protecting your assets. Trust it.

16.44 – It’s not to say that using entities are never good. If using them, know which jurisdiction is best.

22.27 – The Tax Extender Bill was written for those dealing with short sales or foreclosures.

26.20 – Everyone complains about the US and its laws and regulations, but we should look at ourselves compared to other countries and consider what we have.

28.03 – Diane Kennedy gives her views about real estate, the Holy Grail of tax benefits.

29.56 – You can’t just get away with calling yourself a real estate professional. There are certain hoops to jump through.

34.33 – For more information, head to www.USTaxAid.com

 

Mentioned in this episode

The Off-Shore Tax Guide by Diane Kennedy

 

Tweetables

Why is the Socialist Republic of California doing everything to make people want to leave?

Businesses and the economy just get more and more stifled through a lack of certainty and ability to plan.

Search for depreciation. With potential tax losses with the IRS, positive cash-flow and property values doubling, there’s nothing better.

 

 

Transcript

Introduction:

This show is produced by the Hartman Media Company. For more information and links to all our great podcasts, visit www.HartmanMedia.com

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 multi-millionaire 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, this is Jason Hartman, your host, and I hope you have your Christmas shopping done – only a few days left. We’re down to the home-stretch here. I was out yesterday, I went shopping at Nordstrom Rack. I think Nordstrom Rack is a great store, don’t you? They don’t pay to be advertised on the show, but it’s a pretty good store. You know, in some ways it’s better than the main Nordstrom department store because there’s so much more selection there. Anyway, save yourself money on things. As long as you don’t spend too much time and effort doing it, it’s a good idea. As Ben Franklin said, ‘A penny saved is a penny earned’, right?

I hope you have that all done and I’m wishing you the best for a holiday season here. We will have another episode on Wednesday, though, and it’s going to be one you don’t want to miss. First of all, our guest today is Diane Kennedy, renowned CPA and asset protection expert, and also speaker at upcoming Meet the Masters event. You’re really going to like what she has to say, both on this episode and at our Meet the Masters. I know she’s saved a few surprises for you that you will only get live at Meet the Masters on January 10th and 11th. It’s going to be an awesome time.

By the way, a lot of you have been asking about our Friday dinner, and we decided this Friday to better prepare for the event. On our Friday dinner, we’re going to do a team get-together and team dinner with our speakers. There will not be a Friday dinner for clients – however, Saturday dinner is on, and we’re going to have a fantastic dinner planned for Saturday. It’s our treat, so don’t bring your wallet to that dinner because we’ve got it all taken care of for you. It’s going to be a really fun time.

Our Wednesday show on Christmas Eve will be with a business credit expert. I have long followed this, I have long followed contract for deed and land contracts like our last episode, and lease options and wrap-around mortgages or all-inclusive trust deeds. All of these different – I’ll call them ‘creative’ parts of the real estate industry. They’re great, but there are a lot of hucksters out there, a lot of scam artists out there. The business credit thing has always intrigued me because basically, you can get about another $180,000 potentially, to buy properties with. You can get it for a good year to 18 months, potentially. I always have to say that because not everybody can qualify for this, obviously. It’s not that difficult, though. You’ll hear more about that from our guest on the next episode, on 456.

There are some great opportunities, and I wouldn’t have even done a show on this if this person was not referred by someone I trust. That’s why I did it, and I know of people who have actually used this and actually done it in real life, and that’s what’s always important to me, rather than just having someone you find online or some potential huckster out there who’s going to take your money and nothing’s going to happen.

One of the nice things I do on the show is I get this stuff on tape! That’s really helpful, too, so there’s a record of it and you can really know about what’s being promised and what’s being said. Anyway, that will be our next episode.

Today, we’ve got Diane Kennedy. We’ve got a great dinner at Meet the Masters on Saturday evening – Friday evening, because we’ve got our flight schedules and because we want to meet with our speakers and better prepare for the event, we will not be doing our dinner. We’ll do it on Saturday night and that is on us, so don’t bring your wallet. It’s our treat. If you don’t have tickets yet, well what are you waiting for? We are almost sold out – not quite yet. This room has a hard limit because it’s the stadium-style room, and it’s a beautiful auditorium called The Conference Theater. There is a hard limit and we probably have about 20 seats remaining. I’m not exactly looking at that right now, but I’m going to guess it’s something like 18-20 seats remaining from my last update, and probably a few more have registered since then. Get your tickets at www.JasonHartman.com and come for all these great speakers. We’ve got the last episode on contract for deed and land contracts and how you can purchase those and have a much more passive investment. If you don’t like the management side of real estate investing – you can’t do quite as well on the return, but you can do pretty darn well. We’re talking projected returns in the neighborhood of 13-14% annually, basically without being a landlord and without having that responsibility. That’s pretty good and it’s pretty reliable.

We will have that speaker and Diane speaking, and we’re lining up a talk on business credit as well. It’s unconfirmed still, but I think we’re going to get that confirmed today or in the next couple of days. Keep on listening for more good stuff and we will look forward to seeing you at Masters.

Let’s get to our guest today, renowned CPA and asset protection expert, although not an attorney – I should make that disclaimer for her: Diane Kennedy. Here she is.

It’s my pleasure to welcome renowned CPA, Diane Kennedy, back to the show. She was on a few years back and she’s the author of several books including Loopholes of the RichHow the Rich Legally Make More Money and Pay Less Tax, The Insider’s Guide to Real Estate Investing Loopholes, The Insider’s Guide to Making Money in Real Estate, Smart Lessons to Building Your Wealth Through Property and Real Estate Loopholes: Secrets of Successful Real Estate Investing. She comes to us today from beautiful Reno, Nevada. Beautiful, tax-free Reno, Nevada. Diane, welcome, how are you?

Diane Kennedy:
Boy, I’m great and you absolutely underscored it. Tax-free Reno, Nevada. We like that.

Jason:
I noticed that about you. When you lived in Mexico, you were living in – probably – well, living off-shore you can take some tax deductions, but the IRS is the only taxing agency on planet Earth that taxes all world-wide income. You can probably shelter some of it, though – I think $95,000 and some more if you’re married. You would know better than I!

Diane:
Yeah, that’s a great deal. It comes up to about $200,000 per couple, plus your housing. You get about $240,000 you can shelter.

Jason:
It’s interesting, and I don’t want to make this a big topic, but since we opened with this topic – on my Jet Setter Show (www.JetSetterShow.com and on iTunes), I’ve done a couple of shows on the Puerto Rico tax benefits, and you have a very global focus. I just thought I’d quickly ask you your thoughts about Puerto Rico. It seems to be a deal made in heaven, but one of my friends moved there. He’s a very successful Internet marketing start-up business guy. He left San Diego about 8 months ago and he’s moving back; he just didn’t like it.

Diane:
Oh, that’s interesting. I mean, you’re living on an island, so there is that to take into account, but yeah, the tax breaks are huge. You have to live there and you have to invest there to take advantage of it. The investment could be in business, it could be in real estate, but you actually have to have your footprint there. Anybody who’s interested can get hold of me – I have some contacts there with some of the guys in the legislature who actually wrote the law. My latest book is The Off-Shore Tax Guide, so I am talking about that in the book, too.

Jason:
I didn’t mention that one!

Diane:
It just came out!

Jason:
I didn’t even know about it. What prompted inviting you back on the show this time, and I want to make sure we talk about this first, but we’re going to talk about several issues – many of our clients are asking about asset protection, about the best structures for asset protection and tax reduction. The series LLC has always been really interesting to me. Of all the entities I have, I do not have a single series LLC. I’ve been fascinated by them, I’ve heard the good, the bad and the ugly about them. What is your take?

Diane:
It’s interesting, and you’re absolutely right. There is the good, the bad and the ugly. Maybe just kind of taking a step back about what a series LLC is. A Limited Liability Company, an LLC is traditionally, the way we love to hold real estate. It is a way that protects us from something that might happen with the property, and it also protects the property from a lawsuit that might come from us. It becomes a great way of protecting both ways. Typically, we don’t elect any other kind of tax treatment, we just let it flow through. If it’s a single-member LLC – only one owner – it just reports on your schedule tax return. If there’s more than one owner, then it’s a partnership and you file that return. Basically, there’s not a tax savings, but it’s just a great way of protecting your assets.

Now, what happens with the guy who’s got 10 properties, and maybe he’s got a lot of equity in each one of these properties. There’s a concern that if Property A has a lawsuit and all of those things are in one LLC, that lawsuit could suddenly affect those other properties because he’s got a lot of equity tied up there.

Jason:
Right, so the idea of the series LLC is that it’s one entity, but there are firewalls between sections of it, or parts of the series, I guess you would say. How many sections or parts of the series are there, Diane?

Diane:
You could have a million. There really isn’t a limit on that. This is the best of all worlds; I don’t have to pay to get every one of these LLCs set up. I have each of these little segmented parts that are, theoretically, safe and everything’s wonderful, and you can collapse it all down into one tax return.

Jason:
Okay, and before you go on, you have it as a disregarded entity – I’ve never understood, and oddly, I’ve never really been able to get anyone to answer this question for me: for every entity I have, I’ve got to have a separate bank account, obviously. With a series LLC, do you have just one big bank account for the whole series? I don’t know how you do that. It seems like they’d all have to be separate anyway, which is part of the big hassle of having all of these entities.

Diane:
Well, there are a couple of ways to do it if you’ve got real estate. One is, and this is what I’ve personally done, and I have a series LLC – each one of my little series cells have their own bank account. I’m an accountant – I can reconcile a bank account, you know?

Jason:
But do you have to do it that way?

Diane:
No, you don’t. If you’ve got real estate, for example, you might just set up a main holding one as a property manager – just like any other property manager, you have lots of different accounts that you’re handling, and you just segment out from your bookkeeping system where you keep track of Property A, Property B etc.

Jason:
Okay, go ahead. Maybe the series LLC is dead, right?

Diane:
Here’s what happened. There was a case with a guy named Alfonz and everything was crumbling – he had a property that there was a foreclosure on and there was a debt and there was a big mess with it. The thing that’s interesting is the company that actually held the debt, and that he was coming back and suing because he said it was one of the robo-signing things and so there was a bunch of problems. Rather than just suing that one particular cell that had the mortgage, he brought the whole parent company and everything into that lawsuit.

This is the part that’s upsetting to those of us who have used a series LLC: the court let him do it. According to everything that we’ve heard and that it’s all segmented, the most he could do was have a lawsuit against that one little part of it, that cell, but instead, they allowed everything to come into the lawsuit. Now, the question is, and the part that lawyers and the people who study this sort of thing have looked at, they’ve said ‘Well, if you’ve got an outside agreement with anyone, probably the series LLC is not good for you’. If you have a property that’s got a mortgage on it and something goes wrong with that, it sounds like any other property in that series LLC could be grabbed by the mortgage holder. That’s maybe not a good thing to have, then. We want to have those regular LLCs then.

Now, they’re saying if you don’t have this outside party agreement or running separate little businesses or something, maybe it’s still okay.

Jason:
Well, what do you mean ‘outside party’? Of course you’re going to be dealing with outside parties.

Diane:
Right, and that’s the problem.

Jason:
Tenants, property managers, vendors etc.

Diane:
Exactly. The case of real estate, which is why we all love the series LLC: multiple properties. I’m not recommending it anymore because I think that this opened a door where we could see a lot more lawsuits now. The problem when you have one court-case is it’s something other ones can hang onto, just like the case of Alfonz.

Jason:
It sets a precedent.

Diane:
Exactly. It’s District 4 and then there’s the question that I’m in District 9, as are you. Does that still apply to District 4? I am concerned.

Jason:
Right, okay. Good. Several years ago, you were promoting an idea called the Trust Sandwich.

Diane:
Right.

Jason:
Can you explain what that is? I don’t remember..

Diane:
That’s been a while ago.

Jason:
It was a long time ago..

Diane:
Yeah, it was. It was back when mortgage companies weren’t giving loans out to the trusts, so it was a way of getting your financing coming through the trust. I don’t even have my website up where we talked about that, but this was pre-2007, and then when we had everything collapse and now there’s a whole new way of getting loans, it’s not something we’re recommending anymore.

Jason:
Okay.

Diane:
Honestly, I would have somebody hold the real estate in an LLC and I would have that owned by a living trust. That way, they’re getting that estate protection for the family  and they’re also getting the LLC to give them protection.

Jason:
Sounds good. So what are you recommending now? We didn’t mention jurisdiction, of course, which is critically important on this. Do you want to mention a jurisdiction? You just like traditional LLCs if someone is using an entity at all. I think people kind of over-do this and put the cart before the horse, if you will, a lot, with worrying about entities and all. Most of the stuff that comes out of real estate can really be covered by insurance pretty well.

I’m happy to say I’ve never had any legal problem with a tenant where they’ve been able to get a judgement against me or anything. I’ve had a few that have gotten mad and destroyed the property, and I’d kept their security deposit. Imagine that!

Diane:
I’ve never had it either.

Jason:
I don’t want to say destroyed, but damaged. I was over-exaggerating, obviously. So if you do want to do an entity, or multiple entities, where should you do them? Do you have a jurisdiction preference?

Diane:
Yeah, generally it’s wherever the property is. This one also gets a little asterisk. We’ve got to pick on our friends in the West there, California. California’s got a new rule that if you live in California, and let’s say you buy a property in Georgia and you set up your Georgia LLC and everything’s great – well, California now says if you live in California, you still need to pay the California fee of $800/year on top of it, because you live in California.

Jason:
Oh my God.

Diane:
I know.

Jason:
So just the fact that you live there and own a property in another State – are you kidding me?

Diane:
Right, so you have to have Georgia if there’s any issue that you need to bring a lawsuit against a tenant or whatever – you’re going to need to be authorized to do business in Georgia, PLUS California’s wanting it, just because you live there.

Jason:
The Socialist Republic of California is just giving everybody a good reason to leave it. I left it 3 years ago, glad I did. There’s an odd tax reason I might have to move back to establish residency for a little while again, and it’s almost never that someone comes back to California to save on taxes – my accountant recently found a little tweak that’s kind of funny. If you own property in your personal name in Georgia and you live in California, it’s irrelevant, right?

Diane:
Correct.

Jason:
It’s if it’s in an entity.

Diane:
Yeah. It’s that $800/entity charge that California has. It’s kind of goofy with California.

Jason:
Every time I deal with any legal issue, it’s always like California and New York have their own set of additional laws. It’s complicated enough to figure out the Federal and the State and then all the different jurisdictions and how they all work, and then maybe domesticating your entity in one area if the entity lives in another. And now this, unbelievable.

So maybe Californians want to actually consider dissolving their entities, or one way I can see around it, and I should mention that I am not an attorney – I’m not qualified to give legal advice, I’m just talking from my own experience and what I’ve learned interviewing people. You probably aren’t an attorney either, right, Diane?

Diane:
That’s correct, I’m just a CPA.

Jason:
You’re a CPA, okay. It seems like what you could do is you could have one entity in some State, maybe a preferable state would be Nevada, Wyoming, maybe Alaska. I hear Alaska’s got some good corporate law, too. Or Delaware, too, that sometimes makes sense. Then you can have that entity own all the other entities. California can only charge you one time.

Diane:
Exactly. That’s the bottom line. It ends up being that they only get the one shot at it, and you can use that one that’s a holding one as a property manager. That’s how we’ve been doing it and this is how we interact – just through this one company.

Jason:
And that’s really pretty good because it gives you some pretty good asset protection too. You’ve got an extra step there, which is kind of nice.

Diane:
Yeah.

Jason:
OKay, good. Maybe the California thing either says ‘number one, move out of California’, which might be your best choice; ‘number 2 – [because there’s lots of other reasons to leave California]: form a new entity in a favorable jurisdiction, and then have it own all the other entities so you only have one $800 fee, or number 3: just dissolve the entity and just own the properties in your personal name.

Diane:
Right, and make sure you have good insurance.

Jason:
Yeah, obviously.

Diane:
And have an umbrella policy. I really recommend those, as well.

Jason:
Oddly, in all my years and hundreds of tenants, I’ve never had even a thread of a slip and fall lawsuit. Nothing! I think that’s kind of overplayed to be honest with you, but you know, the one time it happens will be a disaster, of course, right?

Diane:
Yeah, I had one client who had an apartment building and there was an escaped convict who was armed, and he was reportedly in that area. Somebody then said ‘Oh, we saw him in the building’, and so he gave the key to the police to go into an apartment that they thought the guy was in, and nobody was answering the door. It wasn’t them and the lady sued. It turned into a big mess because he didn’t have the right to give the key to the police. He didn’t have an LLC and he ended up settling for a lot of money.

Jason:
That’s amazing. And there was no damage? It was just, what, an invasion of privacy? You have to give 24 hours’ notice or something?

Diane:
Exactly. That’s exactly what is was.

Jason:
That’s a pretty small claim, I would think.

Diane:
It turned into a big deal.

Jason:
Wow. What State?

Diane:
I was just going to say, I think it was California, as long as we’re bashing California.

Jason:
No wonder. California deserves it. OKay, so that’s interesting. He could have just let the police bash down the door, and then he would have been okay because they have immunity.

Diane:
Exactly.

Jason:
Interesting. So what else do we need to know about this?

Diane:
About this? Or just real quick on some tax things going on?

Jason:
Yeah, I want to talk about some other stuff, but just anything more on the series LLC. Just do regular LLCs – are we done with that discussion?

Diane:
I think so. Just be careful. If you’re in them right now, you can roll over into regular LLCs. Talk to somebody who knows about this, talk to an attorney and get that done correctly.

Jason:
Okay. Good. What else is interesting that’s going on, tax-wise?

Diane:
Well, the interesting thing is we have a very late bill, the Tax Extender Bill that December 2014 passes for the Senate, and it’s effective for January 1st 2014.

Jason:
OKay, so the Tax Extender Bill – I always do extensions to file my returns, I’m always late.

Diane:
That’s not what that’s about. It’s talking about some things that expired at the end of 2013, and what’s happened is that Congress has just gotten really good at not handling things until the last minute. This has to do with depreciation and Section 179 and bonus depreciation. Another big one was for people who’ve had short sales or lost their homes through foreclosure, there’s usually cancellation of debt. In the past, if it’s your primary residence, you don’t have to pay tax on that. That expired at the end of 2013, so for anybody who had a short sale in 2014, they might have gotten hit with taxes.

Luckily, that Bill has passed. I’ve got to tell you, this is the thing that drives CPAs crazy. Down at the end of December, we now have to do tax planning for the entire year, when they could have had it done. By the way, this extender bill expires December 31st, 2014, so the exact same thing can happen in 2015.

I would say for tax planning, the key is just to be really flexible and make sure you have good financial records that are fairly current. if you’re doing last minute planning in the last 2 weeks of the year, you need to know what kind of income you’ve got, what type of decisions you need to make.

Jason:
Okay. I don’t understand what that is: The Tax Extender Bill. I understand everything you said after it, but I don’t know what it means.

Diane:
Okay, so what they call these things that they haven’t done firm law, like Section 179, does not have firm law on it. It just needs to keep getting renewed. In the past, it would get renewed for like 5-10 years and nobody cared, but lately, it only goes for one more year. Section 179, which is something that business people love, allows us to currently expand certain assets  – you don’t have to depreciate them. It’s a big deal for us, and it has expired. We find out at the end of December that we’ve got that particular law extended for one more year, that’s why they call it the Tax Extender. There’s 55 things that really don’t have a permanent place in the tax code that we just have to keep extending.

Another one is for restaurants. Restaurants have had the ability to write off the cost for over 15 years instead of what’s normally 39 years. That’s a big deal for restaurants, and that expired as well. Now that’s been extended for 1 more year, until the end of December 31st, 2014.

Jason:
Do you mean in another year, a restaurant will have to depreciate all their tenant improvements or the building, or the equipment inside, the kitchen equipment or what?

Diane:
Yeah, all of the above.

Jason:
Over 39 years?

Diane:
Yeah.

Jason:
That’s a terrible deal.

Diane:
I’ve got a client who’s looking to buy a restaurant, and it’s really about timing for him. He’d rather buy it in 2015, but if this special law passed for 2014 and he bought it and got all these great write-offs for 2014, he’d buy it then. He’s sitting here on this hundreds of thousands of dollars purchase, and everybody’s sitting there waiting to see what Congress is going to do for when he’s going to buy this restaurant. It makes tax planning hard because we need certainty in the tax world, and businesses need certainty so they can make smart decisions.

Jason:
Well, this has been the problem with the Obama regime. There’s been a huge lack of certainty, whether it be good or bad – just knowing what is going to happen. It just stifles the economy, it reduces the velocity of money, it’s a terrible thing to have uncertainty, and if you look at all these podunk countries around the world, they have all these knee-jerk changes and nobody can be sure of anything so nobody’s going to plan anything big. They just don’t know – they think ‘Well, the government might just take my property away the next day’.

Diane:
Exactly.

Jason:
It’s not that bad in the US, fortunately, but there’s a lot of uncertainty going on out there.

Diane:
There is. We were actually having this conversation off-tape about how the US sometimes struggles with some of the laws, but face it, there’s a lot of money coming into this country because we do have laws that protect property and give us that certainty that you do need for investments.

Jason:
Yeah. I think you want to make the distinction there. In the conversation we had, we just talked for a couple of minutes before we started this show, but that was that every other country is managed worse than the US. The US is terrible, but it’s better than everybody else. It’s not really better than everybody else, there are some very well managed countries out there, but just the position in history and geography the US finds itself in, and the fact that it won the industrial revolution, it’s still benefiting in a huge way from that. Very interesting.

Diane, what are your thoughts about the real estate profession, the Holy Grail of tax deductions? I know this is a big topic and we don’t have to go into it; we’ve done prior shows on it with other CPAs and so forth. Maybe we talked to you about it last time, I can’t remember. This is really the Holy Grail of tax benefits. Far and away, income property is the most tax-favored asset in the country. There’s not even a close second that I know of. What are your thoughts about a real estate profession, and so forth?

Diane:
It’s a fantastic tax break, but you’ve got to follow the rules. The IRS has been hitting – gosh, what is it, I think they started in 2008 with just hard-hitting audits against people who take the real estate professional status. What that does is it allows you to take 100% of your real estate tax losses against your other income, no matter how much money that you have, how much you make otherwise and no matter how much the loss is.

Jason:
Let me just comment on that for a moment. So that means you have unlimited passive loss write-offs, meaning depreciation – the world’s best tax benefit is called depreciation because it is a non-cash write-off, it is a phantom write-off, you can have positive cash-flow every month, you can have the property double in value every year and you can still take a tax loss with the IRS. It is the Holy Grail, and taxes are the largest expense in anybody’s life. Well, for most people.

Diane:
Yeah. I like to point out that when I say ‘loss’, I’m really careful to say ‘tax loss’ because you can have property that gives you cash flow all the time; you’re putting money in your pocket. But for tax purposes, you’re getting a loss and it’s because, just like you said, there’s a phantom expense of depreciation.

Jason:
Good point.

Diane:
And you can even accelerate your depreciation – it’s called a cost segregation study, but let’s say you buy a house and there are certain items in there: the HBAC system, the carpeting, the dishwasher. Those things have got a shorter life.

Jason:
Yeah, are those 5 or 7 years, or are they all different?

Diane:
They’re all different. They’re typically 5-7 years, but even the paving on the driveway; that’s a 15-year asset. You can break that out and accelerate up that depreciation so that’s a great break. It all hangs on that real estate professional status, so I think what has happened is people got maybe a little lazy and said ‘I’ll just do that to say I did it’, but aren’t really, truly, real estate professionals. There are 3 rules to that real quick. 1: You have to have at least 750 hours in real estate activities, and more in that than any other trade or business for which you’re paid. 2: You have to have material participation on the properties and there’s a special rule.

Jason:
It’s 500 hours, right?

Diane:
Actually, in some cases you can get by with just 100, or even being more than anybody else who’s working there. There are some ways around that too.

Jason:
Oh, that’s really good to know. One of the things, and I’ll tell you – my listeners know. I was audited, believe it or not, for a real estate professional, I believe it was for my 2007 return. I won the audit, but I tell you, I wouldn’t have won, had I not been really persistent. It took 3 years, I spent a lot of money with my CPA, but it was a great victory. The thing that they were trying to get me on, Diane, and I’m actually glad they audited me because we found a whole bunch of new deductions and they ended up paying me a lot of money.

Diane:
Oh good!

Jason:
It was actually a great thing. If the IRS would like to come in and help me look at my books and help me with my bookkeeping, they’re welcome to. It’s like having a free bookkeeper!

Diane:
Exactly!

Jason:
That was really a blessing in disguise. At first, I thought it was terrible but it turned out to be a huge blessing. So anyway, what they tried to get me on was material participation because for most of my properties, I had property managers.

Diane:
Right.

Jason:
So that’s a harder part, and I do teach our clients how to self-manage their properties if they want to do that. I think that can be a great thing. I’ve self-managed properties that I’ve never seen, with tenants in them that I’ve never met from 2000 miles away and it has worked. I teach a whole course on that.

Can you do it with property managers? To materially participate, do you really have to not have a manager?

Diane:
The problem is just like you had. You’re absolutely right. If you get audited, you’re going to be questioned about this if you have a property manager. We always recommend that people keep diaries or calendars where they show the time they’ve spent on that property. But yes, you can take that deduction. You just need to prove that you’ve had more time than the property manager has on that property. That can be easy if you’re in the fix-and-stay property. It can be a little harder once a tenant’s in place and they’re stable and there’s not so much going on. I would make sure that you’re involved in taking a look at the property. If it’s out of State, then go out there at least once a year and spend some time. Look at comps, make sure that you’re pricing things properly and that is all going to go a long way to that.

The third part of this – the first is the hours you’ve got, the second is material participation, which by the way, can be you and your spouse (you can combine for that) – each property stands alone, unless you make an election to aggregate all properties. If you aggregate them all, you just have to meet the one material participation test. There is a little gotcha on that one, and the gotcha is that if you later sell one of those properties in that group for a loss, you can’t take the loss against your other income. It has to stay in that group until you sell a property at a gain to offset that.

Jason:
Oh, I think you’ve got to just explain that again, maybe a slightly different way so that we get that.

Diane:
Right. So the aggregation is let’s say you’ve got A, B, and C.

Jason:
You’ve got 3 properties.

Diane:
Right. You make the selection on your tax return and for example, with that 500 hour rule you say ‘Hey, I’m not going to try to do that for each one of those, I’ll just do it once’. In that case, you get to continue taking those losses as you’ve got it. Let’s say time goes on and you sell property A for a loss. First of all, we don’t want to sell for a loss, but let’s say you do. You’ve got this loss. In normal circumstances, that loss goes to offset your other income that you have that year – you lost $50,000 on this house, it offsets your other income of $250,000. It works against that. However, if you’ve aggregated that, it’s considered that $50,000 loss – you can’t take it right now against your other income. Instead, it stays in that group. You’ve got maybe additional bases with properties B and C, so some day down the line when you sell them, you won’t have to pay as much tax on a gain you have.

Jason:
Interesting, okay.

Diane:
It’s probably not as big an issue right now, but people were getting caught on that one when the recession happened and there was a lot of loss happening when they sold properties. Make sure you have careful planning when you make that election.

Jason:
Good to know, good to know. Diane, give out your website, tell people where they can find you and your books and so forth.

Diane:
You bet. You can find me at www.USTaxAid.com. My latest book is The Off-Shore Tax Guide and we talked a little bit about some international tax pieces. It’s interesting to me too that one of the things that we were talking about before we started is that my biggest growing business right now is foreign nationals who are coming into the US to buy investment property.

Jason:
We get a lot of that, and there’s a lot of those people listening.

Diane:
Yeah. It’s interesting how many great deals there are. For my international guides, they don’t even get as many tax breaks. Made in the US kind of stays in the US, it doesn’t offset their other income. As we were talking about the real estate professional status, we talked about depreciation and the ability to accelerate it. If you set this up right, I absolutely agree with you – real estate gets you appreciation, cash flow and tax breaks. I don’t know anything else that does that.

Jason:
It is the most tax-favored asset in America, it is the most historically-proven asset class in America and I tell you, I heart real estate. I love income property, it’s the greatest thing going. It’s not because I’m in it, I’m in it because I love it. It’s not the other way around. That’s a good thing.

Well, Diane, this has been very informative. Any other thoughts you want to share before you go?

Diane:
I’m just going to say, adding into the real estate – I don’t believe you should let tax ever drive your financial decision.

Jason:
It’s a huge perk, though.

Diane:
Exactly. It’s a huge perk, and that’s where the more you know, the better it is. Getting informed about that is important.

Jason:
No question about it. Well, you are very informative and we appreciate you joining us again. We’d love to have you back, maybe have you on the Jet Setter Show, just to talk about international jurisdictions and tax planning internationally for people that want to have something off-shore outside of the US. That would be interesting.

Diane:
Love to do that, thank you.

Outro A:
I’ve never really thought of Jason as subversive, but I just found out that’s what Wall Street considers him to be.

Outro B:
Really? Well how is that possible at all?

Outro A:
Simple, Wall Street believes that real estate investors are dangerous to their schemes because the dirty truth about income property is that it actually works in real life.

Outro B:
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Outro B:
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Outro A:
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Outro B:
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Outro A:
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Outro B:
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Outro A:
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Outro B:
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Outro A:
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Outro:
This show is produced by the Hartman Media Company, all rights reserved. For distribution or publication rights and media interviews, please visit www.HartmanMedia.com or email [email protected]. Nothing on this show should be considered specific personal or professional advice. Please consult an appropriate tax, legal, real estate or business professional for individualized advice. Opinions of guests are their own and the host is acting on behalf of Empowered Investor Network Inc. exclusively.