- So I just saved myself $7,650
because I took Evan's advice.
- You would still pay
income tax on that $50,000
and along with the $50,000
that you received via W-2,
that would go through all the usual
standard deduction or itemized deductions
and all the various
individual tax benefits,
but you would not pay any employment taxes
on that second $50,000.
- Got it.
(elegant music)
You're listening to the
Kniep'n It Real JODcast.
This is your host, Seth Kniep.
(elegant music)
Ladies and gentleman, boys and girls,
everyone watching today I'm super excited
because we have the opportunity
to interview a guest who is an expert
when it comes to tax law.
Noe before you say oh my goodness,
this is going to be so boring.
Who in the world wants to learn about tax
when I'm trying to make money?
Let me remind you,
I the young grasshopper a few years ago
would not have been able
to say this but now I can.
I did not understand how important it is
to understand how to legally save taxes
because when you start
making a lot of money
and if you're listening to
this podcast or watching,
that should be your ultimate goal.
Not in all of life,
but I hope that you're
wanting to make more money
because we teach you how to do that.
Your biggest expense is not your car.
It's not your house.
It's not staff.
It's not salaries.
It's not cogs.
It is your taxes.
If you make a lot of money,
you are now in the 37% tax bracket,
which means for every $100,000 you make,
you will take 37,000 of
that hard earned money
and you will give it
back to the government.
Now, I'm not anti-government,
you guys know that,
but I do believe in being smart,
and there are so many ways
you can plan out your future,
so that your money is working for you
instead of you working for it,
and for every person out there
who says, ah passive income.
That's just a stupid pipe dream.
Allow me to remind you,
that the IRS even has,
they have a designation.
They have a term for passive income.
There's such a thing as
a passive income entity
versus an active income entity.
Even the U.S. government
recognizes that term.
So ladies and gentleman,
allow me to introduce
you to Evan Kirkpatrick.
Evan, thank you so much
for being here today man.
- Great to be with you.
- Just so you guys know
a little bit about Evan,
his focus, his goal, is
tax savings for people,
using practical strategies,
so that you don't have a
ton of risk and headaches.
It's all about derisking.
I just want to throw this
out there really quick Josiah
and Josiah thank you for
being here as well today.
- [Josiah] Absolutely.
- What do you guys think
about when people say
hey, this person must be a fraud.
He doesn't pay any taxes.
Like what is your guys' reaction to that
when you hear that?
I'm just curious.
Evan, Josiah, what do you guys think
because you hear about it.
It becomes political sometimes.
- [Josiah] I think it depends
on the knowledge you have
because the average citizen does not know
very much about taxes.
All they know is what they need to pay
for their employee job, and that's it.
They just need to pay their taxes.
So when they hear that
from another person,
they think oh, he's being illegal,
because that's all they know.
So it really depends on the knowledge.
Business owners, some business owners,
know that there is more
to taxes than just that.
I think it depends on the
knowledge of the person.
Back like a few years ago,
I'd have though well that's,
I wouldn't be judging towards them,
but I would be like well that's.
- Sounds shady.
- [Josiah] Yeah, it sounds shady.
It doesn't sound legal.
- The first time I heard a
podcast Evan, on this topic,
and they said you could actually
literally pay no taxes
the rest of your life.
I was like okay, that sounds ridiculous,
and then someone says, are
you looking for loopholes?
They always find a way.
They always find a way,
but then, wait a minute,
there are actually incentives
that can reduce your tax liability
at such a low level,
that there are some people
who don't pay taxes.
So I'm gonna ask the question Evan
and I think everyone's gonna
really appreciate this.
Here's my first question.
How should my business be
setup for tax purposes.
What do you recommend?
- Well, one of my big
things with tax filing
is everything is specific
to your circumstances.
Now, for most people
starting out these days,
sole owner in a business, our go to.
I have to preface everything I say
when we talk about legal stuff.
I am not a lawyer.
I'm an accountant.
So a lot of things come
into asset protection
and things like that.
Those are related to the things we do
but they're not tax centric,
but most businesses
these days start as LLCs.
As Limited Liability Companies.
For a variety of reasons.
As a sole owner,
if you're the sole owner of an LLC,
you have a lot of choices in terms
of your tax treatment.
I refer to LLCs as chameleons for tax law.
They can kind of be whatever you want.
They change if you've got
one owner versus two owners.
Usually in positive ways.
You can make elections as the sole owner
to be treated as different ways,
to potentially minimize taxes.
LLCs are kind of the go to,
because they're easy.
Lawyers like them because
they work pretty well
for asset protection.
They're not a ton of effort to setup.
You can kind of do whatever you want
in terms of your ownership structure.
You can change your ownership structure.
You can change your tax
structure a lot of times.
- Evan, if I just open a business
and I just put in my
social security number
as my tax ID and open, I'm not an LLC.
I'm a sole proprietorship.
So I have big risk, right?
- Yeah, I mean that's what
a lawyer would tell you.
Definitely on the asset protection side
and there's times where LLCs are treated
for income tax purposes the
same as sole proprietorships.
There are times where that's desirable,
but we have the option
to go away from that.
At a time where it makes sense.
- So when you talk about
an LLC, can you give us,
what are some of the tax benefits?
Having an LLC versus a
different kind of company?
- So the main thing with an LLC
is it has all of these choices.
An LLC, a single owner LLC by default,
is treated the same as
a sole proprietorship,
but it can elect to not be.
It can elect to be treated
as an S corporation,
in particular.
That's where a lot of these go.
If you form as a corporation,
a legal corporation is
a tax law corporation.
There's no way around that.
LLC has the option to
be a sole proprietorship
but has the right of multiple
owners to be a partnership.
It could be an S
corporation, a C corporation.
- So flexibility.
If I'm an LLC, I have lots of options.
Is it correct that with a C corp,
you have to have a certain
number of meetings per year
and you have to have
minutes on those meetings
and they're documented?
Whereas with an LLC you don't,
but with an LLC you could
be taxed as an S corp
but it doesn't mean you have
to do that documentation?
- Yeah, I mean again,
some of that sort of gets
into lawyer territory
but at the end of the day LLCs
primarily these days
for actual corporations
you see actual corporations
set up for things
that know in the long term
they're gonna wanna be C corps,
which it's things like
startups, stuff like that,
that are gonna have a multitude of owners.
The corporate form is really useful
if like hey, I'm gonna
have 55 different owners
at the end of the day,
because if you do that in an LLC,
something that's treated
differently for tax purposes,
they're all out of headaches
that come along with it
and inside a C corporation,
you can kind of do whatever you want.
For most solo-preneurs,
people just starting out,
if you're not like a
tech startup or something
where you know you're
gonna be talking to VCs,
to venture capital at some point,
the LLC is just kinda the go to.
It also gives us the most options
in the event of future tax law changes.
Which definitely
politically seems like it's,
there's a good chance of
that over the next few years.
We don't want to lock
ourselves into something
and have the ground shift under us.
- [Seth] Well said.
- Right now in particular.
- So let's say Evan, for
example, I start a new company,
and I hire three people.
I start a new company.
I take your advice.
I'm an LLC.
I hire three people.
Do you recommend I remain
an LLC with passive income?
Do you recommend I be taxed,
and by the way these three people
they're not contractors.
They're full time employees.
Should I become a C corp, a B corp?
What would you tell me in that situation
when it comes to taxes?
- That's totally going to depend on
what your long term goals are,
how much money you're making, how much,
are other people gonna be
owners with you in this?
- Let's say they're employees.
They're not owners.
Let's say we're doing $100,000 a year.
Three full time staff employees.
Each of them is on salary with benefits.
- The employees don't
really change the game
from a tax perspective.
The truth of it is,
you could hire these people as employees.
You could hire them as contractors,
and it could make sense to be
a sole prop in some situations
or an S corporation in others.
Ultimately, the main players in terms
of what we wanna be for tax purposes
in terms of any structure
related to ownership.
How many owners and what
structure is the ownership
and how much money we
have at the end of the day
and what are we going
to do with that money?
- When I pay salaries
to those three staff,
those are tax deductable expenses.
Like insurance, health insurance.
Anything that I pay.
The taxes I pay.
The FICA.
Okay, cool.
Here's the next question,
and feel free to jump in Josiah,
on any of these if you want.
If I'm an LLC, but I'm taxed as an S corp,
can you help me understand the
advantages in that situation
because a lot of people ask this question?
- The big thing that trips up
a lot of people starting out,
I mean besides just generally
not thinking about taxes at all,
which comes up a lot.
You need to be saving money.
Saving money for taxes has to
be built into your structure,
but the big thing that trips people up.
It's not income tax,
because people are kind of used
to thinking about income tax,
but it's what's known as
the self employment tax
which is essentially a replacement
for the Medi-care and
social security withholding
that as a W-2 person,
you have withheld from
your check every month.
- And the employer pays half of it, right,
and then I the employee pay half of it,
but it's already taken out.
- Yeah, so you don't even think about it
and the employee, and like you said,
the employee pays half, 7.65%.
The employer pays an equal amount.
Well, as a self employed individual,
you pay both halves.
It's a 15.3% tax.
- Oh fun, so my FICA tax has just doubled
because I'm running my own business?
- Yeah, and it's on net business income.
It doesn't go through things like
the standard deduction
or things like that.
Now if I'm a sole proprietor,
and I make $100,000 in a year,
for income tax purposes I'm gonna get
a standard deduction.
I might have other things going on.
Itemized deductions,
student loan interest.
Who knows what,
but for the self employment tax,
if I have $100,000 of net
self employment income,
I have a $15,300 of tax on that, period.
- [Seth] Regardless.
- Yeah, and that's a big
sticker shock to people
a lot of the time.
The purpose of the S corporation
is that there's ways to mitigate that
using the S corporation structure
and that's why we go down that road.
By making the owner an
employee of the corporation.
- Is there a minimum salary I have to have
to be an employee,
because wouldn't a lot of people say,
ah, I'll just take $10.00 a year
so that reduces my self
employment taxes liability.
See what I mean?
Like how do we?
- There's a concept called
reasonable compensation
that underlies in particular
the S corporation.
Where you have to pay
yourself something reasonable
versus what the market would
pay someone in your position.
Obviously, we want to
be aggressive as we can
on reducing that amount,
but the IRS is aware of this concept.
It's not something that if
it ever comes up to IRS,
you'll be huh, I don't know
what you're talking about.
They're aware of this,
and so there's a game to be played there.
We want to be as aggressive
as we can within reason
but they're aware of it.
- So real quick.
I just want to break it down for everyone
and tell me if this is correct Evan.
Let's just say for example,
making $100,000 a year,
owning my own company,
and I'm an LLC,
which helps reduce my liability.
In case I get sued,
I can still keep my personal assets.
Now, if I'm making $100,000 a year,
if I take let's say $50,000
and for my position,
and based on the context
where I live and expenses,
that's a reasonable salary,
so it's obvious I'm
not working the system.
$50,000 as an employee of my company
because I'm taxed as an S corp,
even though I am an LLC,
with the Secretary of State
based on the state where I registered.
So if I take $50,000 as my own income,
I'm not only paying income tax on that
but I'm paying self employment taxes
also known as FICA,
also known as one of the two,
social security and
Medi-care, correct so far?
I just want to make sure I
understand this correctly.
The other $50,000 is not
taxed for self employment tax
because it's the business' income?
Am I saying that correctly?
- Right, in an S corporation that income
would still come out to you personally.
It's what's known as
a pass through entity.
- I'm with you.
- It confers its income to its owners.
You would still pay income
tax on that $50,000,
and along with the $50,000
that you received via W-2,
that would go through all the usual
standard deduction or itemized deductions
and all the various
individual tax benefits,
but you would not pay any employment taxes
on that second $50,000.
- Got it.
So I'm saving now,
so that when you said
it was 15 point what?
- [Evan] 15.3
- So 15.3% of $50,000,
that I would have had to pay if I was not
registered or taxed as an S corp.
I'm now saving 15 point.
I'm just super curious what that is.
.153 times 50,000.
So I just saved myself $7,650
because I took Evan's advice.
I'm gonna take my family on
vacation with that money.
- Yeah, and that's the sort of things
that have to be considered
for every new business.
Once you get some money going,
as soon as you get some
of that cash going,
as soon as you start
living off your business,
Uncle Sam's gonna come a calling
and it really.
I don't like having these conversations
with people in April,
and it happens all the time,
where it's like hey,
they come talk to me in March.
I need to file taxes.
I started this thing last year.
Whatever, and then it's like oh hey, yeah.
You owe $20,000 in taxes or whatever.
- A decision you made six months ago
that you didn't plan for correctly.
- Would you say that's the biggest mistake
new business owners make?
Is they're not planning right?
Because every time.
I love this about you.
Every time I ask you a question
in our meeting earlier last time,
about taxes, you always say that depends
on your plan, on your goal,
on your setup, on your structure.
- [Josiah] There's no static
answer most of the time.
It all depends.
- Yeah, because there are people
that are thinking about this from day one,
but if you're looking at,
I've had a W-2 before,
and I'm going into business for myself,
and I kind of have an idea.
This is how much money I'm gonna make.
This is how much revenue I'm gonna have.
This is what my gross
margins are gonna be.
This is what I'm gonna spend my money on
and then I get to live off of this.
Well, if you're not thinking about taxes
and you're living off
your entire bottom line,
or you're planning to reinvest part of it
but you haven't considered, oh hey,
I've got to pay some of this.
Especially in year one,
when people aren't used to it.
It can be a real shock,
and it has to be built
into the business model.
- Josiah, yeah, take it away.
Questions.
What do you wanna ask?
- [Josiah] Let's go with this one.
So Evan, what are some big
picture financial concepts
new business owners often overlook?
- We've talked about tax,
and that's obviously a big one,
but beyond that, any sort of business,
you're really looking at
three or four key numbers
from the accounting side.
We're looking at revenue,
and people get obsessed with revenue.
It's like okay, well my business made.
We had a million dollars
of revenue last year.
- Can I just be blunt?
It's dumb,
because it doesn't matter
how much your revenue is.
It matters how much you are
able to keep of the revenue, right?
Is that where you're going?
- Yeah, because how much revenue
did Uber have last year?
Uber made no money last year.
They don't,
and then stuff like
that's where you get into
well, they didn't pay any
income tax or whatever
and their owners are
worth billions of dollars.
- People love to say that.
That's easy to say, but
they didn't make money.
I would ask anyone watching
would you rather make a million a year
and by make, I mean revenue,
and not get to keep any of it,
or would you rather make
$250,000 of revenue a year
and keep $100,000 of it?
What's the difference between the two?
Planning.
- Yeah, and from ground up,
any sort of business,
whether you're in e-commerce,
you're buying things,
or drop shipping things,
it's buy for X, sell for Y,
and a service business,
I buy people's time,
and I sell it not necessarily by the hour,
but I'm selling it via
charging people for services
and that has to be built into my model.
I buy time for X.
I sell it for Y.
I have overhead.
I pay for this office I'm in.
I pay for software.
I pay for marketing,
and then there's a bottom line
that I get to keep.
I get to use to pay for food.
To pay down debt on things.
To go on vacation.
- There are some situations where
you might not want to make money on paper.
In other words, just for a minute,
if we can nerd out on real estate a bit.
Let's just say you
generate a million dollars
in a couple months,
and you're like, a million,
and you're going oh my goodness.
That means around $370,000,
all things considered equal,
is going to the government
next April 15th.
Everyone's favorite
date on their calendar.
So like, what do I do,
and I hear a lot of people
saying you know what?
If you take that money,
and you buy properties,
and those property in
your real estate business
is acting as an active income entity,
where you or your spouse or
a real estate professional,
so you can actually take
your costs and share them
like business expenses of one business
applied to the other,
so I can take the costs of
my real estate investments
and with amortization and depreciation
which we can get into
more specifically later,
I can use that to reduce
my tax income liability
and yet, still keep the
majority of the money I made.
I just turned it into a house
or a commercial property
that generates me income.
Can you elaborate on that Evan?
Like I find that to be one
of the most fascinating
yet very confusing for many
people topics out there
because once you do start
making a lot of money
when Uncle Sam knocks on the door,
you have to donate a couple organs
and most people prefer not to do that.
So what are your thoughts?
- Really quick, just to add to that.
For those who are listening,
that doesn't just apply to real estate.
Real estate has extra benefits,
but that can also apply to
just the average business.
Spending money on things
to help grow the business.
For example, if you
have an Amazon business
or a consulting business,
you can take that money,
invest it back into the company.
Hiring, Facebook ads,
Google ads, marketing,
and now your profit is
zero or you lost money,
but you grew your business
and your long term value is greater.
- You have a bigger market share.
Your brand is stronger,
or what if you're starting
a software company.
A lot of people do this,
out of your Amazon experience
and that's costing you,
it cost you $250,000 that year,
but over here you made
$250,000 on your Amazon income,
well boom, if I can take the
cost of the software company
and apply it to my income
from our Amazon stores,
I owe no tax.
Can you elaborate on this concept, Evan?
I would love to get your
detailed thoughts on this.
- There's a few different
things going on in there.
One is what Josiah was saying,
which is for a business,
we're looking at net income,
which is calculated.
It's not necessarily net cash flow,
it's starting point is
net cash flow typically,
but based on what you spend,
but especially when you're
talking about operational things.
When you're not buying
real estate and cars
but when we're spending
money on advertising,
on people, things like that,
we can deduct all that stuff.
The tax law term is an ordinary
necessary business expense
which covers very very very many things.
Most things that you're
gonna spend on a business.
Would some other person
consider spending this
in your line of business?
We can deduct that.
Number one, is if you're
spending money in your business,
we get to deduct that.
It's not just oh hey,
I bought these things
for $0.70 on the $1.00.
I sold them for $1.00.
I've gotta pay $0.30.
I've got $0.30 of income on each of these.
Now you get to deduct all your stuff.
- Real quick must for a moment.
Don't lose that train of thought
but I want to park on that for a minute
to make sure everyone understands.
For example, let's say Josiah
and I take you to lunch
and over lunch we talk about the options
for collaborating as business men,
or talk about using your
services or vise versa.
Can that count, and I think
in this case it's 50% of it
and we can talk about that too.
- It is a 50% in this case.
- Because it's a meal.
Because it changed in 2018 or something.
Let's just say the meal was $100.00.
Don't get any expectations, Evan.
Can I take $50.00 of that cost
and count it as a business expense.
For example, if by the end of the year
for simplicity's sake I made $100.00,
$50.00 of it was
attributed to $100.00 meal.
Therefore I'm now taxed on the
remaining $50.00 of my income
not the full hundred?
- Correct, and there's
so many other things.
One is mileage.
That comes up a lot.
Especially if you're someone
that's local to something.
You're dealing with real estate.
Something like that.
I don't remember the exact rate for 2020.
For 2019, it was $.58 a mile.
For just driving around business wise.
As long as you keep track of it.
Then we get that,
and that's kind of a non
cash one a lot of time.
- But April 15th is
almost around the corner.
Oh shoot, I'm doing real estate
and I completely forgot.
Can I go back, make a spreadsheet,
and just kind of put in the
approximate miles, odometer?
What are your thoughts?
I'm sure you've run into this before.
- In general, yes,
and that happens frequently.
The technical tax law is it
has to be contemporaneous.
If it's a practical matter,
the IRS respects reasonable
efforts to comply
and as long as you're not making stuff up.
- Josiah, explain that.
Real estate professional,
or what are you referring to?
This is for anyone in real estate,
this is fascinating.
- [Josiah] The real estate professional
is a tax designation.
It's not a real estate license
for a real estate agent.
That's totally different.
- If I go to get someone to show me
a house or a condo,
that's not a real estate
professional necessarily.
That's someone with a license.
This is a tax designation.
It's not necessarily like a title.
It's just on the tax paper.
What it means is you have to spend
750 hours per year and this could change
and at least 50% of your time
on anything that makes you
money for your business
on real estate, on ordinary
real estate activities.
- But if I have more than one property,
I have to have a minimum of
500 hours per year per property
which gets really interesting,
if I have 500 properties.
I will die.
- That second part is
not completely accurate.
- Help us out.
That's why you're here.
- There are two different components
when you're talking about this.
You talked about passive
activities earlier.
In an individual activity,
and an activity can be anything.
It can be your business.
It can be owning a particular
piece of real estate.
It can be investing in
someone's else's activity.
It can either be passive
or active for tax purposes.
If it's passive,
there are restrictions on your ability
to deduct losses.
We're talking about things.
We could have a three hour long,
completely garbage
conversation about this.
- Podcast number two.
We go through,
there's so many topics we could go deep
on every single one it'd be fascinating.
Keep going.
- Well yeah, we're
talking about something.
To be a CPA these days, you have to have
essentially a master's
degree in accounting,
and I have a specialty in tax,
and I've been doing this for a decade
and it's just limitless, right?
It's like a Las Vegas buffet.
I guess not these days.
- That is how a CPA would call it.
It is a buffet at Las Vegas.
I love it.
- With a passive activity,
there are certain restrictions
on how you can utilize net losses,
and so any individual activity
can be active or passive,
and there's things about
grouping activities
which is often a thing in real estate.
All sorts of different stuff.
There is a tax law presumption
that all real estate
activities are passive
unless they are directly connected
to a trader business.
If I owned this office building,
then everything related to that
would be active for me,
because I'm working in it.
- [Seth] Because you're working in it.
You're actively working in it.
- It's related to my job.
There is a tax law presumption
that all real estate
activities are passive
unless you are a real estate professional
which is independent of
individual activities.
That's the 750 hours standard.
- Yep, with so far.
- And then if you're a
real estate professional
and then you have the right
to essentially demonstrate
that individual activities
or groups of activities
are active.
There are ways to be active
in individual activities
besides spending 500 hours a year in them.
Typically, it's if you have,
essentially ordinary
repeated activity in them,
there's one if you spend 100 hours,
and you spend more time than anyone else,
there's seven different ways
you can qualify as active.
500 is the bright line.
If you spend 500 hours on
something, you are active.
- So 500's sort of like
the bare minimum per unit
but there's other ways
where it doesn't literally
have to physically be 500
hours of my time to qualify?
- 500 will get you there
pretty much regardless.
- For sure, but there's other ways.
I gotcha.
This is really interesting.
- For a real estate professional,
it is the one test that Josiah said.
It is 750 hours plus it's gotta be
half of your time spent on
money making activities.
- So I can't be running a
boutique shop on the side
and that makes me 60% of my income,
but this makes me 40% of my income.
Therefore I qualify.
Okay, gotcha, of your time.
- [Josiah] So if you
were vetted by the IRS
you would have to prove,
and this is where it gets into the logs,
you need to have a log where
you're contemporaneously,
logging all the hours you spend,
describe each activity,
and that way you could
just show it up to them
and be like, look this
is how much time I spend
and you only have so many hours in the day
just in case that happens.
- Real quick guys, before we go on.
Josiah, because the original
reason we brought this up,
can you explain why would someone
who is investing in real estate
but has an active income business,
why would they become a
real estate professional
or have their or ask
their spouse to do so?
- [Josiah] The primary reason is
because like Evan was saying before,
real estate by default,
if you're spending time in real estate,
it's a passive entity.
Passive income entity,
but let's say you have
another business on the side,
like an Amazon business or boutique shop
and you're also spending time in that.
That's an active entity by default.
- Because I'm working in it.
Whereas real estate I just buy it,
and they send out monthly rent.
- No matter how many hours
you spend in real estate
unless you have a real estate
professional designation,
tax designation where
you're logging your hours,
real estate will always
be considered passive.
So what it does, is it
turns the passive entity
of real estate, into an active entity,
and now you can use your
losses from real estate,
your expenses, on paper if you lose money,
you can use those as deductions
for your other business.
- Evan, is there anything
you want to add to that
before we move on?
I'm sure you have thoughts.
- There's two big things with real estate,
which is why real estate
is so tax advantaged.
One is that in real
estate so much of the time
real estate's about cash flow,
but it's also about appreciation.
You're building wealth via appreciation.
Most real estate, not
most, well sometimes most.
It kind of depends on what you're doing.
A lot of real estate when you buy it,
isn't cash flow positive right away.
It's kind of like break even-ish.
- By that you mean,
just to make sure everyone understands,
I am spending more per month
than I am making per month.
So the mortgage I'm paying is $1,000.00
but the rent I'm receiving
is $800.00, for example.
If you're looking at your wealth
only by your checking account,
you are getting less wealthy every month,
but in real estate,
you're making money in the long term,
because the value of
the underlying property
increases with time.
For tax purposes,
that appreciation is not taxed
until the property is sold,
in some sort of taxable transaction.
- In other words, if the
property's $100,000 this year,
especially this is so true in Austin.
Actually, let's start with $300,000.
If the property's $300,000
this year in Austin
and next year it's $325,000 worth,
that $25,000 of net worth that just grew,
I'm not taxed unless I sell it
and receive that $25,000 as a paycheck,
versus a light exchange.
That's what you're referring to, right?
- Yeah, that is exactly it.
You can grow your wealth without
having to pay taxes on it at the time.
It's kind of like a retirement
account in some ways.
Number two, is well, I don't know
if I'm spoiling your thunder here.
- [Seth] No, go for it.
- It's depreciation.
Is the big thing with real estate,
which is in real estate
I'm buying securities.
With securities, if I buy a stock,
I buy a share of Apple,
well it might pay dividends,
and when it pays dividends,
I have qualified dividend income for it
and when I sell it I have gain or loss.
I have taxed income, or
I get a tax deduction,
essentially for the difference
between what I sold it
for and what I paid,
but you don't get to do
anything with that money
that you've invested in this
stock while you hold it.
If you hold it, I spent
$1,000 buying stocks right now
and I hold them for 30 years,
that $1,000.00 is locked
in there for tax purposes.
With real estate, there's a
concept called depreciation
which is if I buy a building, not land,
but if I buy a building,
something like that,
I get to deduct a portion of
my purchase price each year.
Even if I don't sell it.
So that if I had gotten.
- I can't deduct the whole
$100,000 in year one.
I can do a portion of it in year one.
Then another portion year two,
until it's completely depreciated, right?
- Right, and then it changes what tax laws
essentially your deemed purchase price,
and there's a bunch of
technical provisions
but what it comes down to,
is if I buy a house,
I buy an Austin house
for $300,000 right now.
I buy my Austin 1,200
square foot starter home
for $300,000,
and 30 years from now, if I
still own it for tax purposes,
I will have essentially
paid very little for it,
because I will have deducted everything
except for the lot cost
over those 30 years.
Now the big thing with
real estate in particular
why it's used by the
wealthy and as these tax,
this repetition with tax benefits,
it's partly that,
but there are also ways,
that you can deduct
portions of it up front
via a technique called cost segregation.
- I love where we're going.
You gotta listen to what
Evan's about to say.
Evan, I think we shared this with you.
We went through so many CPAs,
who either wouldn't talk
about cost segregation
or didn't want to look at it.
It was frustrating,
and when I first found you on LinkedIn,
I was like this guy, he knows his stuff.
This is so important when
it comes to tax savings.
So carry on.
The theory underlying cost segregation
is that a building itself,
has a long depreciation life.
Either 27.5 or 39 years depending on
what it's used for.
There are components of a building
or a piece of property,
that have shorter depreciation lives.
Obvious examples are things like
parking lots and driveways,
are depreciated over 15 years.
Variety of things on the interior
have five or seven year
depreciation lives.
Cost segregation is the process
of taking a building or property
and then splitting up that one big asset
into smaller assets,
particularly looking for ones
that have shorter depreciation lives,
and right now, under current tax law
and this may change, it
will change at some point,
but under current tax law,
there is a concept
called bonus depreciation
and what this is, is any asset
that has a tax depreciation life
of less than 20 years,
you can generally, not every single asset,
but most assets,
have a depreciation
life less than 20 years,
can be 100% deducted in year one.
You can essentially,
I kind of refer to it as
you can just take them
and in tax world you can just put them in
your personal tax dumpster right away.
There are some caveats to this.
Cost segregation is not
something you can do arbitrarily.
The IRS does not allow that.
- If you like you can get
a cost segregation study or something.
- There has to be an actual
engineering report done.
- Got it.
- Depending on the context,
there are ways, single family,
or small residential properties,
less than a half million
dollars, sorts of things.
There are ways to do this pretty cheaply
and on an automated basis.
If you're talking about something like
an apartment complex.
Or a strip center or something like that.
You're gonna have to have
an actual engineer come in
and do things,
and those reports can
be five, 10, $20,000.
So it has to make sense for
your individual circumstances
and that's part of what I do is,
hey, we need to evaluate
if we want to spend money
on this before we do it.
Depending on how much it is,
what your tax situation is,
how long you're gonna hold it,
but there are ways,
and particularly as Josiah was saying,
if you get to that real
estate professional level
there are ways you can potentially create
very large tax deductions
that you can use to offset
the income tax on other
things you have going on
and that's how depreciation.
It's all time value of money
but if I'm borrowing deductions
from 30 years from now
for the governments without
paying any interest,
I'm going to make money on that.
- Totally.
Could you explain a little bit
on why it's called depreciation,
because before you were talking
about appreciation,
and when I first learned
about depreciation
I was like why is it called depreciation,
because isn't it going up in value?
- There's a presumption.
Depreciation is.
When you're training baby accountants,
when an accountant is in,
or a business major is in business school,
depreciation is the first thing
that starts tripping people up,
because it's not a cash concept.
Depreciation is just the fundamental
accounting concept of,
we have to account for the fact
that most physical things
decrease in value with time.
If I'm a farmer and I buy a tractor,
if I'm an accountant,
and I buy a computer or a desk.
- It gets less value over time for us.
The gears break down.
The software gets slow,
but here's the question.
How it also does the opposite.
It goes up.
- [Josiah] And here's the thing
the price value goes up.
So what you're saying,
the value over time goes down.
So could you explain that difference?
- Yeah, it's essentially
accounting for the fact,
okay, this big asset.
Both tax law and accounting have decided
we're not gonna just write
off assets in year one.
Although the Republican party tried.
They won it too as part
of the 17 law happened.
They wanted to be just like
you can buy a building and write it off.
That's not the way the cookies crumbled.
It's a way of essentially accounting for,
I have this big expensive asset
that I'm gonna use in multiple years
and it's gonna go down in value
presumptively to zero,
which a building would over time.
Like if you don't do
anything to the building.
- True, the worst thing
you can do for a building
is not live in it.
Cobwebs, rot, termites, yay.
- Yeah, it's eventually
gonna crumble into dust
if you don't do things.
So how do we account for that
for accounting purposes?
- That's a good point.
You have to pay for, for
example, air conditioning.
Keeps it at a nice temperature.
Heat, cold, things like that.
What if the roof gets?
Well, if you're living in it,
you're going to fix the roof,
because you don't want to sleep
with water dripping on your head.
So this makes sense.
So there is money you have
to pour into the building
to keep it livable.
So does that answer the question why
you call it depreciation,
even though from a marketing
or a market perspective
the value does go up.
There's costs going into it.
Therefore we get to use that
as a business tax write off.
- Yeah, at the end of the day,
it's called depreciation,
because fixed assets in
general degrade with time
and buildings are just kind of special
where they don't degrade,
because you put money into them,
but tax law in particular
is structured in a way where
even though for most things,
there are rules when it comes to,
okay, if I make a big
repair to a building,
what do I do with that for tax purposes?
Do I have to capitalize it as a new asset
or do I get to just
write it off immediately
and there are specific rules
for different things,
and there's pages and
pages of IRS regulations,
but we're allowed to deduct more stuff
than, like if I buy a house for $300,000,
I'm going to get to write
that off over 30 years.
Putting aside cost seg and all that stuff
and I'm gonna spend money on upkeep
and maintaining things
over those 30 years.
Well realistically, I'm
going to get to deduct
more of that stuff over time,
than logic would dictate,
when I get to the end
and the building is worth more.
- And this is why a lot of smart people
and you don't really have to be that smart
once you learn it,
is they invest in real estate
because of the value going up.
I mean, simple example,
you buy a car, and the value goes down.
You will probably never sell it,
for the same price that you bought it.
It'll always be less.
You buy a house.
You wait five years.
If you live in it, keep
up on the maintenance.
The minimum maintenance needed
even if you don't do some fancy upgrade
and it's a pretty crappy looking house
you can still probably sell it for more
in most situations.
This is fascinating.
Guys, this has been an
awesome conversation.
Before we go, and I think,
Evan, do you want to do this again?
- Oh absolutely,
because there's so much
more we could talk about.
Before we go, I just want to share
two things with you guys.
Number one, KirkpatrickPLLC.com
Kirk, K-I-R-K,
Patrick, P-A-T-R-I-C-K,
P-L-L-C.com.
If you want to talk to Evan,
and you are thinking about ways
not only to setup your business well,
and structuring your assets
in a way that is wise,
and to get your money working for you
and to legally, legally
reduce your tax liability
so you can grow your net worth.
You need to reach out to Evan Kirkpatrick.
Again, it's Kirk, K-I-R-K.
Patrick, P-A-T-R-I-C-K.
P-L-L-C.com
You need to go there.
Evan, before we go, 30 seconds only.
What is one advice you would give
to everyone listening right now?
- When in doubt, plan.
Have a plan for tax.
Have a plan for your business.
Know what you're doing.
If you're working,
you need to work with someone
that understands taxes.
When in doubt, talk to
them before you do things.
We can fix stuff before.
It's a lot harder afterwards.
- Well said.
Awesome.
Thank you Evan for being
here on the JODcast.
Thank you Josiah as well for being here,
and guys, I hope you have an awesome day.
Again, go to Kirkpatrickpllc.com.
Just for the record, I'm not an affiliate.
I'm just recommending Kirk
because we believe in what he does
and hope that you guys got a ton of value
out of today's JODcast.
This is Seth Kniep, Kniep'n
It Real signing off.
You have an awesome day.
Take ownership.
Do something with your life,
that your future self would thank you for.
Have a great day.
