Listen Here
Amanda Han & Matt MacFarland are CPAs and tax strategists who specialize in helping people use real estate to save massive amounts in taxes and keep their hard earned money. They help educate investors on how to maximize tax write-offs, legal entity strategies, tax-efficient ways to access profit, how to use 401K money for real estate, and much more.
They are authors of the highly rated book Tax Strategies for the Savvy Real Estate Investor and they have been featured in prominent publications including the Forbes Finance Council, Money Magazine, Talks at Google, CNBC’s Smart Money Talk Radio as well as the BiggerPockets podcasts. They have helped thousands of investors nationwide to save on taxes with proactive tax planning.
Amanda and Matt shed light on the importance of working with a knowledgeable real estate expert, who specializes in navigating the complex tax landscape. As they discuss the limitations of CPAs’ understanding of real estate investing, they emphasize the value of strategic planning in this lucrative market.
They dive deep into the three most effective tax strategies for passive investors. These secret sauces are a game-changer! They uncover the latest tax benefits, incentives, and economic changes to ensure maximum returns.
Looking to improve your tax strategy? In this episode, Amanda and Matt share valuable insights on how to develop a new mindset and approach taxes with confidence. Grab a notebook and get ready to take notes!
In This Episode
- Amanda and Matt’s background and how it all started for them.
- The importance of working with a tax strategist.
- Top 3 tax strategies for passive investors.
- Key tax changes to be aware of in the current economy.
- What recapture is and how you can plan it as a strategy.
Welcome to another episode of Wealth Strategy Secrets. Today, we’re joined by Amanda Han and Matt MacFarland. Amanda and Matt are CPAs and tax strategists specializing in helping people use real estate to save significant amounts in taxes and keep their hard-earned money. They educate investors on how to maximize tax write-offs, implement legal entity strategies, access profits in a tax-efficient way, and utilize 401(k) money for real estate.
They are also the authors of the highly rated book Tax Strategies for the Savvy Real Estate Investor and have been featured in prominent publications, including the Forbes Finance Council, Money Magazine, Talks at Google, CNBC Smart Money Talk Radio, and the Bigger Pockets podcast.
Matt, and Amanda, welcome to the show!
Matt and Amanda: Thanks, Dave. Thanks for having us. We appreciate it.
Dave: You bet. As I mentioned earlier, I’m excited to have you on. We’re about a week or two post-tax season, so I appreciate your time. I can only imagine what it’s like during tax season.
This is a highly relevant topic for many of our investors, as part of having a solid wealth strategy is establishing a good tax strategy. I think this will be a valuable show for our listeners. To kick things off for those who may not have heard of you before, could you share a bit about your backgrounds and journeys into tax strategy?
Amanda: Sure! Matt and I met when we started our careers at one of the big four public accounting firms. I ended up in the real estate specialty group, so most of my clients were larger real estate companies and developers. Although I grew up in a family of real estate investors—my grandparents invested quite a bit, and my parents dabbled a little—I was always taught to get a stable career as a CPA. I didn’t get into real estate myself until later in my career.
Matt: I remember having my moment when I was working at that same Big Four firm. A couple of years in, I was reviewing a tax return for a 67-year-old retired gentleman. He was making over $200,000 in cash flow, but thanks to depreciation expenses, he wasn’t paying any taxes. That was when the light bulb went off for me—I realized there was something significant happening here.
Fast forward, we both worked in different places before deciding to start our firm. For full disclosure, we are married to each other, which might be helpful for our listeners to know! We’ve had our firm, Keystone CPA, for the last 15 years. As you mentioned, we specialize in working with real estate investors; about 85% to 90% of our clients are in real estate, whether they are full-time investors or working and investing on the side. It runs the gamut, and it’s something we genuinely enjoy and understand. We’re not experts in manufacturing or retail, but we do know real estate.
Dave: That’s great to hear! So, why do you think there are so few tax strategists in the CPA industry compared to traditional CPAs?
Matt: I think the first reason is that not many CPAs focus on the strategy side. When you go through school, what you typically learn is how to file tax returns. Most CPAs you encounter who work in taxes primarily handle compliance work, helping people file their tax returns and similar tasks.
So, that’s the first hurdle: there are not many people who focus on the strategy side. When you drill down further to those who specialize in real estate specifically, that population gets even smaller. Most CPAs, like in any other business, tend to take on all types of clients when they first open their doors.
If I have no clients and someone approaches me about owning a restaurant or a clothing business, I would take that client. Matt and I are fortunate that by the time we started our firm, we were already real estate investors. We recognized the need among our peers in the investment community and realized that this was a niche with significant demand.
I find that in the market, there is a widespread misunderstanding of taxes. Through my entrepreneurial journey, I fired over five CPA firms. I kept paying more in fees each year and was constantly surprised by my tax liability due to the lack of proactive planning. It was incredibly frustrating until I read Tom Wheelwright’s book, Tax-Free Wealth. I believe he is one of the early thought leaders in tax strategy, offering insights on how investors and business owners can approach taxes differently to maximize benefits. I think people need a paradigm shift in their thinking about taxes to leverage a solid tax strategy effectively.
Amanda: For us, coming from a Big Four firm, tax planning was historically reserved for very wealthy individuals—high-income, high-net-worth people. That was the clientele we worked with in the big firms. Our goal has been to take those same strategies and apply them to everyday investors and business owners because the concepts are similar.
The dollar amounts in savings differ, of course. For instance, someone making $10 million who saves $1 million in taxes is great, but for someone earning $300,000 who saves $100,000, that can be life-changing.
Dave: Absolutely. The only downside I’ve found to having a strong tax strategy is that traditional lenders often don’t like it when you seek financing and your reported income is zero or very low. Have you been able to help your clients overcome that hurdle in securing financing?
Matt: Yes, we get that question frequently, especially from real estate investors refinancing or looking to buy new properties. They’ve utilized available strategies to legally reduce their tax burden, but then face scrutiny from underwriters or lenders who see low income on their tax returns. We advise clients to ensure they work with underwriters or brokers who understand real estate investors.
They need to know that the depreciation expense, for instance, is a deduction and not necessarily reflective of actual cash spent. If your deduction was $50,000, it doesn’t mean you spent that amount out of pocket. It’s crucial to have a team that understands how to navigate these situations.
It’s a team sport; we work with our clients and their lenders to clarify these points. Some tax write-offs won’t impact their debt-to-income ratio, while others might. It’s about understanding the numbers and making educated decisions. Typically, we see newer investors struggling with this, especially if they’re just starting with a few single-family homes. However, as they scale their portfolios into commercial properties, it becomes less of an issue since those aren’t as income-dependent.
There are always alternative financing options available, like creative financing, seller financing, or private money, which can help overcome these challenges.
Dave: You made an excellent point about the importance of having a strong team. In my journey of creating a wealth strategy, I’ve found that navigating real estate investing and tax strategy can feel like swimming upstream, especially since most people don’t share the same perspective. That’s why forming a virtual family office and a mastermind group of experts in their specific domains has been crucial for me. Everyone speaks the same language and can support your goals.
I’ve had countless discussions with clients—especially entrepreneurs—who are working on tax strategies as they exit their businesses and aim to optimize their situations. Unfortunately, many tax attorneys and M&A professionals aren’t familiar with these concepts, which can be very frustrating without a solid team to help navigate these complexities.
Amanda: I agree; it’s hard to be a specialist in every area, which is why the team approach is so vital. Even within the tax field, we have colleagues specializing in areas like charitable planning or estate planning, which we may not be as specialized in. It’s often beneficial to take the client out of the middleman role to avoid miscommunication between their attorney and CPA. I love your mastermind concept where everyone comes to the table together to collaborate.
Dave: So can you share with the audience some of your top strategies that you’ve seen people successfully implement?
Amanda: There are so many strategies.
Dave: Let’s simplify this. If you could provide your top three tax strategies for passive investors, what would they be?
Matt: If we define a passive investor as someone who is working full-time or running a business and doing real estate on the side, there’s a common myth that investing in real estate passively offers no tax benefits. That’s far from the truth. When people invest passively, they often participate in syndications. For instance, a company might syndicate a deal to buy an apartment building or a mobile home park.
When you invest passively in such a deal, your goal is to generate cash flow. A frequent question arises: “I received a $20,000 distribution check this year. Does that mean I have to pay taxes on it?” The answer is, not necessarily. In the first couple of years, due to depreciation and other factors, you might pay very little in income taxes on that $20,000 distribution. You might even show a loss on your K-1. This is a significant tax advantage that people often overlook: they have $20,000 in their pocket while paying minimal income taxes.
This leads to what I call tax-free wealth—tax-free cash flow. For most passive investors in these asset classes, you typically need to be an accredited investor, which usually means you’re in a high-income or high-net-worth bracket, translating to a high tax bracket as well. If you’re paying substantial federal and state taxes, understanding that real estate is one of the few asset classes that allows you to earn income, like cash flow, without increasing your tax liability is crucial.
When tax advisors claim there’s no benefit for passive investors, they do a disservice. They have tunnel vision, overlooking the fact that while it might not offset taxes from your business, it still reduces your overall tax burden. This way, you keep more of your profits without losing 40% or 50% to taxes like you might with your business income or W-2 job.
Dave: That’s a powerful perspective!
Matt: Absolutely. Another important lesson I’ve learned is that if you actively participate in tax strategy with your tax advisor, it changes your outlook on financial decisions. Every time you go on vacation or make a purchase, it should be part of your decision-making process. There’s usually a way to integrate those expenses into your strategy.
For example, about ten years ago, we purchased a property in Italy. We rented it out for just one month each year, but it allowed us to travel there tax-free. We could visit our assets and even involve our kids in the business, teaching them about the strategy in a meaningful way.
Dave: Do you have any additional thoughts on how people can learn more about tax strategies and position themselves to take advantage of these opportunities?
Amanda: You’ve brought up so many great points. The first step is to be proactive and maintain an open line of communication with your tax advisor and your team of advisors. You’re the one who knows what’s going on in your life, right? We won’t know you’re potentially selling a property unless you tell us.
Matt: Exactly! Just having that open communication is key. Once you start that process, it becomes much easier. It doesn’t have to be an hour-long conversation; it can be as simple as a quick email saying, “Hey, I’m thinking about doing this.” This helps us assist you better and encourages clients to think ahead about their decisions.
For example, when planning a business trip or even something as straightforward as going to the store for supplies, consider how it relates to your business. This mindset can apply to various scenarios, and it’s all about being proactive in your planning to achieve your goals.
Dave: That personal story you shared highlighted several important strategies, including pre-planning for trips and income shifting to children or family members, especially if you have retired parents in a lower tax bracket. Why not take them along on the trip and have them contribute to managing the property?
Amanda: Exactly! One tip we share with investors during educational events is to ask themselves whether a purchase could be a potential tax deduction before spending significant amounts. If you’re unsure, that’s where your tax advisor comes in. As Matt mentioned, sending a quick email or making a phone call can be incredibly helpful.
The word “how” is powerful in this context. Clients often tell us that shifting their thinking to ask, “How can I write off my trip to Italy?” instead of “Can I write it off?” changes their perspective. Do I have the real estate activities arranged ahead of time to justify the expense?
Dave: That’s such a valuable approach! For those listening who might be W-2 high-income earners, we’re always looking for ways to add value to our clients and solve their problems.
The word “how” is so powerful… There’s something interesting about that word that puts you in a different mindset when you’re thinking.
Matt: Exactly. For instance, we have an oil and gas fund that offers 100% tax deductions against your investment on active income, which has been incredibly beneficial for many. I often suggest that even if you don’t have a business, consider starting one. You might have a passion, hobby, or family interest that you could develop into a business. This could create an additional revenue stream and allow you to categorize some expenses under that business.
Dave: Any thoughts on how W-2 earners can navigate this?
Matt: Yes, it’s essential to understand that if you own rental property, even if it’s passive, you are considered a business owner in the eyes of the IRS. This means you can maximize your write-offs through business development, travel, and meals because you’re engaged in real estate investing. You don’t necessarily need an LLC or corporation; you simply need to be a real estate investor.
For high W-2 income earners interested in real estate, we often work on leveraging the short-term rental tax loophole. This strategy provides significant tax benefits for those treating real estate as a side hustle.
There are ways to leverage short-term rentals. If clients are willing to self-manage for the first year or two, they can create losses through accelerated depreciation and cost segregation studies. These losses can then offset their W-2 income simply because they are managing those short-term rentals. In our experience, it’s often easier to do this than to qualify as a full-time real estate professional, where you need to be fully immersed in real estate activities.
We have clients making around $300,000 who can write off over $200,000 against their W-2 income using this loophole. It’s an attractive option for many of our high-income clients. I also loved your example about oil and gas investments because we have many clients involved in that area as well. The first-year benefits are fantastic, allowing for write-offs against all types of income, including W-2 income.
Dave: Absolutely. What’s interesting is that in subsequent years, when the investment starts generating royalty income—typically classified as passive income—you can leverage rental losses or losses from other real estate syndications to offset that income as well. We’ve seen clients pay no taxes on their oil investment income by utilizing those losses. The multiyear tax benefits can be phenomenal. Can you explain a little about Intangible Drilling Costs (IDCs) and depletion? I know a bit about it.
Amanda: Sure! We typically work with investors rather than those directly involved in drilling, but the IRS allows people investing in oil and gas partnerships to write off a significant portion of drilling costs in the first year. In some cases, this can be as much as 80% or even up to 100% of the original investment, depending on how the partnership is structured. If structured correctly, these losses can be non-passive, allowing them to offset your active W-2 income or other business income.
Dave: Let’s circle back to real estate professional status. Could you give a high-level overview of what it is and what it takes to qualify? I know it’s around 750 hours, but could you explain that briefly? Also, do you see this status phasing out as bonus depreciation sunsets, and what are your thoughts on that?
Amanda: Real estate professional status is especially important for individuals with higher incomes—those earning over $150,000—who have rental losses, whether they come from natural losses or losses created strategically. If you aren’t classified as a real estate professional, those losses are considered passive and can only offset taxes from passive income, not W-2 income. Many investors want to know how they can use rental losses to offset their W-2 or business income.
To qualify, either you or your spouse must be a real estate professional. It has nothing to do with licenses like being a realtor or broker; it simply requires spending a certain number of hours on real estate activities throughout the year.
There are a couple of key tests: you need to spend more time on real estate than on all your jobs or businesses combined. For example, if you work full-time at 2,000 hours, you must have more than 2,000 hours in real estate activities to qualify. If you don’t work full-time or if you have a spouse who isn’t employed, you only need at least 750 hours in real estate activities.
Additionally, you need to meet the material participation requirement, which means you must have at least 500 hours of active, hands-on involvement with your properties. If you meet all three of these criteria, the benefit is that you can use your rental losses against your W-2 and business income. It’s important to note that we’re specifically discussing long-term rentals here.
Matt: If you own long-term rental investments, you must be classified as a real estate professional to use those losses effectively when you’re a high-income earner. However, for short-term rental investors—like those using Airbnb or Vrbo—the IRS doesn’t require you to be a real estate professional. You only need to meet the material participation requirement. Depending on your situation, such as whether you have a full-time job, the type of real estate you invest in—long-term, short-term, or mid-term—can significantly impact how and when you benefit from tax losses.
Regarding your second question about bonus depreciation and its potential phasing out: I see it evolving. This year, we’re no longer at 100% bonus depreciation; it’s down to 80%. While that’s not as advantageous as before, it’s still better than nothing. However, looking ahead a few years, as bonus depreciation is set to decrease by 20% annually, it wouldn’t surprise me if this benefit is reinstated in some form. Bonus depreciation has been around for 15 to 20 years in various iterations, so it’s plausible it could return.
Dave: That’s a good point. The benefits related to energy tax incentives have been in place since the Reagan era, which shows a significant history behind these policies. This paradigm shift is interesting because the government is essentially looking for you to partner with them. When you invest in energy, for instance, you contribute to GDP growth and national defense. Similarly, in real estate, you provide housing, and in business, you create jobs. These incentives exist to encourage that kind of support.
Matt: The psychology around taxes is also intriguing. People often discuss “loopholes” or accuse others of cheating on taxes, but for those who are educated on the matter, it’s more about strategy. The tax code is essentially a series of incentives for business owners and investors.
Amanda: Exactly! They incentivize you to act in ways that align with their goals. There are indeed both incentives and loopholes. For example, bonus depreciation exists to encourage investment, and in 2022, the ability to write off 100% of meals was designed to support restaurants during the COVID-19 pandemic.
However, some loopholes may not align with the original intent of the tax law and could arise from court cases or oversights. In the context of short-term rentals, what we’re discussing might be considered a loophole. The government may not necessarily want to promote more Airbnb rentals.
Both incentives and loopholes are important in tax planning. It’s crucial to have a knowledgeable advisor because tax regulations are always changing. What might be a loophole today could be closed or modified in the future. Your advisory team needs to stay current with these changes as they emerge.
Dave: That’s a perfect segue into discussing the importance of having a robust advisory team. Do you see anything significant on the horizon? We’re just finishing up April 2023, so as we move into the remainder of the year, are there any key changes people should be aware of? In my perspective—setting aside political commentary—President Biden and his team have proposed various measures over the last couple of years, but they haven’t gained traction, for lack of a better term. Now that he has announced his intention to run for reelection, it’s uncertain what will happen next.
If I were a betting person, I wouldn’t expect anything drastic in the next year and a half, but, of course, things can change overnight. Traditionally, we hear about potential cuts to what some consider unfair real estate tax benefits. For example, proposals to eliminate or limit 1031 exchanges come up repeatedly during budget discussions, yet they never seem to go anywhere. As Matt mentioned, we can likely expect more of the same for now.
Matt: Exactly. Another interesting aspect of this is that it often depends on which congress members have a vested interest in certain issues. A classic example is the Augusta Rule, which allows homeowners to rent out their residences for a certain period without tax implications. This law benefits some members who own property in Augusta and want to take advantage of it. It’s as simple as that—legislation gets written to support specific interests.
Dave: However, it’s interesting that despite this loophole existing for so long, many people still don’t understand it or know how to use it correctly. Can you unpack that a bit?
Amanda: The Augusta Rule states that if you rent out your home for fewer than 14 days in a year, the income you receive is entirely tax-free. This often comes into play during events like the Masters Golf Tournament in Augusta, but it’s applicable elsewhere too. For example, in California, there are many music festivals in the Palm Springs area where homeowners might rent out their second homes for a couple of weekends and earn significant income, all of which is tax-free.
Dave: That makes sense. It can work well in the right situations.
Amanda: Absolutely. It can also serve as a strategic approach even if you’re not renting to the general public. We have clients with beautiful homes who hold events for their businesses. For instance, if they own a corporation and want to host top clients or their internal team for a mastermind or training event, they can rent out their house to their corporation. The corporation pays them for the rental, which becomes a deduction for the business while remaining tax-free for the individual.
Dave: That’s a fantastic strategy, especially for business owners.
Amanda: Yes! Another crucial topic that would benefit the audience is understanding recapture. There’s complexity surrounding this, especially for investors involved in multiple syndications.
Dave: Can you explain what recapture is and how one might plan for it as part of their overall strategy?
Amanda: Recapture refers to the process where the IRS reclaims some of the tax benefits you’ve received on a property when you sell it. Essentially, it involves the depreciation deductions you’ve taken over the years. When you sell the property, the IRS will tax that previously sheltered income at a lower capital gains rate rather than your ordinary income rate. Understanding recapture is vital for planning exits and structuring investments effectively, especially for those involved in numerous syndications. It’s all about considering how these elements fit into your larger investment strategy.
Recapture refers to the process where, at a high level, when you buy an investment property for, say, $500,000 and take $150,000 in depreciation over time, your tax basis in that property is effectively reduced to $350,000. When you sell the asset for anything above $350,000, the first $150,000 of gain is categorized as depreciation recapture.
Essentially, the IRS gives you this deduction upfront, but you have to pay it back when you sell. Many people view this negatively, thinking, “Why would I take depreciation if I have to recapture it later?” However, for high-income earners, the tax savings from taking depreciation can be substantial—often at rates of 32%, 35%, or even 37%. When it comes time for recapture, that portion is typically taxed at a statutory rate of 25%, meaning you could still come out ahead overall.
From a planning perspective, when you have multiple passive investments or syndications, there will be various exit points. Generally, as an investor, you can’t control when these exits happen; it’s usually managed by the sponsor or syndicator. That’s why maintaining open communication with your sponsor is crucial. You might ask, “What’s coming down the pipeline in the next 6 to 12 months? Are there any expected exits?” This helps you understand what your share of the gain or loss might be since it won’t always align with the cash you receive.
This information is important for investors to discuss with their tax advisors. You can say, “Here’s what’s coming up; what can we do to minimize my tax impact?” There are strategies the sponsor can employ to minimize recapture, such as allocating the sales price differently. As an investor, you should consider your carryforwards, whether you can sell assets currently in a loss position to offset gains, or if you can reinvest in another syndication before year-end to utilize depreciation benefits. It’s all about having that open dialogue with all parties involved.
Dave: That’s helpful. Let’s consider a scenario where an investor wants to reduce their tax liability to zero. They have real estate and other investments. Beyond simply buying assets, what strategies would you recommend for mitigating that tax burden?
Matt: It is certainly possible to reduce your tax liability to zero, but it requires the right circumstances. It might not happen overnight; typically, it involves a multi-year strategy to transition from a 35% or 37% tax bracket down to zero.
Some pillar strategies we’ve discussed include real estate investments, but beyond that, we look at entity structuring. For example, you can shift income into different entities to benefit from lower or zero tax rates. You might also consider shifting income to family members in lower tax brackets or into retirement accounts. Options like 401(k)s or defined benefit plans can significantly reduce your tax rate.
Additionally, consider shifting assets or income to charities. Many clients are charitable-minded, and this approach not only supports causes they care about but also provides substantial tax benefits. We see this strategy frequently with clients, and it can effectively lower their overall tax burden while doing good in the community.
Amanda: It’s important to note that achieving these tax strategies isn’t as simple as it sounds. It requires considerable effort and often several years of collaboration with your tax advisor to reach that ultimate goal.
Dave: Absolutely, that’s valuable insight. It’s about thinking strategically and working proactively with your tax advisor, rather than being reactive and just sending over historical data from the past year. When you take that reactive approach, your tax planner can’t do much with the information.
Matt: Right! But with a strong relationship and open communication, you can start planning. I genuinely appreciate your time today and the insights you’ve shared. This is such an understated opportunity in the investment world and for those looking to grow their wealth. The ultra-wealthy have mastered this approach. If you look at portfolio allocations in groups like Tiger 21 and ultra-high-net-worth individuals, over 50% is typically in real estate, private equity, and other alternative investments. A significant part of this strategy is leveraging the various tax benefits that come with these investments, which helps drive their overall wealth.
For example, if you’re considering the ROI on a deal and one option is yielding 10% while another is at 15%, what if you could also reduce your taxes by 10%, 20%, or even 30%? That reduction could potentially exceed the investment return itself. When you combine that with the investment’s performance, the overall growth can be exponential.
Dave: Absolutely! Any parting words of wisdom? If you could give just one piece of advice to listeners about accelerating their wealth journey, what would it be?
Matt: I think we’ve covered a lot of tax strategies, and for some listeners, it might feel overwhelming. The key takeaway I’d like to share is that the goal isn’t for you to become a CPA or to master depreciation calculations. Instead, it’s crucial to have the right professionals on your team for tax planning and strategies. Keeping that line of communication open with your advisor is vital, especially before making any significant financial moves. Your team can guide you on the options and opportunities available to you.
For those who are early in their wealth-building journey, my advice is to take action and get started. If you’re working a W-2 job, there’s no better time to begin earning passive income and exploring additional streams of revenue.
For those who are further along in their journey, consider expanding your sphere of influence. Evaluate the people you surround yourself with and determine whether they are helping you achieve your goals.
Dave: Awesome advice! I love it. If people want to reach out to learn more or work on their tax strategies with you, what’s the best way to do that?
Amanda: The best place to find us is on our website, keystonecpa.com. We have a lot of valuable resources available for investors, including a free tax savings toolkit. This toolkit features a self-assessment tool because one of the most common questions we receive is whether someone is paying too much in taxes. While we can’t provide a definitive answer, this self-evaluator helps you assess your risk level.
The byproduct of this assessment is clarity on areas where you might be lacking, which you can then discuss with your tax professional as a next step for planning.
If anyone is active on social media, you can find me on Instagram as Amanda Han, CPA, where I share daily tax tips.
Dave: That sounds great! We’ll link to those resources in the show notes. Thank you again for your time and for sharing so many valuable insights with our audience today.
Amanda: Thank you for having me.
Matt: Thanks, Dave. I appreciate it. Thanks for having us.