[00:00:00] Hi, everyone. This is the how to lower your tax bill 
[00:00:10] podcast. I'm your host, Terrence Hutchins. I'm, a financial and tax advisor in the Dallas Fort worth area. And the goal of this podcast is to help you listeners get 
[00:00:20] educated on different tax strategies. That you can implement to improve your tax situation immediately? Each episode, we'll break down useful tax tips you can use to save
[00:00:30] money no matter what your personal or business income situation. Because our motto is keep more of what you earn. So let's get into today's [00:00:40] episode. All right. So let's jump into this week's episode. We've been talking about real estate investing and how that impacts your taxes specifically [00:00:50] for a primarily W-2 filer. So there's multiple things that could impact a W 2 filer in relation to real estate. And so today I want to 
[00:01:00] focus on two main topics. I want to also introduce just a framework that we have talked to other clients about in relation to how they think about their overall real estate 
[00:01:10] strategy and how that factors into their taxes. Now, number one, I always tell people don't make final decisions strictly for tax impact. But when it comes 
[00:01:20] to the final decision that you're going to make taxes should be a factor because they could allow you to make an extra return on your money. So for example, one 
[00:01:30] of the strategies that is a lot more popular last, let's say decade when it comes to real estate is this idea of the BRRRR strategy. So I'll get into the [00:01:40] acronym in a second, but when I have clients, I want them to think about, okay, one of the reasons you got into real estate was to try to either replace your income, whether that's 
[00:01:50] from the current cashflow and you're trying to build up to replace your job.
So you can actually live off that, or you just want to create a lot of assets and you may be more so focus on the appreciation 
[00:02:00] so that when you're older, you could sell the properties, you could keep renting them. But you would have had the luxury to be able to have someone else pay off all these mortgages that you 
[00:02:10] accumulated while also getting cashflow and tax benefits along the way.
But one of the things that I encourage people to do is to look at what is their current after tax income. So this is going to 
[00:02:20] ignore any special. Situations are deductions, but if you're single in 2025 and you have no dependents and you just take the standard deduction, then the $100,000 that you 
[00:02:30] make, you're going to pay roughly $20,000 in taxes on it.
So your after tax income is going to be about 
[00:02:40] $78,736. But who's counting? That would put your monthly income after taxes at $6,561. And so one of the things that when I look at a real estate [00:02:50] investor, one of the things we measure is their return on equity. That's just going to compare the income they're making from the property to the equity in the property.
And so if you think about whenever people 
[00:03:00] retire. And they have what's called a safe withdrawal rate. Generally, they're looking at targeting four to five percent. All right, that's a whole other topic for another day. But in the real 
[00:03:10] estate game, I encourage them to have a five percent target for their return on equity.
So, for example, if you had a million dollars in real estate equity, you're going to make $50,000 a year off that real 
[00:03:20] estate. So with that concept, if you look at your after tax income, you divide that by 5 percent multiplied by 12. That's going to give you the real estate equity that you could shoot for 
[00:03:30] that would hopefully replace your current after tax income.
So for example, your equity, if your after tax income was $6,500 would need to be about 
[00:03:40] $1.575 million. So you could say, Hey, once I have about a million six in real estate equity, you pretty much. Assuming the cash flow is where you'd want it to be, 
[00:03:50] you pretty much would be independent from your job at that point, based on your current after tax income.
 There's a lot of other things that might go into it, but this is just a simple way for you to think about, alright, what would 
[00:04:00] allow me to be financially independent from the real estate that I accumulate? One of the fastest ways to accumulate your portfolio, or to get to that million six, would be this BRRRR strategy.
[00:04:10] So first we gotta buy something. Then we're going to rehab it. We're going to refinance it. We're going to rent it out and we're going to repeat the process. there's plenty of stuff like bigger pockets. There's a lot of stuff on that actual 
[00:04:20] process. I'm just going to look at it from a tax standpoint.
But, on the front end, when you think about how you buy, we're going to buy with either cash or debt. And many 
[00:04:30] times we're going to do it with a combination of the two. And debt in the real estate space can be your friend if you use it wisely. Not only do you get deductions for the interest, but it minimizes the out of pocket 
[00:04:40] cash that you have to utilize.
And it still allows you to get tax deductions for the interest that you're paying for using that debt. Or, let's just say you're a heavy investor 
[00:04:50] in the stock market and you have either liquid funds or you have retirement accounts, you can actually leverage your investment account so that you can actually take 
[00:05:00] money out of the account without having to sell any of your positions so you can still grow the money And be able to borrow against it.
 you can do this concept also with life 
[00:05:10] insurance. That's another strategy out there that will allow you to borrow against your cash values that's not taxable. So you could actually have investments going in two different places. But with that 
[00:05:20] buy strategy, if we're saying, Hey, I'm trying to get to this million six equity, I got to figure out how do I get to that number faster without just having to save up every down payment and the same 
[00:05:30] way, which is going to eventually happen. It's just going to take longer. So if I do this BRRRR strategy, I got to figure out what's the best way to buy. The good thing is if I'm a house flipper, when I 
[00:05:40] sell that property, I'm paying taxes. So I can't do a 1031 exchange, which we'll get into in a future episode.
I can't do a 10 31 exchange on a house flip. But if I refinance the property, [00:05:50] that's not a taxable event. So I can actually grow equity in this house. refinance it, get the bank to give me a loan and the IRS now I have equity in the property and then I can go rent it 
[00:06:00] out and possibly I can get higher cash flow.
Now I can either do a long term rental or alternatively I could do what's called a short term rental. That leads me into this second Strategy 
[00:06:10] if you're a W-2 filer on what you might be considering and how you grow your wealth in real estate and receive the maximum tax advantages is as a short term rental. Now 
[00:06:20] in the tax code, there is not the word short term rental.
Essentially the IRS defines a rental activity as something that you own, that you rent out 
[00:06:30] more than seven days on average. If what you run out is less than seven days on average, then the IRS doesn't consider that a traditional rental activity. So that 
[00:06:40] just means if I have an Airbnb or a verbal property and I rented out for six days on average, the IRS doesn't treat that with the same rules that they would 
[00:06:50] if I just rented out for the whole 12 months to one tenant.
So, with it not being a real activity, that now means that my activity can be considered 
[00:07:00] active. So in previous episodes, we talked about your three buckets of income. You have your active, you have your passive, you have your portfolio. And we talked about how you can only offset negative 
[00:07:10] income In one bucket with positive income in the same bucket.
So active can offset active passive can also have passive, but you can't cross contaminate unless there's a few exceptions. In 
[00:07:20] this case, real estate is generally considered passive, but if it's considered a short term rental or a non rental activity and I have a tax loss, I can actually use that tax 
[00:07:30] loss to offset my income from my active.
So that now means that I can actually take this short term rental and I could actually be making positive 
[00:07:40] cashflow from it. But if I have depreciation and it creates a loss, I can actually shield that loss. So I'm not paying tax on the money I just made. Plus, I can use that loss to offset 
[00:07:50] my W 2 income.
Now how you supercharge this is what's called a cost segregation study. this is going to be specifically important, at least with current tax 
[00:08:00] law over the next couple of years, because what people have done with these cost segregation studies, is they now get like an engineering firm, and the and the IRS, When they look at 
[00:08:10] your property, whether it's commercial or residential, they will break it out into four components.
So when you think about your house, you have the structure itself. So that's like the brick 
[00:08:20] and all that on the outside. You have the land that it sits on. You have personal property. So that's going to be the walls, appliances, you know, if I have carpet that 
[00:08:30] can be pulled up so you can have all this personal property in it and then you have land improvements.
So that's going to be like your payment. If you have a pool, a deck in the backyard, you're landscaping. All 
[00:08:40] those are considered land improvements. It's important you distinguish that because when you're filing your tax returns. If you could distinguish what's considered personal property inside your house and what's [00:08:50] considered a land improvement, then you have the opportunity to take a accelerated tax deduction on those two components.
So if my house is broken up into four components 
[00:09:00] land, I can't depreciate the structure. I can depreciate on the residential side over 27 and a half years or the commercial side over 39 years. Personal property. I can depreciate five years, land 
[00:09:10] improvements I can depreciate at 15 years. However, for 2025, I can actually depreciate those land improvements at 40 percent as well as the personal property items at 40 
[00:09:20] percent for 2025. Now, the good thing is we are in January of 2025, and you can have this study done prior to you filing your tax return for 2024. [00:09:30] This would actually allow you to deduct those items at 60%. This used to be 100 percent when this tax code just started in 2018
 and theoretically, it could come 
[00:09:40] back. So we'll just kind of see what Congress does with that. But this allows you to say, Hey, if I have a $300,000 property, I could potentially get upwards of $60,000 to 
[00:09:50] $100,000 of tax deductions in the first year. That allows me to then remove the taxes that I paid. So, for example, if you make that $100,000 [00:10:00] and you wiped out your income, you could save $13,000 in taxes.
You still got to pay social security and Medicare, but you can wipe your 13, 000 federal tax bill out 
[00:10:10] that now gives you extra money to invest in other things that can allow you to accelerate your timeline to where you can accumulate enough equity to replace your after tax 
[00:10:20] income. So on our next episode, we're actually going to dive a lot further into the dynamics of the short term rental, but I want to just kind of give you the framework for, okay, 
[00:10:30] how do I think about if I want to replace my income or I want to grow my wealth in real estate and I want to think about the tax component, what are two main strategies that I might consider?
Then we're going to now dive 
[00:10:40] into the short term rentals. And a lot more specifics behind them so that you can be aware if I use this strategy, what are 
[00:10:50] all the things I'm going to need to know to make sure that I carry it out successfully.
But the court case I'll leave you with today actually happened in 2004, and it's just evidence that the 
[00:11:00] IRS isn't always correct, but there was Robert P. Sweet versus Commissioner, so it was a husband and wife and they own two condos in Florida 
[00:11:10] and they actually did not meet the definition of a short term rental because they rented their property out more than seven days, but less than 30 days. Now one thing that I 
[00:11:20] didn't mention which we'll get further into next week is It's not considered a real activity if it fits two criteria number one it's less than seven days on average or it's 
[00:11:30] less than 30 days and Substantial services are provided. Which is generally gonna be like a hotel So I'll get into substantial services, but that was important to this tax court case 
[00:11:40] because this Husband and wife they actually took a loss on their Property and the IRS wanted to specify that this was not 
[00:11:50] considered a passive activity and they thought that they should have been treated as a business.
 Now I don't know the full details of the case, but it seems like the IRS was just kind of overreaching 
[00:12:00] anyway, as far as why they were trying to go after them and they probably just didn't understand the rules. Section 4 69. So these two taxpayers, the IRS actually lost this 
[00:12:10] case. They were able to show that, yes, this is a rental activity.
We don't provide substantial services and we actually are entitled to this loss that we took. And so we don't have to pay 
[00:12:20] this extra penalty that the IRS was trying to levy upon them. Now, the challenge is even if the IRS is wrong, you still have to litigate it. You may have to pay someone to help you so you can have the 
[00:12:30] proper representation, but this is the important of just saying, Hey, I need to keep my records. I need to understand what the law is. I need to work with someone who can help walk me through this so if I do get challenged, I have 
[00:12:40] the proper documentation and have the proper facts of my story. So even if the IRS is overreaching, I can avoid them taking more of my money than they should.
So 
[00:12:50] remember, Our motto here is to keep more of what you earn and we will be back next week to go further into your short term rental strategy from a tax standpoint