WEBVTT 00:00:06.030 --> 00:00:09.250 Hi, everyone. This is the How to Lower Your Tax 00:00:09.250 --> 00:00:12.429 Bill podcast. I'm your host, Terrence Hutchins. 00:00:12.949 --> 00:00:15.410 I'm a financial and tax advisor in the Dallas 00:00:15.410 --> 00:00:18.190 Fort Worth area. And the goal of this podcast 00:00:18.190 --> 00:00:20.789 is to help you listeners get educated on different 00:00:20.789 --> 00:00:23.589 tax strategies that you can implement to improve 00:00:23.589 --> 00:00:26.750 your tax situation immediately. Each episode 00:00:26.750 --> 00:00:29.769 will break down useful tax tips you can use to 00:00:29.769 --> 00:00:32.369 save money, no matter what your personal or business 00:00:32.369 --> 00:00:35.329 income situation. because our motto is, keep 00:00:35.329 --> 00:00:38.549 more of what you earn. So let's get into today's 00:00:38.549 --> 00:00:47.909 episode. All right, so thanks for joining in 00:00:47.909 --> 00:00:50.030 on another episode of How to Law Your Tax Bill. 00:00:50.329 --> 00:00:53.450 We've been going over a series relating to real 00:00:53.450 --> 00:00:55.750 estate and we've probably been looking at it 00:00:55.750 --> 00:00:58.409 through the lens of someone who's a W -2 employee. 00:00:59.580 --> 00:01:01.740 we're gonna pin it a little bit and talk about 00:01:01.740 --> 00:01:03.520 more from the perspective of someone who's actually 00:01:03.520 --> 00:01:06.459 looking to go full -time in real estate. The 00:01:06.459 --> 00:01:08.700 things we're gonna talk about will impact someone 00:01:08.700 --> 00:01:11.239 who invests here and there, but they will be 00:01:11.239 --> 00:01:13.359 more applicable to someone who's actually gonna 00:01:13.359 --> 00:01:16.060 do it full -time or has it as their full -time 00:01:16.060 --> 00:01:19.000 job. In this episode, we're gonna break down 00:01:19.000 --> 00:01:21.680 what it actually means to be a dealer versus 00:01:21.680 --> 00:01:24.900 an investor, how the IRS decides whether you're 00:01:24.900 --> 00:01:27.379 a dealer or an investor. what the tax impact 00:01:27.379 --> 00:01:29.799 of that classification is, and then some strategies 00:01:29.799 --> 00:01:32.519 to help you protect your profits. So if you're 00:01:32.519 --> 00:01:34.500 a house flipper or you're looking to buy a rental, 00:01:34.540 --> 00:01:36.060 so you wanna do a little bit of both, this is 00:01:36.060 --> 00:01:39.159 gonna be a good episode for you. Now, one of 00:01:39.159 --> 00:01:41.219 the more important aspects of getting into real 00:01:41.219 --> 00:01:43.340 estate or any other investment is assessing what 00:01:43.340 --> 00:01:46.060 you're trying to accomplish. If I wanna quit 00:01:46.060 --> 00:01:48.359 my job, for example, and I wanna live off my 00:01:48.359 --> 00:01:50.159 real estate as soon as possible, then that's 00:01:50.159 --> 00:01:52.280 gonna take me down a different road than if I 00:01:52.280 --> 00:01:55.519 was someone who just wanted to build some additional 00:01:55.519 --> 00:01:57.879 long -term income that's gonna supplement my 00:01:57.879 --> 00:02:00.640 other investments. Having an idea of what you're 00:02:00.640 --> 00:02:03.180 looking to accomplish at the beginning, as Stephen 00:02:03.180 --> 00:02:05.799 Covey says, begin with the end in mind. And so 00:02:05.799 --> 00:02:07.540 if I know what I'm trying to accomplish, that's 00:02:07.540 --> 00:02:09.659 gonna help dictate the type of deals that I do 00:02:09.659 --> 00:02:13.500 and whether a deal is good for me or not. But 00:02:13.500 --> 00:02:15.520 in order to make it objective, whether I'm in 00:02:15.520 --> 00:02:17.750 real estate or any other investment, I think 00:02:17.750 --> 00:02:20.069 it's also important to have some kind of criteria 00:02:20.069 --> 00:02:22.530 that helps you filter out the investment that 00:02:22.530 --> 00:02:24.990 you're underwriting to determine if it's something 00:02:24.990 --> 00:02:27.250 you should invest in or maybe it's something 00:02:27.250 --> 00:02:29.729 that you should wait on. And so I personally 00:02:29.729 --> 00:02:33.430 have a seven part component that will help me 00:02:33.430 --> 00:02:35.330 filter out investments that I look at or even 00:02:35.330 --> 00:02:37.689 help clients in that component to where they 00:02:37.689 --> 00:02:40.710 can simplify what is the aspects of this investment 00:02:40.710 --> 00:02:43.090 I'm looking at and then how is that applicable 00:02:43.090 --> 00:02:45.009 to me and how I'm assessing whether it's worth 00:02:45.009 --> 00:02:48.020 it or not. So those seven criteria are, number 00:02:48.020 --> 00:02:50.539 one, risk. What is the chance that I could lose 00:02:50.539 --> 00:02:53.759 my money in this deal? If there's more risk involved, 00:02:53.819 --> 00:02:56.060 then I am gonna want, number two, more upside. 00:02:56.819 --> 00:02:59.319 The upside is just the possible potential. The 00:02:59.319 --> 00:03:01.639 ability to make 20 % is gonna look different 00:03:01.639 --> 00:03:04.539 than something that makes 10%, but the risk involved 00:03:04.539 --> 00:03:07.020 and all the other factors could impact whether 00:03:07.020 --> 00:03:08.500 I would go with something that's just gonna give 00:03:08.500 --> 00:03:10.319 me 10 versus something that's gonna give me 20. 00:03:10.599 --> 00:03:13.500 That's normally how cap rates work. on the commercial 00:03:13.500 --> 00:03:16.259 side, where a low risk investment is gonna have 00:03:16.259 --> 00:03:18.340 a low cap rate, the higher risk investment is 00:03:18.340 --> 00:03:19.819 gonna have a higher cap rate just because you're 00:03:19.819 --> 00:03:23.259 gonna wanna have more upside potential. You also 00:03:23.259 --> 00:03:24.860 have the tax treatment, which we'll get into 00:03:24.860 --> 00:03:26.900 specifically with real estate dealers versus 00:03:26.900 --> 00:03:29.780 investors. But what are the tax impacts of what 00:03:29.780 --> 00:03:32.879 you're doing is gonna play a big role in what 00:03:32.879 --> 00:03:34.379 you decide to do as far as your investments. 00:03:35.060 --> 00:03:38.539 Also control, many people like real estate because 00:03:38.539 --> 00:03:40.439 they feel like they have more control over the 00:03:40.439 --> 00:03:42.479 outcomes. and there are certain things you can 00:03:42.479 --> 00:03:45.060 do to help drive up your returns whether that's 00:03:45.060 --> 00:03:48.400 with financing or expertise. You also have effort. 00:03:48.879 --> 00:03:51.159 Real estate and other investments can look more 00:03:51.159 --> 00:03:54.300 like a traditional job. You want to measure is 00:03:54.300 --> 00:03:56.840 your time better spent investing in this activity 00:03:56.840 --> 00:03:59.539 or just doing work in maybe the career you have 00:03:59.539 --> 00:04:01.439 or in your business because you would end up 00:04:01.439 --> 00:04:03.780 with more money just putting more effort into 00:04:03.780 --> 00:04:07.080 that activity. There's also an element of time. 00:04:07.340 --> 00:04:09.000 How long is it going to take you to get your 00:04:09.000 --> 00:04:11.930 money back? If it takes me a year to get my money 00:04:11.930 --> 00:04:13.430 back, that's going to look a lot different than 00:04:13.430 --> 00:04:15.969 it's going to take five years. So I need to be 00:04:15.969 --> 00:04:17.449 compensated for the longer it takes me to get 00:04:17.449 --> 00:04:21.029 my money back. And then you also have fees. Now, 00:04:21.129 --> 00:04:23.970 fees could be a polarizing topic, but normally 00:04:23.970 --> 00:04:26.230 you want the fees to be worth whatever you're 00:04:26.230 --> 00:04:28.310 putting your money in. So it's not a matter of 00:04:28.310 --> 00:04:30.850 higher fee is worse. It's more about what am 00:04:30.850 --> 00:04:32.589 I getting for that higher fee and is going to 00:04:32.589 --> 00:04:35.259 provide me with more value. So if you look at 00:04:35.259 --> 00:04:38.240 your investment options through these seven things, 00:04:38.259 --> 00:04:40.399 I think it'll help you become a better investor 00:04:40.399 --> 00:04:42.839 and to be more objective. So let's get into the 00:04:42.839 --> 00:04:45.259 crux of this episode as we're talking about whether 00:04:45.259 --> 00:04:47.560 you want to be a real estate investor or whether 00:04:47.560 --> 00:04:49.980 I should say you would be classified as a real 00:04:49.980 --> 00:04:52.540 estate dealer or as an investor. So the short 00:04:52.540 --> 00:04:55.420 of it is a real estate investor is someone who 00:04:55.420 --> 00:04:57.660 buys property to hold it. Maybe it's a rental 00:04:57.660 --> 00:04:59.860 or maybe it's land for long -term appreciation. 00:05:00.360 --> 00:05:02.500 You normally will buy this and think that, all 00:05:02.500 --> 00:05:05.089 right, This is more your traditional person. 00:05:05.310 --> 00:05:08.029 I want to go buy an investment property, I'll 00:05:08.029 --> 00:05:09.990 get a renter for it, and I'm going to hold it. 00:05:10.170 --> 00:05:11.689 If I get an opportunity to sell it at a good 00:05:11.689 --> 00:05:14.490 price, I will, but that's not normally the intent 00:05:14.490 --> 00:05:16.689 of when you first buy it. Rather, if you're a 00:05:16.689 --> 00:05:19.089 dealer, that is actually your intent. You're 00:05:19.089 --> 00:05:21.550 looking to buy something in order to profit from 00:05:21.550 --> 00:05:24.170 selling it at a higher price, normally in a shorter 00:05:24.170 --> 00:05:26.509 period of time. So think of this as someone who 00:05:26.509 --> 00:05:30.029 is like a car dealership. They buy cars to immediately 00:05:30.029 --> 00:05:31.930 sell them and they're trying to make a spread 00:05:31.930 --> 00:05:33.529 on what they originally bought it for and what 00:05:33.529 --> 00:05:35.370 they're able to sell it for, but they're not 00:05:35.370 --> 00:05:38.110 using time on their side to think that it's just 00:05:38.110 --> 00:05:41.550 gonna go up in value by its own. So a dealer 00:05:41.550 --> 00:05:44.310 is thinking someone who owns real estate almost 00:05:44.310 --> 00:05:47.110 has said it's inventory. Now that's important 00:05:47.110 --> 00:05:49.470 because that will determine whether you can pay 00:05:49.470 --> 00:05:52.129 capital gains or ordinary tax rates. It's whether 00:05:52.129 --> 00:05:54.459 you will also pay self -employment. and whether 00:05:54.459 --> 00:05:56.259 you could use certain strategies like a 1031 00:05:56.259 --> 00:05:58.420 exchange, which we've talked about in a previous 00:05:58.420 --> 00:06:01.519 episode. Now, to be clear, being a real estate 00:06:01.519 --> 00:06:04.420 investor does not necessarily mean you're a real 00:06:04.420 --> 00:06:06.560 estate professional. The real estate professional 00:06:06.560 --> 00:06:09.439 is a separate tax term, which we've gone into 00:06:09.439 --> 00:06:12.759 previously, that's tied to rental property rules. 00:06:13.060 --> 00:06:16.360 So that's generally tied to your ability to deduct 00:06:16.360 --> 00:06:20.220 passive losses and also to avoid the net investment 00:06:20.220 --> 00:06:24.660 income tax of 3 .8%. Now, Of course, because 00:06:24.660 --> 00:06:27.920 of the IRS and our system is complex at times, 00:06:28.259 --> 00:06:30.500 or multifaceted, I should say. Then you could 00:06:30.500 --> 00:06:32.120 be an investor, you could be a dealer, and you 00:06:32.120 --> 00:06:33.899 could be a real estate professional all at the 00:06:33.899 --> 00:06:36.379 same time. It just depends on the facts and circumstances 00:06:36.379 --> 00:06:39.040 of your situation. So if you talk to any tax 00:06:39.040 --> 00:06:41.800 professional, that word or that phrase, facts 00:06:41.800 --> 00:06:44.620 and circumstances, will be prevalent in how they 00:06:44.620 --> 00:06:47.639 evaluate your situation because so many things 00:06:47.639 --> 00:06:50.519 depend on one of the specifics of your situation. 00:06:50.839 --> 00:06:53.540 When looking at the tax treatment behind whether 00:06:53.540 --> 00:06:56.060 you're a dealer or an investor, this is really 00:06:56.060 --> 00:06:59.139 the 15 or 20 % question that you have to ask 00:06:59.139 --> 00:07:01.000 yourself. So number one, if you're considered 00:07:01.000 --> 00:07:02.639 a real estate investor, so you're someone who 00:07:02.639 --> 00:07:04.680 buys and is looking to hold the property that 00:07:04.680 --> 00:07:07.620 you have, when you sell, you're gonna pay capital 00:07:07.620 --> 00:07:10.259 gains tax rates. Now, if you sell under a year, 00:07:10.500 --> 00:07:12.199 you're gonna pay ordinary income regardless. 00:07:12.560 --> 00:07:15.579 But generally, if you hold that property for 00:07:15.579 --> 00:07:18.040 a year and a day or more, then you're going to 00:07:18.040 --> 00:07:21.000 pay capital gains tax on the sale. And that capital 00:07:21.000 --> 00:07:25.740 gains tax peaks at 20%. So that is a big difference 00:07:25.740 --> 00:07:28.399 between the ordinary income tax rate, which caps 00:07:28.399 --> 00:07:31.779 out at 37%. So that's a potentially 17 % difference. 00:07:32.300 --> 00:07:34.220 You also have the ability if you're an investor 00:07:34.220 --> 00:07:37.800 to do a 1031 exchange. If you're a dealer, you 00:07:37.800 --> 00:07:39.339 aren't allowed to do that. You're not allowed 00:07:39.339 --> 00:07:41.379 to defer gains that you get from something that 00:07:41.379 --> 00:07:44.610 you sell. You also are not subject to self -employment 00:07:44.610 --> 00:07:47.350 tax. Because the IRS looks at you being a dealer 00:07:47.350 --> 00:07:50.750 as a business, they will treat you as if you're 00:07:50.750 --> 00:07:53.129 self -employed. So if I buy a house and I flip 00:07:53.129 --> 00:07:55.589 it and I make $50 ,000, they're thinking that 00:07:55.589 --> 00:07:58.649 that's actually income from a business and not 00:07:58.649 --> 00:08:01.810 just capital gain from an activity that you are 00:08:01.810 --> 00:08:04.569 investing in. So they'll look to add in that 00:08:04.569 --> 00:08:08.410 additional 14 .13 % tax on top of your profits. 00:08:08.709 --> 00:08:11.189 If you are an investor, you can actually depreciate 00:08:11.189 --> 00:08:13.279 your properties. because they're not looked at 00:08:13.279 --> 00:08:15.639 inventory and you are subject to quote, unquote, 00:08:15.939 --> 00:08:18.759 weird tear over time, the IRS will allow you 00:08:18.759 --> 00:08:21.620 to depreciate the value of your property, which 00:08:21.620 --> 00:08:24.040 is one of the big benefits of real estate is 00:08:24.040 --> 00:08:26.339 being able to have a non -cash tax deduction 00:08:26.339 --> 00:08:28.839 that you're able to claim to offset any income 00:08:28.839 --> 00:08:32.200 that you make. Also, if you're an investor, you 00:08:32.200 --> 00:08:35.019 could qualify for the QBI deduction and you may 00:08:35.019 --> 00:08:37.340 not. It just depends once again on your facts 00:08:37.340 --> 00:08:40.419 and circumstances. However, on a negative front, 00:08:40.649 --> 00:08:42.929 If you're an investor, you could only deduct 00:08:42.929 --> 00:08:46.169 up to $3 ,000 of capital losses. This is very 00:08:46.169 --> 00:08:48.889 similar to if you own the stock and you sold 00:08:48.889 --> 00:08:52.070 it at a loss, you can only use that loss to offset 00:08:52.070 --> 00:08:54.929 gains from other capital assets that you own, 00:08:55.610 --> 00:08:58.649 or you can only deduct up to $3 ,000 of your 00:08:58.649 --> 00:09:01.090 ordinary income. So if I sell a stock for $10 00:09:01.090 --> 00:09:03.250 ,000 or I sell a property at a $10 ,000 loss 00:09:03.250 --> 00:09:07.610 and I make $100 ,000, I can only deduct $3 ,000 00:09:07.610 --> 00:09:11.460 against my income, any... lost over and above 00:09:11.460 --> 00:09:13.679 that threshold will have to be carried forward 00:09:13.679 --> 00:09:16.860 to a future year, which speaks to why we talked 00:09:16.860 --> 00:09:18.820 in a previous episode about why you need to look 00:09:18.820 --> 00:09:21.120 at your last year's tax returns to determine 00:09:21.120 --> 00:09:22.940 if there's something you need to carry forward 00:09:22.940 --> 00:09:25.700 to future years. Also though, if you're an investor, 00:09:25.919 --> 00:09:29.470 you may pay that 3 .8 net income tax. We'll get 00:09:29.470 --> 00:09:31.490 into this on a future episode and kind of dive 00:09:31.490 --> 00:09:33.850 into more of the nitty gritty part of this. But 00:09:33.850 --> 00:09:36.309 if you're a higher income earner, which is Julie, 00:09:36.370 --> 00:09:38.850 as the IRS defines it, more than 200 ,000 single, 00:09:39.250 --> 00:09:41.809 more than 250 married. If you have investment 00:09:41.809 --> 00:09:44.070 income. then you will be subject to paying an 00:09:44.070 --> 00:09:47.389 extra 3 .8 % on any investment income you make 00:09:47.389 --> 00:09:50.090 that is above the 200 or 250 ,000 dollar limit. 00:09:50.230 --> 00:09:52.470 So if you make 300 grand as a married couple 00:09:52.470 --> 00:09:54.669 and you have investment income that exceeds that 00:09:54.669 --> 00:09:58.029 by 50 ,000, you're going to pay 3 .8 on the lower 00:09:58.029 --> 00:10:01.129 of your investment income or the amount above 00:10:01.129 --> 00:10:03.789 the threshold. But importantly, if you're an 00:10:03.789 --> 00:10:06.000 investor, you could pay that if you're a dealer, 00:10:06.200 --> 00:10:08.419 you don't pay that. Also, the selling expenses 00:10:08.419 --> 00:10:10.580 that you have, if you're an investor, they're 00:10:10.580 --> 00:10:14.559 gonna be added to your basis normally, and they 00:10:14.559 --> 00:10:17.580 will reduce your capital gain versus if you are 00:10:17.580 --> 00:10:20.240 a dealer. those expenses, depending on how you 00:10:20.240 --> 00:10:21.600 look at it, they're just going to reduce your 00:10:21.600 --> 00:10:24.620 actual income. So the value of the expenses that 00:10:24.620 --> 00:10:26.559 you deduct is going to be higher. This has a 00:10:26.559 --> 00:10:28.960 byproduct of it's considered a business expense 00:10:28.960 --> 00:10:31.799 versus a capital expense or an investment expense. 00:10:32.120 --> 00:10:34.080 So the value of the deduction could be slightly 00:10:34.080 --> 00:10:36.899 higher, especially if your tax bracket is on 00:10:36.899 --> 00:10:40.840 the higher end. Now that we got into what a dealer 00:10:40.840 --> 00:10:44.480 is, what an investor is, what the tax impact 00:10:44.480 --> 00:10:46.940 of each will get into, how do you determine whether 00:10:46.940 --> 00:10:49.240 you are what you are? Now this is one of the 00:10:49.240 --> 00:10:51.860 things where it's important to have conversations 00:10:51.860 --> 00:10:55.179 with your tax advisors ahead of time because 00:10:55.179 --> 00:11:00.259 your intent is not always how the IRS will interpret 00:11:00.259 --> 00:11:03.220 your actions. The more you give them information 00:11:03.220 --> 00:11:05.940 to help dictate your intent, the more you'll 00:11:05.940 --> 00:11:08.580 be able to back up a claim for why you did what 00:11:08.580 --> 00:11:11.409 you did. I'll give you an example of that in 00:11:11.409 --> 00:11:13.169 a bit when we go through this tax court case. 00:11:13.370 --> 00:11:15.450 But when you're thinking about how do I determine 00:11:15.450 --> 00:11:17.529 if I'm a dealer versus an investor, I'm gonna 00:11:17.529 --> 00:11:19.389 look at eight different things. So I'll go through 00:11:19.389 --> 00:11:22.450 these one by one. Number one is your intent when 00:11:22.450 --> 00:11:24.409 you bought the property. Were you planning to 00:11:24.409 --> 00:11:27.169 flip it or were you planning to rent it? If you 00:11:27.169 --> 00:11:28.830 were planning to do one or the other, you need 00:11:28.830 --> 00:11:31.129 to document that at the beginning. Also the number 00:11:31.129 --> 00:11:34.529 and frequency of sales. If you every month are 00:11:34.529 --> 00:11:35.830 thinking, hey, I'm gonna buy this investment 00:11:35.830 --> 00:11:38.289 and hold it, but then I immediately sell it. 00:11:38.350 --> 00:11:40.110 three months later and I have this pattern of 00:11:40.110 --> 00:11:42.289 doing that, even though you allegedly had the 00:11:42.289 --> 00:11:44.549 intent to hold it for investment, the IRS isn't 00:11:44.549 --> 00:11:46.169 probably gonna see it like that if you're doing 00:11:46.169 --> 00:11:49.690 this consistently. Also, how did you improve 00:11:49.690 --> 00:11:51.629 the property? If you put a whole lot of money 00:11:51.629 --> 00:11:53.929 into it upfront, normally people do that because 00:11:53.929 --> 00:11:56.570 they're wanting to sell it pretty quickly. If 00:11:56.570 --> 00:11:58.330 you just bought it and you put some lipstick 00:11:58.330 --> 00:12:00.850 on it, then you may not be looking as if you're 00:12:00.850 --> 00:12:02.389 trying to sell it at a much higher value than 00:12:02.389 --> 00:12:06.139 what you bought it at. Also your marketing. How 00:12:06.139 --> 00:12:07.840 aggressively are you trying to sell the property 00:12:07.840 --> 00:12:11.139 once you bought it? How big and complex was the 00:12:11.139 --> 00:12:13.500 deal? Is it large scale? Is it kind of a one 00:12:13.500 --> 00:12:15.759 -off thing? How did you acquire the property? 00:12:16.039 --> 00:12:18.720 If you acquired it via inheritance or via gift, 00:12:18.759 --> 00:12:20.120 you're probably not going to be considered a 00:12:20.120 --> 00:12:22.500 dealer in that circumstance. And then how long 00:12:22.500 --> 00:12:24.159 you held it. If you've been holding this property 00:12:24.159 --> 00:12:26.820 for longer than a year, that's going to give 00:12:26.820 --> 00:12:29.700 you a lot better perspective that you are looking 00:12:29.700 --> 00:12:31.679 to hold it for investment versus you just being 00:12:31.679 --> 00:12:34.139 a dealer. If you're selling it after three months 00:12:34.139 --> 00:12:36.259 or six months, then you're more likely going 00:12:36.259 --> 00:12:37.980 to be looked at as a dealer if you're doing that 00:12:37.980 --> 00:12:39.779 consistently and you don't have a lot of the 00:12:39.779 --> 00:12:42.779 other factors that are on your side. And then 00:12:42.779 --> 00:12:44.799 how much of your income comes from selling? Once 00:12:44.799 --> 00:12:48.559 again, if you're trying to get out of your current 00:12:48.559 --> 00:12:50.840 job and you're looking to use real estate as 00:12:50.840 --> 00:12:53.940 your occupation, and all of a sudden your house 00:12:53.940 --> 00:12:56.399 flips becomes a primary driver of how much money 00:12:56.399 --> 00:12:57.799 you're making, then you're probably going to 00:12:57.799 --> 00:13:00.659 look at as a dealer. Now, ironically, you can 00:13:00.659 --> 00:13:02.639 be both depending on the type of property that 00:13:02.639 --> 00:13:05.149 you have. For example, you could flip a house 00:13:05.149 --> 00:13:07.610 in the same year that you buy a long -term rental. 00:13:07.990 --> 00:13:10.029 And so it's really going to be on a case -by 00:13:10.029 --> 00:13:13.149 -case basis, a property -by -property basis so 00:13:13.149 --> 00:13:15.929 that you will determine, am I being a real estate 00:13:15.929 --> 00:13:18.190 dealer in this case or am I being a real estate 00:13:18.190 --> 00:13:21.309 investor? Which is why you need to, number one, 00:13:21.629 --> 00:13:23.769 have objectives on the front end of why you make 00:13:23.769 --> 00:13:26.049 decisions that you do. But then secondly, how 00:13:26.049 --> 00:13:28.269 does the property you purchase feed into that 00:13:28.269 --> 00:13:30.450 objective? And then you could define to say, 00:13:30.470 --> 00:13:33.259 hey, The goal is to buy this house and to be 00:13:33.259 --> 00:13:34.980 able to make a 30 % profit on it when I flip 00:13:34.980 --> 00:13:37.299 it. That's very clear. You're probably acting 00:13:37.299 --> 00:13:40.139 as a dealer in that case. Now, if you do this 00:13:40.139 --> 00:13:43.440 one time, I will tell you, if you're just trying 00:13:43.440 --> 00:13:46.059 to do a house flip here and there, I'm going 00:13:46.059 --> 00:13:48.139 to be treating you as an investor from a tax 00:13:48.139 --> 00:13:50.480 standpoint, more than likely. If it's just something 00:13:50.480 --> 00:13:52.639 you did one or one or a lot, like I'm not looking 00:13:52.639 --> 00:13:54.480 at that as a business. You started, if you just 00:13:54.480 --> 00:13:56.080 got an opportunity to buy a house for cheap and 00:13:56.080 --> 00:13:57.940 then sell it, we're going to look at that as. 00:13:58.039 --> 00:14:00.399 you being an investor. But if you're doing this 00:14:00.399 --> 00:14:02.220 consistently, then you want to be documenting 00:14:02.220 --> 00:14:05.399 your thesis or your reason for buying on each 00:14:05.399 --> 00:14:08.899 property that you have. Now, if you are an investor 00:14:08.899 --> 00:14:10.980 and you don't want to be looked at as a dealer, 00:14:11.340 --> 00:14:12.980 then you're going to want to do a few things 00:14:12.980 --> 00:14:15.080 to help make sure you have that distinction to 00:14:15.080 --> 00:14:16.919 say, hey, I don't want to pay self -employment 00:14:16.919 --> 00:14:19.059 tax on these deals that I'm doing. I don't want 00:14:19.059 --> 00:14:22.419 to pay. the extra income tax potentially on the 00:14:22.419 --> 00:14:23.799 deals that I'm doing. So you're going to want 00:14:23.799 --> 00:14:26.879 to keep a separate account for each property 00:14:26.879 --> 00:14:29.200 that you have. So for example, my investment 00:14:29.200 --> 00:14:31.860 properties, they go in one LLC. My flip properties, 00:14:31.879 --> 00:14:33.600 they go into another one, if you put them in 00:14:33.600 --> 00:14:36.679 an LLC at all. You'll also want to name that 00:14:36.679 --> 00:14:40.139 LLC tied to what its purpose is. For example, 00:14:40.139 --> 00:14:43.200 if I have a long -term rental, I might have ABC 00:14:43.200 --> 00:14:45.799 investment rentals. That would be the name, or 00:14:45.799 --> 00:14:47.700 I may have something related to investment in 00:14:47.700 --> 00:14:51.279 the title. Also, I wanna use third -party brokers 00:14:51.279 --> 00:14:53.600 or agents. So I don't wanna be marketing this 00:14:53.600 --> 00:14:55.980 property myself because that looks like I'm actually 00:14:55.980 --> 00:14:58.980 in the business of selling real estate personally. 00:14:59.779 --> 00:15:01.779 You also wanna document your intent. So keep 00:15:01.779 --> 00:15:04.500 your corporate books, keep your meetings. We've 00:15:04.500 --> 00:15:06.559 talked on previous episodes about you don't have 00:15:06.559 --> 00:15:08.379 to do those meetings locally. You can travel 00:15:08.379 --> 00:15:11.159 and do them. That gives you an avenue to create 00:15:11.159 --> 00:15:13.019 some additional tax deductions potentially, but 00:15:13.019 --> 00:15:14.980 keeping that corporate formality to where you 00:15:14.980 --> 00:15:17.889 could document what you did and why. will help 00:15:17.889 --> 00:15:19.970 you ultimately increase the amount of tax transactions 00:15:19.970 --> 00:15:21.789 that are available to you. Then you're going 00:15:21.789 --> 00:15:23.870 to want to deduct your expenses on schedule E. 00:15:23.950 --> 00:15:25.409 You're not going to want to deduct your expenses 00:15:25.409 --> 00:15:28.409 on a schedule C or anything else if you are considered 00:15:28.409 --> 00:15:30.090 an investor. And then you're going to want to 00:15:30.090 --> 00:15:32.129 check your time. Investors usually spend less 00:15:32.129 --> 00:15:34.389 time on a property than a dealer does because 00:15:34.389 --> 00:15:36.970 they're not looking to try to immediately sell 00:15:36.970 --> 00:15:38.529 it. So they don't have to spend a whole lot of 00:15:38.529 --> 00:15:41.429 time on that property. One other thing to keep 00:15:41.429 --> 00:15:43.950 in mind, though, is if you buy a property with 00:15:43.950 --> 00:15:46.409 one intent, and then you change your mind, you're 00:15:46.409 --> 00:15:49.269 going to want to document that change of heart. 00:15:50.009 --> 00:15:53.009 All right. So obviously as humans, we struggle 00:15:53.009 --> 00:15:54.750 with this. Think DeAndre Jordan, who would you 00:15:54.750 --> 00:15:57.190 have a change of heart? But if you do have a 00:15:57.190 --> 00:15:58.730 change of heart, just make sure you document 00:15:58.730 --> 00:16:01.370 it so that, hey, if I sold this and IRS wants 00:16:01.370 --> 00:16:03.509 to question me, I can point to, hey, you know 00:16:03.509 --> 00:16:05.309 what? I was going to buy and flip this property, 00:16:05.610 --> 00:16:08.309 but I couldn't sell it. So now I'd listed it 00:16:08.309 --> 00:16:11.129 for rent. And even if let's say someone came 00:16:11.129 --> 00:16:13.100 and bought it after the fact. you still have 00:16:13.100 --> 00:16:15.480 a decent argument to say that, hey, I did flip 00:16:15.480 --> 00:16:19.059 my strategy and then someone came and unbeknownst 00:16:19.059 --> 00:16:21.440 to me made an offer that I couldn't refuse. All 00:16:21.440 --> 00:16:24.259 right. So it's important to document, document, 00:16:24.440 --> 00:16:27.100 document, get an idea of what was in your head 00:16:27.100 --> 00:16:29.620 because the IRS doesn't know what's in your head. 00:16:29.639 --> 00:16:32.659 All right. And so you're not in a relationship 00:16:32.659 --> 00:16:34.720 here, so people can't read your minds. So it's 00:16:34.720 --> 00:16:37.419 important to document that so that your intent 00:16:37.419 --> 00:16:39.639 is clear and you can always back that up and 00:16:39.639 --> 00:16:41.779 hopefully save you some money and keep more money 00:16:41.779 --> 00:16:44.940 in your pocket. Now, a few other things as we 00:16:44.940 --> 00:16:47.220 look to wrap up shortly. So a dealer, they're 00:16:47.220 --> 00:16:49.259 gonna report their income on the schedule C. 00:16:49.639 --> 00:16:51.419 And so that's where you're gonna see that self 00:16:51.419 --> 00:16:53.240 -employment tax generated from a schedule C. 00:16:53.729 --> 00:16:55.669 an investor is going to report their capital 00:16:55.669 --> 00:16:58.269 gains on schedule D and then their actual income 00:16:58.269 --> 00:17:01.129 on schedule E. So you'll have those two separate 00:17:01.129 --> 00:17:03.450 things that really start with you working with 00:17:03.450 --> 00:17:05.490 the tax professional or you, if you do it yourself, 00:17:05.490 --> 00:17:08.190 make sure you report it in the proper way so 00:17:08.190 --> 00:17:11.329 that the IRS doesn't get the wrong idea. Now, 00:17:11.349 --> 00:17:13.150 why is this important? Because let's just say 00:17:13.150 --> 00:17:14.769 you're in the top tax bracket, you're a high 00:17:14.769 --> 00:17:17.250 income earner already and you go do a flip project, 00:17:17.250 --> 00:17:19.589 but it was like a one -off time. And let's say 00:17:19.589 --> 00:17:21.690 you made a hundred grand on that project. Well, 00:17:21.690 --> 00:17:25.220 if you pay capital gains tax, you're only going 00:17:25.220 --> 00:17:28.880 to pay $23 ,800 on that flip property. However, 00:17:29.279 --> 00:17:31.339 if you're considered a dealer and you're in the 00:17:31.339 --> 00:17:33.859 top tax bracket, you would pay upwards of $51 00:17:33.859 --> 00:17:37.220 ,000 in taxes. That's a $27 ,000 difference. 00:17:37.559 --> 00:17:40.119 So that would get someone's attention as to why 00:17:40.119 --> 00:17:42.220 they want to make sure they, number one, work 00:17:42.220 --> 00:17:44.599 with someone who is competent that can give them 00:17:44.599 --> 00:17:47.519 the right information so they report it accurately 00:17:47.519 --> 00:17:49.920 and appropriately, but also why they would want 00:17:49.920 --> 00:17:52.410 to make sure they know this. because ultimately 00:17:52.410 --> 00:17:55.789 it will keep more of what you earn. So finally, 00:17:55.950 --> 00:17:59.250 dealers buy to sell, investors buy to hold. Your 00:17:59.250 --> 00:18:01.309 intent, activity, and frequency of sales will 00:18:01.309 --> 00:18:04.750 help determine which one you are. The tax differences 00:18:04.750 --> 00:18:07.309 are big relative to investors only pay capital 00:18:07.309 --> 00:18:10.430 gains tax versus dealers will pay self -employment 00:18:10.430 --> 00:18:13.670 and ordinary income tax. Dealers though do not 00:18:13.670 --> 00:18:16.029 pay that extra net investment income tax. So 00:18:16.029 --> 00:18:19.089 something to keep in mind because who wants to 00:18:19.089 --> 00:18:22.230 pay extra tax? that they're not entitled to already. 00:18:22.690 --> 00:18:25.130 But it's important to document what you're doing, 00:18:25.630 --> 00:18:27.910 keep separate records. So if you have investment 00:18:27.910 --> 00:18:29.670 properties, keep that on one end. If you have 00:18:29.670 --> 00:18:31.710 flip properties, keep that separately. Now, if 00:18:31.710 --> 00:18:34.369 you are a house flipper and you are doing this 00:18:34.369 --> 00:18:36.869 quite a bit and you have enough profit, then 00:18:36.869 --> 00:18:39.269 you might actually consider holding your flip 00:18:39.269 --> 00:18:41.809 properties in like an S corporation. that will 00:18:41.809 --> 00:18:44.289 help reduce your self -employment tax. So that's 00:18:44.289 --> 00:18:45.710 something we'll get into in a future episode 00:18:45.710 --> 00:18:48.170 as far as S corporations and when you might decide 00:18:48.170 --> 00:18:50.470 to do that. But that is a strategy if you are 00:18:50.470 --> 00:18:52.690 a house flipper or a land developer or someone 00:18:52.690 --> 00:18:54.809 in that space where you can use an S corporation 00:18:54.809 --> 00:18:58.309 to help shield you from paying as much self -employment 00:18:58.309 --> 00:19:01.309 tax as you would otherwise. So let's get into 00:19:01.309 --> 00:19:04.230 a tax court case. There was a guy by the name 00:19:04.230 --> 00:19:08.250 of Mr. John D. Byron. And this case went to trial 00:19:08.250 --> 00:19:13.089 back in the 70s. And so between 1971 and 1973, 00:19:13.430 --> 00:19:17.349 Mr. Byron was killing it. He sold 22 pieces of 00:19:17.349 --> 00:19:20.730 real estate, making him $9 million with a profit 00:19:20.730 --> 00:19:23.789 of 3 .4. Now, it wasn't a matter of his profit. 00:19:23.890 --> 00:19:26.490 It was really about, was he considered a real 00:19:26.490 --> 00:19:28.430 estate investor or was he considered a real estate 00:19:28.430 --> 00:19:31.089 dealer? So although in this case, it only took 00:19:31.089 --> 00:19:33.509 three, four years for him to do this and he sold 00:19:33.509 --> 00:19:37.579 22 pieces of real estate. And obviously the IRS 00:19:37.579 --> 00:19:39.819 is thinking, hey, Mr. Byron, you're considered 00:19:39.819 --> 00:19:42.920 a dealer. You're doing this frequently. However, 00:19:43.200 --> 00:19:45.279 the court found that he was actually holding 00:19:45.279 --> 00:19:47.720 these properties for investment purposes. And 00:19:47.720 --> 00:19:50.359 so instead of paying ordinary income plus self 00:19:50.359 --> 00:19:52.900 -employment on that 3 .4 million, he only was 00:19:52.900 --> 00:19:55.619 subject to paying capital gains. So big win for 00:19:55.619 --> 00:19:58.319 Mr. Byron. Now the reason that they were able 00:19:58.319 --> 00:20:01.480 to distinguish this is because he was able to 00:20:01.480 --> 00:20:03.940 show his intent behind holding them for investment. 00:20:04.079 --> 00:20:06.579 He showed that he made no personal effort to 00:20:06.579 --> 00:20:09.200 initiate the sales. He didn't advertise them. 00:20:09.279 --> 00:20:11.559 He didn't have a sales office. He didn't hire 00:20:11.559 --> 00:20:14.259 a broker. He just kind of listed them like any 00:20:14.259 --> 00:20:16.740 other investor might. And he didn't actually 00:20:16.740 --> 00:20:18.880 look to improve the land that he did. He bought 00:20:18.880 --> 00:20:21.619 it. He held it. Someone offered him a price he 00:20:21.619 --> 00:20:24.970 couldn't refuse and he sold it. Also. Even though 00:20:24.970 --> 00:20:28.009 there were 22 sales over three years, the court 00:20:28.009 --> 00:20:30.650 determined that this frequency alone did not 00:20:30.650 --> 00:20:33.130 compel an inference that their properties were 00:20:33.130 --> 00:20:34.849 held primarily for sale in the course of the 00:20:34.849 --> 00:20:38.029 business. And so seven properties a year might 00:20:38.029 --> 00:20:40.710 be a lot, but they didn't feel that that was 00:20:40.710 --> 00:20:44.289 so many that he was actually doing it on a frequent 00:20:44.289 --> 00:20:46.650 basis. He was just trying to buy and flip, buy 00:20:46.650 --> 00:20:49.230 and flip, buy and flip. All right. And it also 00:20:49.230 --> 00:20:50.730 showed that he didn't really spend a whole lot 00:20:50.730 --> 00:20:53.990 of time. in this investment. So Mr. Brown was 00:20:53.990 --> 00:20:56.130 was actually in a good spot, right, making three 00:20:56.130 --> 00:20:59.430 or four million dollars, which, you know, mathematically 00:20:59.430 --> 00:21:02.450 he was making over 150 grand a deal, roughly. 00:21:03.309 --> 00:21:05.369 And so he was doing very well. It's just he was 00:21:05.369 --> 00:21:07.109 spending a whole lot of time doing it. So he 00:21:07.109 --> 00:21:08.490 must have obviously gone through his investment 00:21:08.490 --> 00:21:11.410 filter and it spit out nice results. So this 00:21:11.410 --> 00:21:14.549 shows you that, yes, the IRS is not always correct. 00:21:14.849 --> 00:21:17.089 But if you want to beat them in court, if it 00:21:17.089 --> 00:21:19.480 came to that. You don't want to have proper documentation. 00:21:19.720 --> 00:21:22.480 You're going to have to back your case with prior 00:21:22.480 --> 00:21:25.039 case law or what the law actually says. And ultimately 00:21:25.039 --> 00:21:28.240 you have the ability to win. And as our motto 00:21:28.240 --> 00:21:31.599 says, keep more of what you earn. So thanks for 00:21:31.599 --> 00:21:34.279 listening to our episode. Be sure to like and 00:21:34.279 --> 00:21:36.759 share it if possible so we can get more people 00:21:36.759 --> 00:21:39.400 out there who are trying to quote unquote, stick 00:21:39.400 --> 00:21:41.779 it to the IRS for lack of a better term. And 00:21:41.779 --> 00:21:44.019 we look forward to talking with you next week.