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CPA Answers Depreciation, House-Hacking, and Rookie Tax Questions

Amanda Han is a familiar face to the BiggerPockets audience. She’s been featured on the BiggerPockets podcasts before and has written multiple books published by BiggerPockets (The Book on Tax Strategies for the Savvy Real Estate Investor & The Book on Advanced Tax Strategies). Amanda has worked with lots of real estate investors and invests in real estate herself, so she’s answering some common questions that rookie investors have about taxes.

We run through a mix of topics such as deductions, depreciations, home-office write-offs, expenses, legal entities, and when you should get a CPA. Amanda also talks about some of the most common deductions that rookie investors miss. She also talks through different software for tracking your business expenses, recording your mileage, and keeping your business finances up to date.

It may seem like a lot of information to keep track of, especially when you’re in the middle of a rehab/flip or even just managing your rental. Amanda stresses how important it is for you not only to find a high quality, real estate friendly CPA, but also that you keep them in the loop. If you’re thinking of buying, selling, or transferring property, it’s incredibly important to keep your CPA notified on all things related to your real estate business. That way, you keep more money in your pocket and are able to grow your portfolio even faster!

Ashley:
This is Real Estate Rookie show number 77.

Amanda:
But taxes doesn’t have to be scary. It’s not your job as an investor to understand all these different rules and regulations. Your job really is to keep your advisor updated on what transactions you have coming down the pipeline.

Ashley:
My name is Ashley Kehr and I am here with my cohost, Tony Robinson, and believe it or not, but we actually recorded four episodes today. We are on a roll.

Tony:
I’m losing my voice a little bit, my butt’s getting sore but we’re in the home stretch now. But it was all good stuff. It was all for a good reason.

Ashley:
I know. And I can’t even believe you haven’t noticed yet but I changed my shirt from the first three recordings. I thought for sure you would notice right away and say to me, “Oh, you don’t want to have the same shirt on?”

Tony:
I didn’t even notice that.

Ashley:
We had a five minute break and I actually scarfed down some sushi and I spilled soy sauce on my white shirt so that’s actually why I changed.

Tony:
That’s why I always go black. Soy sauce can be all over this thing and you’d never know.

Ashley:
Right. So today is really exciting because a lot of you might think tax, ugh, boring. But we have Amanda Han on and she basically wrote two books that are geared towards real estate investors to not make it boring. So today’s episode is going to be informational but she actually keeps it interesting because she breaks things down so that it’s easy to understand and easy for you guys to implement into your business.

Tony:
And I think the biggest takeaway from today’s episode is that as a real estate investor you don’t have to be a professional accountant. That’s what you hire a CPA for. But you need to be knowledgeable enough so that you can ask the right questions and really make sure you’ve got the right partner in your CPA. So she breaks down what you should really ask a CPA when you’re looking for one, she breaks down a lot of the kind of mistakes that she sees rookie investors make, and so many other things that I think are going to help the listeners today.

Ashley:
Yeah. And also we have a little teaser for you guys. There’s something really interesting at the end that she’s teaming up with BiggerPockets to put out for you guys. So make sure you guys listen for that.

Tony:
Amanda Han. The one and only. Thank you so much for joining us on the podcast today. I’m sure there are quite a few people in the audience that have already been introduced to you through your books and your podcasts. You’ve done further BiggerPockets related things and we are excited to have you here with us today.

Amanda:
Yeah. Thank you so much. I’m so excited to be here with you guys. I’m so starstruck by a lot of your Instagram posts so glad to be here.

Ashley:
All of our Instagram reels we do together.

Tony:
Yeah. Now Amanda, I’ve read your book. I’ve learned a lot from it myself. But for the listeners who don’t know you just give us a backstory. Who is Amanda Han and yeah, just what’s your story?

Amanda:
Well, I guess my background is I’m a CPA by trade. I call myself real estate investor by night. So I am like a lot of the rookie investors here where I still have a day job and also have been doing real estate. But I’m actually the third generation of real estate investors in my family. So my grandparents invested in real estate, my parents invested in real estate, and surprisingly I didn’t start out on the real estate path. I went to college, got a degree and started working in public accounting and it just so happened I ended up in their real estate specialty group and that’s sort of where I learned or came to the understanding that there are so many tax benefits associated with real estate investing. And that’s sort of how my husband and I got started years ago. It was really for the tax benefits of it. And so we’re really fortunate to be able to kind of combine our passion in tax strategies as well as our passion in real estate investing and be able to kind of do both at the same time.

Tony:
Awesome. Now Amanda, you’ve written a couple books for BiggerPockets so why don’t we go ahead and let the audience know what those books are and kind of what the basic premise of those were.

Amanda:
Yeah. The first book we wrote was called Tax Strategies for the Savvy Real Estate Investor. And it’s actually good for all investors. You don’t have to be a super savvy investor to read it. The reason we wrote the book was because Matt and I, we do a lot of learning ourselves, listening to other CPAs and things like that, and when we read a lot of the tax books they were just very dry. It was very boring to the point where I found myself falling asleep. And so I thought, “How would investors get any benefit from reading something like that? That’s so dry.” And so we set out with, let’s write a book using real life examples. Story examples of clients that we’ve worked with and what worked out well and what didn’t workout well. So that’s sort of the premise of the book. It’s not for CPAs, it’s not a bunch of code sections. It’s really just stories. Both success and failure. Or horror stories, let’s say. About how you can save money when it’s done correctly in terms of tax savings and then how you can end up costing yourself a lot of unnecessary tax bill.
So that’s the premise. And then we wrote the second book, The Advanced Tax Strategies. That’s more for more seasoned investors where they’re looking at maybe selling properties or how do they scale up to different properties. So a little bit more advanced topic but we tried to keep within that theme of storytelling. Our goal is to try to captivate the investor’s attention because I understand tax is a very boring topic. So try to do what we can to get people excited about it.

Ashley:
Well, I’ve read both the books and I love that. And I’m so glad you’re on the show today so that we can pick your brain and really tailor this to rookie investors just getting started. You have such an opportunity to start learning how to save those tax benefits and having all of those advantages before you had this huge portfolio and you look back and realize on all the savings you missed out on. So rookies, make sure you guys listen to the show and start implementing these strategies now so that when you go into next year you have everything ready for your 2021 taxes to show. So Amanda, the first question I have for you are what are some of the common tax mistakes that rookie investors actually make?

Amanda:
Yeah. That’s a great question. I think rookie and just even seasoned investors I would say, the most common mistakes that we see are missed tax deductions. As investors ourselves, usually we’re pretty good about writing off common expenses like mortgage interest. If we have debt we’re writing off our mortgage interest. We’re writing off property taxes, insurance expense. If we hired a management company we’re always … Most people are good about writing those things off. But what a lot of investors don’t think to write off about or maybe don’t know to write off are some of these other expenses that are not property specific. So an example might be BiggerPockets subscriptions. So if you’re a pro member or something like that. You’re buying books. Maybe a tax strategies book about real estate.
So oftentimes we see people miss out on those types of things. I’ll have someone who found us through BiggerPockets or through the book and then when we do their tax returns we don’t see those expenses. So those are common mistakes that people don’t know that they can track and write those things off. Also things like a home office, I would say. Especially since COVID. Most of us are working from home for our real estate. And even outside of COVID I don’t know many investors who rent an office space just to manage their rental properties. So home office is the huge one that a lot of investors should be taking advantage of. And of course car, cell phone. We use all of those things for our real estate business and a lot of people miss out on those deductions either because they’ve been given wrong advice or they didn’t know that they can write those off.

Ashley:
Amanda, just real quick, can you give us a breakdown as to how a rookie investor should be tracking their expenses? Maybe just recommend some software and what are they doing with receipts? What’s the proper way to actually track their expenses so they can write them off?

Amanda:
Yeah. I love that question because that’s one that I get a lot too. There’s not a specific methodology that fits all investors. Because people will ask me, “Should I use QuickBooks? Should I use Stessa or property management software?” And it really depends on you. So if you’re someone who likes software, QuickBooks is really great. It can automate with your bank account and credit card and you can download a lot of that stuff. But we do come across rookie investors who just don’t like software. And that’s perfectly fine. So if you don’t like to deal with software, Excel is perfectly sufficient for you to track your income expenses. As long as you’re listing those things out. Or we do have some people who still like paper and pencil so that’s okay too. I tell people, it has to be something that you will like using. Because if I tell you to use QuickBooks but you hate software, guess what’s going to happen? You’re going to buy QuickBooks and you’re going to be afraid to touch it. And then months or a year goes buy and then you realize, “Gosh, I wish I would have been tracking those things.” It’s really up to what each investor likes.
But in terms of apps and stuff, I do like Trip Mileage. That’s where you can track your car miles and your car expenses. So that’s a really great one. But yeah, in terms of receipts too, a common misconception is that you have to keep those little thin pieces of paper and you actually don’t. What I do is I just take a picture. Whenever I’m spending money on business stuff I take a picture of that receipt and it goes into my phone. It’s already labeled by date. And then I just throw it up into a folder. For me personally, I don’t look at it again because all that is already tracked through my bank or my credit card. But I do have that receipt there because if I were to be audited years from now, that will kind of be my insurance policy to show what I spent money on.

Ashley:
Just a real quick thing too, something that I’ve learned is that when you have software such as QuickBooks or even property management software like AppFolio, Buildium, you pay for these services. So if you leave those services and you’ve attached all of your receipts … Which is nice because if you want to go into your bookkeeping and pull up an expense the receipt is there, the expense is written in there and it’s all nice and neat together. When you leave that software, you have to individually go in and download. They do not make it easy for you to take those receipts with you so I loved your tip Amanda is to just throw it all into one Google drive folder or One Drive or whatever you use and save it there and make sure that you are the owner of those receipts because it can be very time consuming to go back and pull all of those receipts from software.

Amanda:
Well, that’s for sure. They don’t want you to leave. That’s why they make it harder.

Ashley:
Yeah.

Tony:
Amanda, you also mentioned something that I think was a really, really good piece of advice, not just for tax but for life in general. But you said that which software or strategy you use isn’t as important as picking one that you’ll stick with. And that is such good advice. Even outside of tax preparation. There’s so many different strategies and niches in real estate investing in general. And people are like, which one should I do? Which one should I go for? And it’s like, whichever one is best suited for you as an individual is the one that you should go for. So I just really wanted to pause and highlight that because you said it real nonchalantly but that was like a bomb being dropped in my mind so I had to highlight that.
So I want to go into the next question here Amanda. And this is something Ashley and I were actually talking about before we started recording today. But it’s, at what point should I as a new real estate investor hire a CPA? Is it before I get that first property? Is it immediately after that first property? When I’ve gotten to five? When does it make sense to engage with someone like yourself?

Amanda:
Yeah. And that’s a great question. So part of that is also a little bit investor specific. If you’re someone with an accounting background yourself, you might be able to get away with waiting until after you have one or two properties to talk to someone. Generally I do recommend interviewing CPAs when you’re ready to make that first acquisition. So if you’re thinking, should I do this? Should I do a BRRRR? Should I do a house hack? Maybe it’s a little bit premature to start looking for CPAs. But for sure after you’ve started investing in real estate, maybe even that first property, it could make sense to start at least interviewing. That interview process to find someone who is a good fit.

Tony:
That’s a great point. So if I’m a new investor, what kind of questions should I be asking a CPA? Like if I’ve never really dealt with one before. Maybe I don’t even know how to filter out a good one from a bad one. So what are some good interview questions we can ask?

Amanda:
Yeah. Well, I think there are some common things that people always talk about like do you invest in real estate? What is your experience? Do you have clients who invest in real estate? And I can tell you that you ask 10 CPAs that question, nine, maybe even 10 of them will tell you that they work with real estate investors. Because someone who has one investor client will say “Yeah. Yes, I do have real estate.” I think a really kind of cool way to talk is not to ask those obvious questions but maybe have them talk to you about real estate. So what are you seeing in the real estate market with your other clients? What are they doing? What’s going on with the short term rental market? What kind of strategies are your other clients using in the short term rental space? And also maybe just using different languages that we talk about on BiggerPockets that we take for granted. Like the BRRRR strategy or house hacking. I think you’ll quickly be able to gauge whether that person is well versed in real estate or if they just kind of get lost and have no idea of what you’re talking about. Good way to gauge how experienced they are indeed in real estate.

Ashley:
I think that kind of rolls into another question we put together is, how complicated do taxes actually get once you start investing in real estate?

Amanda:
Well, it really depends on what kind of real estate transactions you’re doing. And I hate to use the word depends but I’ll give you some examples. Okay. If you’re a newbie investor and you’re going to buy one turnkey property … Someone already rehabbed it. It’s already tenanted. You kind of step into the shoes as an owner and you just get your cashflow. That’s fairly simple because there’s not a lot of expenses. They’re pretty much recurring. And so it might not be very complicated when you do tax returns either. As another example, if you are someone who is doing the BRRRR strategy, that might be something a little bit more complex because you’re making a lot of improvements to the property so you’ll want to be working with a CPA or a tax advisor to know, how am I treating these? What can I write off for faster depreciation or can I write them off immediately? Or even if you’re someone who’s house hacking. A lot of newbie investors start with the house hacking side of things. Those can get very, very complicated. And I say that from experience in terms of the tax side. My home, I rent out two rooms. And partway during the year the roommate moves out and now it’s a short term rental.
So there’s all these different tax treatments of gosh, well that was just your home but now we have to split it into three or maybe even have a home office for one of the rooms. So now it’s one property, four different treatments and it could get complicated. So you can see that’s very different than one turnkey property where everything’s sort of already done for you.

Ashley:
For that example right there, using a home office or renting out one room, how does someone go about as to tracking and proving that that room was used as that? Do you have to take measurements of the room and divide that by the square footage of your house? How does that all work? Because I think that’s a common investing strategy that people miss out on and aren’t very sure as to how to actually do it. It seems like a little bit of work to put into it to actually prove that you’re using it as a home office.

Amanda:
Yeah. Sure. That’s a great question. So you’re right, there’s two different methods. You can measure the square footage of your office versus the square footage of the entire home. Or you can look at number of rooms. So number of rooms as an office versus total number of rooms for the whole house. And so in both of those you come up with a percentage, a ratio. And whichever one is the higher percentage is the one that you can use for your home office deduction. So for example using one method, 25% of my house is a home office. You’re going to get a larger tax write off than if only 10% of your house. Because then you can write off higher percentage of your utilities and cleaning fees and all that good stuff.

Ashley:
When does that ever happen, they let you use the higher percentage?

Amanda:
I know. It’s rarely the case but that is true for home office. I never thought about it that way. But you’re right. So yes it is a little bit of time to kind of measure out the square footage of you’re home office. I think most of us know the square footage or our home already. If you bought it or you’re renting, you know that you have it already. And it is one time. One time you measure it and you get to utilize it every year until you actually move. So it is a huge benefit. I still hear from a lot of investors where their CPA or their tax person tells them not to take the home office because it will be audited. I think that kind of advice does a real disservice to real estate investors because IRS has changed their position on that many, many years ago and they are of the understanding that if you have a legitimate home office a lot of us are using it correctly in that manor. And even for people who are renting. If we have rookie investors who don’t own their home, they’re just renting and apartment, you can claim your home office and write off part of the rent that you’re paying to your landlord as well. So that’s also one that we see missed from time to time.

Tony:
Now Amanda, one additional question for me and this has kind of taking a step back to look at like the bigger relationship between the CPA and the real estate investor. But outside of your CPA doing your taxes or helping you with your taxes at the end of the year, what else should I as a real estate investor be expecting from a solid CPA?

Amanda:
That’s a great question because there’s two different things. What you’re talking about is maybe tax planing. During the year, what should I be doing? How should I be tracking my home office? How should I be tracking my improvements? And that’s what we consider proactive planning. So that’s when you contact your CPA to let them know, “Hey, here are some things I’m planning on doing. What so I do? Should I have an LLC? Should I have a corporation? How should I pay for this large investment I’m making?” And that’s very different than meeting with your tax person in February or April and saying, “Hey, here’s all my tax documents. Go ahead and file the tax return.” And I think most investors if they have a CPA they’re doing that second part which is, “Okay, here are my documents. Help me save taxes.” And the reality is for a lot of the things, that’s a little bit too late because the year has already gone by. And either you already tracked those expenses or you didn’t. And you’re in a situation where you had to sort of guess what you spent money on or maybe even lie which is something that none of us want to do.
So it’s very important to make sure you’re being proactive with your CPA or your tax advisor during the year. I always want to harp the point that … Because I know a lot of people are scared of taxes or they just don’t like taxes. Don’t want to hear about it, don’t want to read about it. But taxes doesn’t have to be scary. It’s not your job as an investor to understand all these different rules and regulations. Your job really is to keep your advisor updated on what transactions you have coming down the pipeline. I’m buying some short term rentals. I am maybe selling this property on Main Street. And with a simple statement like that, if you’re working with a good advisor, they can help you strategize and say, “Oh, short term rentals. Have you thought about what kind of furniture you’re buying? How can we write them off? How are you going to pay for those?” Or, “Hey, you’re selling a property. What is it going to sell for? Are you going to seller finance it or something like that?” So from those conversations is where your tax advisor can think more strategically and help you plan.
I think one thing is how do you know if you’re working with someone strategic currently? One way is to ask yourself, what is my plan? What is my plan to save taxes right now? Do I know how to track my expenses? Do I know whether I’ll be able to maximize my write offs with real estate professional or short term rentals? If the answer is yes, great. That means you have someone great on your team. If the answer is no, then you might want to start interviewing people and trying to figure out who would be a good fit for your team.

Tony:
Amanda, I just want to recap what you said here to make sure that we’ve got it the right way for the listeners. But there’s two types of relationships that you can have with your CPA. One is a transactional relationship that’s just here’s everything, let’s file the taxes. The other is a more strategic relationship, which is saying how do we plan for the future to make sure that we’re being proactive and reducing our tax burden?

Amanda:
Yeah. Exactly. During the year. The proactive planning happens during the year before you implement these purchase, sale, refinance transactions on your rentals. Sometimes your CPA that’s planning for you is the same person or firm that’s doing the tax filing, which is great. Other times it might be two different people. There are more firms now that are focused on the planning side and that’s not the end of the world because if you’ve done the planning, meaning if you’ve captured your expenses, you’ve implemented the transactions the correct way during the year, then odds are, regardless of who’s filing your tax return, the results should be pretty similar because you’ve kind of done that pre work to make sure you’re doing everything correctly in the right steps.

Ashley:
Amanda, I want to know what are some of the tax advantages for the different real estate strategies? I do mostly buy and hold investing. Tony is short term rentals. For example, what are the advantages of doing a short term rental that maybe you don’t get for a longterm buy and hold investor?

Amanda:
Oh, wow. Well, first off I would say both of those are really great. Longterm rentals and also short term rentals are great because we get the benefit of depreciation. Depreciation, as in the ability to write off part of the purchase price of our building regardless of whether the property value actually goes up or down in value. And I think that’s really, really huge because especially for rookie investors … An example might be, let’s say you buy a $100,000 property and you put 10% down. So $10,000 down. But for that property, using depreciation, and right now we have bonus depreciation, you might be able to get a tax write off of anywhere from $15,000 to even $30,000 if we assume the building is $100,000. So your tax write off might even be higher than what your down payment is, which is really huge. And you can do that for both short term and longterm rentals.

Ashley:
Amanda, can you just break down what depreciation is and even bonus depreciation for our rookies? Just kind of explain what it is and how it’s a benefit to real estate investors?

Amanda:
Sure. The IRS has a rule where if you buy an asset or investment, a house in our example, their thinking is that the home will go down in value. Why? Because of wear and tear and things like that. And that is the reason why you can write off depreciation. The IRS has a set of rules to how you calculate these different things. But basically you’re taking a tax deduction on a paper loss because for a lot of investments it actually goes up in value over time. At least that’s our hope if we’re operating correctly and doing forced depreciation. But nonetheless, under tax law you can still take a write off for the value of the property over time based on your purchase price. So that’s why I was saying if you bought a building for $100,000 your depreciation could be anywhere from 15% to 30%. Bonus depreciation is something that’s currently available, which is that for certain assets that you buy for your real estate you might be able to write off up to 100% of that asset. Now, it doesn’t apply to the building so it’s not like we bought a $100,000 building, we just write of $100,000. We wish that were the case, but that’s not how it works.
But if you’re someone who is in the short term rental space for example and you buy furniture and fixture to get everything all beautiful and ready to be rented out, those are things that are eligible for 100% bonus depreciation. Which means if you spent $15,000, $20,000 on all that, you might be able to write off the whole thing in the year that you’ve purchased it.

Ashley:
Yeah. Here’s a little example for rookies. You have your first property. Say you have rental income of $10,000 and you have your expenses of $5,000. So you have your water bill, you have your lawn maintenance, you have your property management fee, all that. So you have a $5,000 profit. So you go to your CPA, they do your taxes, and it shows wait, you only have $3,000 profit. What happened? And that’s where the depreciation comes in. So it’s not cash out of your pocket but you’re not paying any taxes on that income because it’s getting taken off for that depreciation. So that’s a great benefit to investors is a lot of times you have to go to … You want to lower your taxes? Okay. Then go buy something for your property. Do an expense. But this is a way where you’re not actually taking money out of your pocket to get that tax write off. So depreciation is definitely a great resource for investors.

Amanda:
Yeah. I love the way you explained it too. And if we just go over another scenario where earlier we said, okay, if you put $10,000 down, but for rookies a lot of times we’re talking about creative financing. No money down real estate. And that works the same exact way. If you buy a property with no money down, you still are able to get the same depreciation, just as if you put 10% or 20% down. So it’s certainly a big benefit for investors to make sure they take advantage of.

Tony:
Another question from me Amanda is what are some fatal entity mistakes that you see newbie real estate investors make? And maybe before you answer that, just define what an actual entity is for those that aren’t familiar with the term.

Amanda:
Yeah. A legal entity, typically what we’re talking about is an LLC, a partnership, C corporation, S corporation. Those are legal entities. If you hold your rentals in a land trust or in a sole proprietorship, those are not legal entities. So legal entities you actually form it with the state and it’s a legal structure. Gosh, I hate to say this but there are so many fatal mistakes that I see with respect to entity structuring. I think one of the most common ones is, going back to this concept of people missing out on tax deductions. And a lot of people are told that they can’t write off their real estate expenses like podcasts or membership fees and those type of stuff, they can’t write them off unless they have a legal entity and that’s not true. If you are in the business of investing in real estate, the money you’re spending to help that real estate activity is tax deductible regardless of whether you have legal entity or not. So for a lot of rookies starting out, they might not have a legal entity but they might have already even done one or two deals. So just keep in mind, you can write off those business expenses even though you don’t have a legal entity.
And when we say business, we just mean you’re in the business of real estate investing. Not that the business of having an LLC or something like that. So I think that’s one that I see a lot. Another one I see a lot … Sort of interrelated. Sometimes I see investors on the rookie side who come to us with a bunch of entities formed already. And one of the issues with that is if you don’t have any rentals yet or any flips, rentals, you’re not doing anything yet, then odds are what happened was you might have spent a ton of money to form those entities without actually needing them and that might be money that really could have gone to good use had you instead utilized that to invest in a deal or something like that. So try to avoid forming entities too quickly.
And then the flip side is I also see clients who form it too late where they have a lot of properties and they later form an entity but they don’t really utilize the entity so it’s kind of just this shell corporation that’s sitting there. And in the meantime, they continue to own their real estate personally, pay for everything personally. Then they don’t get any of the benefits of the entity from that liability protection perspective because it’s just a shell entity that’s hanging out there and you have this false sense of security that you’re doing something when you really didn’t.

Tony:
Can we talk about that last point, Amanda, about people waiting maybe too long to form that entity? At what point would you recommend that people really seriously consider creating that legal entity?

Amanda:
Part of that’s going to depend on the type of real estate deal you’re doing. So if we’re assuming it’s rental properties, then usually you want to have an entity once you have a decent amount of equity in the real estate or if you personally have a lot of assets because you’re trying to protect them from a liability perspective. Now, I’m not an attorney so for rental investors, short term rentals, longterm rentals, people doing the BRRRR strategy, that’s also rental essentially, you’ll definitely want to talk to an attorney as soon as you start owning real estate to figure out when is a good time to start putting it in. From a tax perspective, again, whether you have an entity or not, same depreciation, same tax benefits, home office. All that is exactly the same. It’s a little bit different for active real estate though. So if you’re a flipper or a wholesaler or if you’re a realtor, those income … If you earn those inside of a legal entity, you might be able to save on some taxes. So in those scenarios I typically recommend forming an entity earlier rather than later. If you’re a flipper, maybe before you sell that first flip deal. So you can have all that income earned inside of the entity.

Ashley:
I want to talk a little bit about house hacking too since a lot of our listeners, that’s how they get started in real estate is house hacking. So we did touch on writing off a room and how to calculate how much to write off. What are some other expenses that they should look … I mean, are they taking the electric bill and taking a percentage of that? What are some other things that house hackers need to look for?

Amanda:
Yeah. Certainly. House hacking itself, I’ve seen it come across different arrangements from someone renting out a room to someone buying a duplex and renting out one of the units. The tax side is pretty similar on both of them in that basically the rented unit or room, whatever expenses you have for that particular area you can write off 100% of it because that’s 100% real estate related. The portion that relates to your main home, for example, utility bills for the home, internet for the home, roof for the entire home, those, you take a percentage of it. So the portion that is related to the rental, you get to expend or depreciate just like you normally would. The other part that’s personal where you are living then is just like any other primary home where you get to deduct the interest and taxes and then the rest of that is kind of your cost basis in that building to help you save taxes in the future. So we’ve seen that from both scenarios. And from a recordkeeping perspective, it’s really important to take that next level and track in terms of which one of these expenses are for the whole property versus which ones are for the rental unit specifically.
Let’s say if we have a duplex and I spent $10,000 to repair some stuff in my rental unit. That’s great because I write a lot of those off. But if I spent the same amount of money on my primary unit then it’s not as ideal because it’s just a personal expense and I don’t really get any current tax benefit. I know it’s almost counterintuitive because a lot of times it’s like if we have a duplex I want my home to be very nice and fix it up. But from a tax perspective it’s better for you to really fix up the rental part because you get better tax savings for it.

Ashley:
I want to just talk about writing things off. What exactly does that mean? I have had this happen to me a couple times where people have thought that … And it was a girl that interned for me actually was the first person back when I was a property manager. She thought that writing off meant that you’re buying stuff but the government’s paying you back for it because you’re just writing it off. So in case there’s anybody else that thinks that … And you don’t learn these things in school, really. I mean, I may know this stuff because I worked in business and I went to school for accounting, but I feel like there’s a ton of these phrases that go around and misconceptions. So maybe for a very rookie investor and rookie entrepreneur, what is writing off? Because if you’re working a W2 job, you’re most likely not writing off anything on your taxes so you could really just break that down.

Tony:
But before Amanda even answers that, Ash, we got to start lobbying some politicians or something to make that the actual definition of write off because that would be fantastic if the government just cut us a check for everything.

Ashley:
I know. And the poor girl, I think it was her fiance at the time, I don’t think they were married yet, but she was just like, “Why can’t we just go buy this? We’ll get paid back for it.” And he’s like, “Well, how much money have you been spending on the credit card thinking this would happen? That we’d be getting it paid back.” But if you could just explain how writing it off and how that actually works is that you’re not getting money back from the government, you’re just paying less income. I’m sure you can explain it better than me and simplify it for everyone.

Amanda:
Yeah. Well first, I agree with Tony that we should lobby for something like that. That would be great. Yeah. Writing off means you are taking a deduction against the income that’s being earned. For example, you said earlier if I have a rental property and I have $5,000 worth of rental income, I have $1,000 of write offs, now I have $4,000 worth of rental income. Depending on your tax rate. So if you’re someone in the 10% tax rate, then you’re going to pay 400 bucks in taxes. That’s the savings. It’s based on your tax rate. So the higher your tax rate is, the more the actual tax savings you get. The lower the rate, the lower the tax savings. So it’s not a dollar for dollar. What they’re looking at is maybe like … There are some tax credits where oh, I spend a dollar and I get a dollar in credit. But it doesn’t necessarily work the same way in terms of write offs. It is applied against whatever the tax rates are going to be.
That’s a really great point because sometimes people will say, “Hey, what should I buy to get tax savings? I want to write off as much as possible because I can save on taxes.” And that’s never a great starting point because your tax rate is never 100% so if you’re spending $100, even if you’re at 50% tax bracket, you’re going to save 50 bucks in taxes. So we only want to spend money on things that will help grow our real estate that are needed. We don’t ever want to spend money just for the sake of tax write offs.

Ashley:
And just from an investor point of view too is the lower your income is or the more stuff that you write off, it’ll be harder to get a loan too going forward because banks want to see that your rentals are profitable and that you’re not losing money. So keep that in mind too. If you really are scavenging to pay no income tax at all and trying to find every single thing to write off, that can hurt you too in a sense when getting a loan.

Amanda:
Yeah. And that’s a great question because yes, that is a common issue that we see with investors, especially for more the rookie investor starting out, maybe don’t have a huge rental portfolio yet. One recommendation I would say is make sure you’re working strategically with a lender as well. A good lender is someone great to have on your team because a good lender who words with investors will know how to explain your tax return to their underwriters. So write offs are not treated equally. A lot of times we might be writing off things like depreciation. So a lender will be able to explain to the underwriter, “Hey, this is not money that Ashley is spending. This is a paper write off or a car expense and home office.” These are things that we have anyway so they maybe should not count against you or against your income when you’re applying for loans. So there’s differences in terms of how to write them off and what you write off that might be able to get you the tax savings and not hurt you as much on the loan side.

Ashley:
That’s a great point because when I worked for another investor, I would do all of his financing and I remember going after a loan on a big multifamily property and there was a lot of remodeling that was done throughout the units and the bank didn’t take that into consideration because it was a one time expense or replacing the roof. The cap ex expenses, sometimes you can do … What is it where you can … Section 179?

Amanda:
Yeah. Bonus depreciation.

Ashley:
Equipment or something. Yeah.

Amanda:
Right. Yeah.

Ashley:
So different ways you can write off but they wouldn’t count any of that because it’s not like it’s a continuous expense every single year, it was a one time deal.

Amanda:
Exactly. And a lot of times you get to the same answer where you’re still writing it off. It just shows up on a different form and then the lenders won’t count it against you. So definitely some planning room there as well.

Tony:
The next question I have Amanda, the majority of my portfolio is in short term rentals and I’ve heard that there were some additional benefits to owning a short term rental that you don’t necessarily see with a traditional longterm. So I’m curious if you could highlight, if any, what those benefits might be to owning and operating a short term rental.

Amanda:
Yeah. We’re seeing so many investors now go in the short term rental space because I think cash flow is always good and it’s just gotten better in the last year because of COVID and we expect that to continue. So such an exciting time. I think if I had additional time, that’s what I would probably want to get into next so I have to come to you for advice on that. But in terms of taxes, besides the furniture and fixtures, we’re talking about as a short term rental operator we’re including those in the property. A lot of those are eligible for bonus depreciation, which means you can write them off immediately under current rule. So that’s one huge benefit. In the rental space there is a rule called the passive activity loss rule. And that’s one we can talk for eight hours about. But just in general it means that if you’re someone whose income is over 150,000, to the extent you have losses on your rentals … And I don’t mean losing money. I just mean you’ve created a loss because you’ve done all this depreciation and home office and all these write offs. So if you’ve created a loss, you cannot use that loss to offset taxes from your W2 income unless if you’re a real estate professional.
So there’s a lot of rules around well, what is a real estate professional, which we talk about in the book. But effectively, being a real estate professional means that you have to spend more time in real estate than your job. So for you, Tony, if you’re working 4,000 hours at BiggerPockets, then you have to spend more time in your short term rentals to be a real estate professional and use those losses from the longterm rentals to reduce taxes from your job. Those rules are a little bit modified for short term rental properties. So for people who own short term rentals, you don’t necessarily have to be a real estate professional and you might be able to use any of those created losses from the short term rentals to offset taxes from W2 income. And the requirements for short term rental is that you meet what they call material participation. So usually there are seven tests for that, but the two most common ones we see are that one, you personally are spending at least 500 hours in your short term rentals. So if you’re working, again, 2,000 hours at BiggerPockets but you’re spending at least 500 hours in your short term rentals, then you can use the short term rental losses to offset taxes on the W2 side.
So bonus depreciation, cost segregation, all that fun stuff comes into play. If you can’t meet the 500 hours mark, then the other one is the 100 hour rule. So it sounds like it’s easier but it’s actually a little bit harder. And that scenario means that you, Tony, are spending at least 100 hours in your short term rentals but no one else is spending more time than you. And that no one else includes your partners, the cleaning crew, the property management. So other people that’s working in that short term rental. So if you can meet that rule, then you also might be able to use those losses to offset taxes on the W2 side. That rule we typically see people use for investors who self manage their rentals. Because odds are if you have property mangers and people that are doing the cleaning and all that, oftentimes they’re spending more time than you on the investment side.

Ashley:
Well Amanda, thank you so much.

Amanda:
Just real quick, that’s a huge one because we have a lot of clients who are still working full-time. Because not everybody can afford to quit working and do real estate. And that’s where this huge loophole comes in like, hey, you’ve got a couple local short term rentals that you’re managing or that you’re running, then there could be some huge benefits to not have to worry about quitting your job to do real estate full-time.

Ashley:
Well Amanda, thank you so much for all of this knowledge, but you do know you’re on the Rookie Show so we do have to ask you one question. We have to know what is a rookie deal that you’ve done? If you could just share one of those deals, one of your first deals that you did with us.

Amanda:
Oh my gosh. Should I share a good one or a bad one? I’ve done a couple of rookie deals.

Ashley:
Share a bad one with us. People usually go for the good. Let’s hear a bad one.

Amanda:
Okay. I’ll give you both. They’re pretty short. I’ll start with the bad and we’ll finish on the good. Okay.

Ashley:
Okay. Good.

Amanda:
The bad one when I was a rookie, my husband Matt and I first started out, back then there was these real estate conferences that you just paid obscene amounts of money to attend. Thankfully now we have BiggerPockets. And as part of the conference we met a really nice team of gentlemen. They were starting apartment investments in Texas and we decided to invest with them as a passive investor in the deal. So it’s a failure story because at the end of the day I lost all of my money in that investment. And what I learned was because I love those guys so much, they were very personable, I loved their bio, but I didn’t take into consideration that this was their first deal and the market was changing. I didn’t do due diligence on the deal. So you know how investors, sometimes we fall in love with the property and not look at the numbers? In that scenario, I think we fell in love with the syndicator and we didn’t look at the numbers. So that’s what I learned from my failure rookie mistake.
My success story was actually a deal that we did on our own. This was one of our first deals in Las Vegas. We bought a property that was in a fairly bad neighborhood but it was in a gated community. So it’s kind of an outlier within a bad community. It was a home that we bought back then for about 60,000 and had the best tenants. And we later sold that for about 270. And very passive. Nothing I had to do. Barely had my property management go out there at all. So one of my favorite deals that haven’t been able to replicate recently.

Tony:
And Amanda, we actually just had a passive investing pro on the podcast. So for the listeners, I think if you go back three episodes maybe, we had Travis Watts on the podcast and he’s a professional passive investor so he can outline some of the, I guess, advice that maybe people should follow so that your first passive investment deal doesn’t quite end up like Amanda’s. But thank you for sharing that Amanda. I’m glad that the first deal taught you some lessons that helped you do better on the second deal.
If you don’t mind sharing, how big is your portfolio today? How many properties do you guys still own?

Amanda:
We have a mixture similar to before. I am still a passive investor in a lot of deals because I’ve learned it doesn’t mean I stopped, I never gave up. Because we still do work full-time and we’ve got two kids at home, can’t really be as active on the short term rental space which is next on my goal. So we do have a lot of passive investments in multifamily in the Texas area. And then the ones that we are more actively involved are mostly in Las Vegas, which is where I’m from originally. So couple single family homes as well as some condos as well. So those are the ones that I’m more emotionally connected with because I actually self manage some of those.

Ashley:
This week we are going to do our rookie rockstar and our rookie request line voicemail all in one. We actually pulled this from the Real Estate Rookie Facebook group. Make sure you guys join. Tag us in your wins, your successes, and we’d love to shout you out as a rookie rockstar. This rookie rockstar has a win and has a question about is this actually going to be a win. Today’s question is from Natalie Wynn and her question is, “I am in contract for my first out of state property in Clearwater, Florida. It’s a duplex, longterm tenant, occupied for another year. Purchase price, 267,000 with 2,300 monthly income. I just found out about the property being in a flood zone and requiring flood insurance. Not to mention it already has high insurance premiums out there really cutting into my cash on cash. Over 6,000 a year for insurance only. Inspection is scheduled for tomorrow. Doing the math, this could leave me with as little as 2% cash on cash after all said and done. I would appreciate any advice. Thanks.”
Okay Amanda, what would be your advice on this?

Amanda:
I’m up first? Gosh. Well, because I’m a numbers person, I think the decision is going to be based on the numbers. The question is going to be are you okay with that cash on cash return and if not, are there similar properties you can get under contract that are in a similar area where it might not be a flood zone? If you’re not going to be able to operate the property, at least comfortably in your mind, without that flood insurance, that is something that potentially could break the deal for me as an investor, strictly looking at the numbers.

Tony:
That’s great advice Amanda and I want to chime in just a little bit because I had a similar situation with one of my investment properties. We bought a longterm rental in Louisiana that ended up being in a flood zone also. And this was our second investment property but the first one that I had with my partner. And we made the decision to move forward even though the cash on cash was pretty slim. And for us, we made the decision for a couple of reasons. One, and this was the biggest reason, is that we wanted it for the experience. This was our second time going into a property, doing an out of state BRRRR, and for us being able to educate ourselves on how to refine that process of BRRRRing out of state, I think, was more important to us than the actual cash flow. Now, we knew that we had enough capital. And actually that deal didn’t cost anything out of pocket because we got really good financing on it so we were able to buy it with zero down. So technically it was infinite cash on cash return but it was very small cash flow.
But for us it still made sense because we knew that we had more than enough capital to go out and get subsequent deals. I think for you, Natalie, if this is going to tie up all of your capital and you’ll be kind of stuck after this, then maybe consider whether or not this is the right deal. But if you know that you’ll have more funds after this one to go on to the next deal, if this is going to be your first one, the purpose of the first deal is to educate yourself, is to learn the ropes, is to give you the confidence to do the second deal. So some factors to consider but hopefully that helps.

Ashley:
Yeah. Natalie, first of all, congrats on taking action and getting a deal under contract. That’s really great. My advice would be, and it’s probably going to be too late for this by the time this episode airs since it says your inspection is tomorrow. But my advice for anyone that comes into a situation like this is to use this as a time to do a counter offer. So after your inspection you can try to get money off of the deal. So I would use this as a situation, if you just found out that the property was in a flood zone. So was it not on the listing or was the seller not upfront with you about it when you first looked at the property? So this could actually be some leverage for you to negotiate a better deal where it actually does make sense. And since you’re already under contract, it’s worth asking for them to take some money off of it and for them, it might be worth it to take the money off because they’re already in motion with you than having to go and find another buyer.
But Amanda, thank you so much for joining us. We’ve loved all of the value that you have brought for us today. Can you tell everyone where they can find a little bit more about you? And I’ve recently learned about something really exciting that you’re teaming up with BP to do.

Amanda:
Yeah, yeah. This has been so much fun for me. Thank you guys for involving me. And yeah, people can find me … Our company website is www.keystonecpa.com. And of course, we have the BiggerPockets books that I encourage people to read if they haven’t already. And yes, I’m also very excited that we’ve been teaming up with BiggerPockets. We have a four day mini course that we put together. Really it’s designed for more of the rookie investors who are starting out and talking about what are some common mistakes to avoid and also we touch on some of the top 10 tax saving strategies that are available for real estate investors. So those can be found on our website. And I think for pro and premium members, they actually can get a 50% discount from BiggerPockets. I think it’s in their pro section in the membership section.

Ashley:
Okay. They can go to biggerpockets.com/perks/pro. And actually you guys can get that at 50% off right there. I think it’s only $20 to get all of Amanda’s knowledge for rookie investors. I would say well worth it. I hope me and Tony get to come.

Amanda:
Yes. Yes, of course. It’s an on demand course that we put together so you don’t actually have to go anywhere.

Ashley:
Oh, very cool.

Amanda:
You can do it from the comfort of your home.

Ashley:
Oh, that’s awesome. I knew it was virtual but I didn’t realize it was on demand so yeah, that’s really awesome. So everyone can do it at their leisure. Well, thank you so much for joining us today. Tony and I both love your books and we felt very honored to have you on the show today and I’m sure our rookies took a lot of value so I really hope that they’re all looking at their accounting setup and making sure their bookkeeping is accurate and tracking those receipts and taking advantage of all the software and the tools that are out there to help them easily and accurately track their bookkeeping.

Amanda:
Thanks guys.

Ashley:
Yeah, thank you. And make sure you guys join the Real Estate Rookie Facebook group and we will be back on Saturday with a Rookie Reply. You guys can tag us in a message on Facebook if you want your question or your topic to be featured on the Rookie Reply or you can also send us a DM. I’m Ashley, @wealthfromrentals, and he’s Tony, @tonyjrobinson on Instagram. Thank you guys so much for joining us. And Tony, I really think we need a closing tagline here. Every time I just say something different.

Tony:
We’ll try and figure something out for the next one.

Ashley:
We’ll see you guys on Saturday for the Rookie Reply.

 

Source
CPA Answers Depreciation, House-Hacking, and Rookie Tax Questions is written by Real Estate Rookie Podcast for www.biggerpockets.com

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