Insider Secrets Podcast Season 2, Episode 18
Guest: Brady Slack and Michael Scicluna
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High Country Finance specializes in helping business owners, independent contractors, entrepreneurs, and investors reduce their tax bill and elevate both their business and personal wealth. We pride ourselves in having top notch customer service to help each and every one of our clients reach their goals and increase their knowledge about taxes anytime our services are needed.
Services offered include: Tax Filing, Tax Preparation, Tax Planning & Strategy, Bookkeeping, Payroll (typically managed and outsourced), CFO Services, Controller Services, and Financial Projection & Analysis.
Confidence is not just about being assertive; it’s about the willingness to learn and be coached.
Life is a journey with its ups and downs; winning the small battles leads to winning the war.
Consistency in facing ups and downs allows for success through the big challenges.
The language of business is accounting; understanding that language enhances your chances of success.
Real estate investing has the potential to never be taxed if leveraged with write-offs, expenses, and depreciation.
Don’t let the tax tail wag the dog; sometimes, there are valid reasons to exit a property despite tax implications.
“CPA stands for cannot protect assets. So part of the conversation does need to involve an attorney.” – Brady Slack
“Real estate, very rarely, if ever should cause a tax consequence. By nature, real estate is classified as a passive activity.” – Brady Slack
“When we talk about real estate with our clients, we’re discussing LLCs, we’re discussing how many partners are in those LLCs?” – Brady Slack
“Don’t let the tax tail wag the dog. If you’re like, ‘Oh no, I don’t want to pay taxes on this,’ the question shouldn’t be whether or not you’re going to pay taxes. The question should be what’s my gain on this asset going to be and how am I going to use those funds to grow my wealth.” – Michael Scicluna
“If you plan it right, you can make that part of your retirement plan, a way to pass on wealth to your children where you would never pay taxes on it.” – Michael Scicluna
“And that’s where that 1031 comes into play, where take advantage of the depreciation. Don’t worry about the recapture because you can just roll that over into the next property.” – Brady Slack
[02:05] Intro to episode guest
[02:50] One word that describes Brady personally and professionally.
[06:46] Can you share a brief overview of your background, current role, and your company?
[10:10] What are the tax planning strategies for limited partners, and how do they benefit as investors?
[16:36] Brady, discuss business entity structuring and mapping as Mike mentioned. How should people structure their entities?
[20:54] Discuss cost segregation, its mechanics, and how it relates to leveraging depreciation in your investments.
[31:13] Explain what a K1 is and how it’s utilized for new investors or passive investors exploring deals.
Kristen: [00:00:00] Welcome to this edition of Insider Secrets, the weekly podcast that turns real estate investing goals into reality. Each show, we interview guests who are seasoned real estate professionals actively closing and managing real estate deals. Mike is the founder of My Core Intentions and would like to help you make your real estate investing dreams a reality.
Mike coaches you to buy investment real estate, creating short term cash flow and long term wealth. Your host and real estate coach, Mike Morawski, has more than 30 years of real estate investing and property management experience. Here’s your host, Mike.
Mike Morawski: Hey, what’s up everybody? Good morning. I certainly hope that you’re enjoying some time and being intentional about your activities and what you’re doing, whether that’s time with the family or finishing up, catching up on some things from the work week.
And, looking forward to this morning. We’re going to talk this morning about tax planning and strategies and[00:01:00] how that will benefit you in the multifamily space, whether you are a general partner in a deal, or whether you are a limited partner and what the benefits are that you’ll be able to see on both sides.
I want to welcome you. If you’re new to the show, if this is your first time listening in, welcome. Glad that you’re here. I’m always trying to bring great guests smarter than me with a lot of content that’s going to help you on your multifamily journey. So whether you’re doing small multifamily two to four units or doing large multifamily, 200 units and plus.
There’s going to be a lot here on both sides of the aisle for you. Not just today, but in the rest of our events. If you go out to either my YouTube channel and subscribe there. Hey, my guest this morning is Brady Slack. Brady’s with high country finance. He’s calling in from Utah this morning. We’re going to talk about tax planning, tax [00:02:00] strategies and how those can benefit you. Let me bring Brady in.
Morning, Brady. How are you?
Brady Slack: Good, Mike. How are you? Thanks for having me.
Mike Morawski: Yeah. Thanks for being here. I appreciate it. You’re in Utah and before the show, you were saying that there was a little bit of snow up a little higher elevation than where you’re at.
Brady Slack: Yeah, it’s great this year. Last year we had a wonderful snow year and it’s almost to the point where not all the snow’s melted and we’re already starting to get new snow. So it’s good for us. Our mountains are our reservoirs. We love it. And I love the weather.
Mike Morawski: Yeah, nice. Listen, I always ask one question and I always say, I’m going to write a book on this. Cause I’ve asked 300 times this question of people. And one of these days I will get a book published on this, but in one word, what best describes you personally and professionally?
Brady Slack: One word is difficult. Mike. Coming up with one word is difficult. I think personally, my word would have to be confident. And I think professionally I would pick my word also as confident. I [00:03:00] think they have different meanings, but I think that’s my word for both personal and professional.
Mike Morawski: So have you always been confident?
Brady Slack: There’s a funny story behind this.
Mike Morawski: Yeah, let’s hear it.
Brady Slack: My mom and dad actually told this to me not too long ago and I had no idea up until not too long ago. When I was in, it was kindergarten or first grade and they had like the back to school night or your parent teacher conferences. I didn’t go for some reason and the teacher was really concerned and she said to my parents, hey, he’s really confident. He’s not arrogant, but he’s confident.
He answers questions. He’s the first one to volunteer to do things and I’m really concerned about him. And my mom and dad were like, why are you concerned? That’s a great trait to have if he’s confident, let him be confident. And I would say that growing up, there were definitely times where maybe my peers would say that Brady wasn’t confident. He was very cocky.
And I would admit that during times of my life, I’ve been very cocky and I haven’t been able to approach that confidence with aspects of humility and willingness to learn and be coached [00:04:00] and understand that still human and I still have lots of errors, but I am confident. I work hard. I’m determined. But yeah. That’s a funny story. I’ve always been like that, apparently.
Mike Morawski: Good for you. That’s great. I have to say and I’m serious when I say I’ve probably asked that question 300 times, at least 300 episodes I’ve done. And, don’t know that anybody’s ever said confidence. So you’re confident and, I like that. So I think in the world today that you need to be confident, if you don’t have that quality or character trait in your DNA, it’s hard to be an entrepreneur. It’s hard to succeed.
Brady Slack: I completely agree. And I also think it can be taken in a lot of negative connotations as well. That can come off very strongly to some people and I understand how it can but I’ve been through a lot. I’m very young. I’m 28 years old, but I’ve had a lot of great life experiences that have helped me learn. Hey, I can do hard things. Other people can do hard things. I can help people do hard things. And that’s allowed me to build that confidence. I’ve [00:05:00] also had a experiences where, jeez, I have failed greatly at some things and that’s created the humility side to it. It’s like, I’m still human. I still make errors, but I can build upon those.
Mike Morawski: Good for you. That’s awesome. Yeah. I think that life is that journey that we have those ups and downs. We have good times, bad times, and we have losses and we have successes. I read a book one time by Pat Riley, and you may or may not know who Pat Riley was, but he’s a coach of the Lakers and then Miami heat for years.
But he wrote a book called The War Within and I love sports analogies and he talked about the little wars on the basketball court, the back and forth. This was after the Lakers had won like their sixth championship and he’s on the beach and ran into a couple of guys that were on vacation where he was. And he said, that there was the war within and the one who won the big war, the game, were the ones who won the [00:06:00] small battles, the most battles back and forth, whether that was offensively or defensively.
And I think it was a great analogy to look at life. Every day you get up and you go after it. And if you’re intentional about what you do and you fight that battle and you win the battle of the day. You’re going to win the war.
Brady Slack: Yeah. The consistency. You hear a lot of like self development individuals, coaches, high performing individuals who talk about the consistency, and I think that falls right in line with what you were just describing. The consistency in what you’re doing, being able to conquer and be consistent throughout the little ups and downs allows you to be consistent and successful through the big ups and downs. So I 100 percent agree with that.
Mike Morawski: Yeah. Awesome. Let’s talk about you a little bit. Talk your background and what you’re doing today and your company.
Brady Slack: So Mike, I don’t know that I’ve ever met anyone who grows when they’re asked what they want to be when they’re younger, they say, I want to be a tax accountant like that. [00:07:00] And that certainly wasn’t what I wanted to do. But I got tripped and pushed into the position that I’m in, kind of got tripped and pushed multiple times. To be honest with you, I was going to school, figured out the medicine wasn’t the route that I wanted to go, but I knew I wanted to make a lot of money and I knew that I didn’t want to go get a business management degree.
Cause I felt like everyone else in their dog was getting a business management degree. Not that it’s a bad degree to each their own, but I just felt like accounting would maybe separate me from my peers in that regard. They always said, accounting is the language of business. And I figured if I could understand that language, then I might have a better chance of being successful.
I got tripped and pushed at the time. She was my girlfriend. Now she’s my wife and her dad owns a very successful business. And he said, Hey, you’re going to school for accounting. My accountant needs some help. Do you want to go work for him? And he happened to be offering me more money than where I was currently working.
So I did, my wife tripped me, my father in law pushed me and I started to work for that accountant. I just fell in love with it. To be honest, it was really fun. I started working with some high net worth individuals.[00:08:00] Gross revenue or net profit a million dollars plus every year. And it was really fun for me to see how those individuals let their money work for them.
So I put myself in a position where I tried to learn as much as I could. And very quickly, I was working in an advisor role with some of these individuals. Then after some partnerships opportunities that arose and some training opportunities that arose, I left that firm and I started my own high country finance roughly four years ago, and it’s been awesome.
We’ve built a team in under four years to almost 30 employees. We advise companies a little bit past the startup phase through growth modes to the point where their enterprise needing accounting departments in the organization, or they’re looking to exit their businesses, a million to $25, 30 million.
And we’ve had a blast doing it, and along the way my wife and I have bought real estate. We’ve invested, we’re real estate investors. I’m co founder in a couple other organizations and companies. I’m a board member. And so it’s been fun [00:09:00] along this way to build the businesses, help others build their businesses and be successful and again, always make more money and try and pay as few taxes as possible.
Mike Morawski: I like what you said about accounting being the..
Brady Slack: Language of business.
Mike Morawski: Thank you. Yes. I always say the math never lies.
Brady Slack: Yeah, I can make it lie. I can make it lie, but it doesn’t lie.
Mike Morawski: Yeah, let’s not go there. We get in trouble for that. Yeah, you can make numbers do whatever you want. But if you stick to the course. And I’m in the syndication business, so I syndicate multifamily deals and for people that don’t know what that is, we’ve raised capital from individuals, partner with them on a real estate deal and sharing the profits. Our limited partners or investors get the lion’s portion of the returns.
And I’m a conservative guy, like no rent growth year one, no post renovation rent growth in today’s market. So let me go here real quick. There’s three things I like to accomplish. One is [00:10:00] create cashflow for my investor along the way, create long term wealth, and then some tax planning strategies. So let’s dive into that. Let’s dive into what some of those tax planning strategies are and what they look like. And how the limited partner can benefit from them as an investor.
Brady Slack: Yeah. Great questions and a great preface to the conversation, Mike. The overarching opportunity that I see in real estate is that real estate investing has the potential to never be taxed. Meaning, in the years that I owned the rental real estate, whether I’m managing the properties or I’m coming in as a limited partner, and I’m receiving the cash flow, but I’m able to utilize write offs and expenses and depreciation, which we can get into if we want in a little bit. But my rental real estate could or should always be a [00:11:00] loss on paper.
Okay. And it should always allow me to be able to use or offset other incomes. The other benefit to real estate is, lots of people will tell you, buy, hold, and die with your real estate because you can execute tax deferred exchanges through internal 1031, so that you don’t have to pay a capital gains tax when you sell the property. You can just roll it into a bigger or bigger valued properties. So I can defer a capital gains.
Mike Morawski: I like how you started that. You said never be taxed. When Donald Trump was first running for president, everybody was yelling and screaming because he didn’t pay taxes, but he was just a smart real estate investor. And, you’re saying it here, never be taxed. Are there ways other than 10 31 to never be taxed?
Brady Slack: When we talk about getting out of the property, there’s three time periods that I look at, or should be looked at when you’re talking about tax planning, what [00:12:00] is the tax consequence now? What is the tax consequence when I buy or sell? And what is the tax consequence when I die? Those are the three time periods that should be looked at when you’re talking about doing tax planning. And the now with real estate is great. I get to utilize depreciation to offset the profits from the business.
The die is when I die, as it is written in the tax code right now, my beneficiaries receive a step up in basis to fair market value and can sell the properties for a $0 gain and not have to pay the tax on those properties. The, when I buy or when I sell the property is the capital gains consequence, and unless I execute a 10 31 exchange, odds are, as I probably will be paying a capital gains tax. So that’s the one caveat to that one time segment.
Mike Morawski: So let me ask you this. Have you ever looked at somebody’s portfolio and been able to say that they have the ability to [00:13:00] move their money into another piece of real estate, not do a 10 31, but because of depreciation and those other things that go, expenses and things like that, that go along with it. That you would be able to offset that tax basis.
Brady Slack: Not necessarily because it’s a different kind of tax. So if someone had money coming from another resource that they wanted to put into real estate, potentially depending on their tax classification in real estate. But if they own real estate and are just looking to sell the real estate, odds are is you’re going to be paying a tax on the sale of that real estate.
Mike Morawski: Okay. Okay. All right. So, have you ever penciled it out though to say, no tax here on a 10 31, but if you moved your money into here and paid the tax that you make back X over X period of time?
Brady Slack: I can think of one or two situations where it’s actually made more sense. I’ll give you an example. I had a [00:14:00] client not too long ago, they were really heavy into the house hacking idea. Buy a house, live in it for a period of time and then start to rent it out while they moved into another house. And that’s how they’ve built their real estate portfolio. There’s some exclusions are allowed to individuals that have lived or utilized a property as a primary residence and then look to sell that to where they might be able to exclude some of that income from being taxed.
250 If you’re a single, 500 if you’re married. And so I’ve been in situations where an individual has lived in the property, met the requirements, moved out, and is still able to sell the house in a reasonable time frame and qualify for those exclusions. And in those situations, it makes way more sense to qualify for the exclusion, not have to pay the tax because then you have a gain of whatever that you don’t pay taxes on.
You can do whatever you would like with them. If they don’t qualify for that, I [00:15:00] would say the opportunity is less to sell the property, pay the tax and do whatever you’d like with it, then to execute on the 1031 exchange. But I would also argue, and this is where I think it’s important to say, Mike, don’t let the tax tail wag the dog.
There are situations that come up in an individual’s life where maybe I do need to exit this piece of real estate because I have to pay for X, Y, or Z, or this piece of real estate is just really not making sense. And right now the market doesn’t make sense to get back into real estate, but I can do something else with this money to where it might make sense to exit, pay the tax, and then do something with that money on the back end.
Mike Morawski: Brady, should we bring this special guest in?
Brady Slack: Yeah, bring him in.
Mike Morawski: Should we?
Brady Slack: There we go. That’s Mike.
Mike Morawski: Mike, how are you?
Michael Scicluna: Doing great. Yourself?
Mike Morawski: I’m good. I was wondering who was sitting in my waiting room there. So I texted my assistant and she said, that you’re Brady’s partner.
Michael Scicluna: Yeah. Yep. Me and Brady have been working together for years now.
Mike Morawski: Okay. How does that work? You know what? So talk about your business a little bit. How does that work for you [00:16:00] guys?
Michael Scicluna: You guys have been talking. You probably know that he is the tax guy. He understands taxes, business entity set up and creation and business mapping.
I’m in charge of all the CFO and bookkeeping and accounting services. Essentially, Brady does all the stuff that I don’t like to do, and I do all the stuff that he doesn’t like to do.
Mike Morawski: Hey, I have a partner like that, too. She does all the stuff that I don’t like to do or I don’t have the mental capacity to do it, just because when you sit down to read an LLC agreement or a subscription agreement, I’m asleep by page three and it’s hard to get through those. She loves it. It’s always good to have a good partner. Well, good.
So Brady, Mike brought up a good point, business entity, business mapping, talk about that a little bit and how should people be structuring, their entities?
Brady Slack: Yeah, really great question. And I’ll preface the explanation by saying CPA stands for cannot protect assets. So part of the conversation does need to involve an attorney. Because, like I [00:17:00] mentioned before, when we are discussing real estate, very rarely, if ever should cause a tax consequence.
And by nature, real estate is classified as a passive activity. So it’s not subject to self employment, social security or Medicare taxes. That being said. Primarily when we deal with real estate, we discuss LLCs, not corporations for a few different reasons. But I think when we discuss real estate or when we discuss entities, I always want to make sure people have gotten past maybe that proof of concept point.
Let’s invest. Let’s start to do the properties because there are some costs associated with setting up a business, bank accounts, accounting files, maybe cards, debit or credit cards, making sure that all of your accounting is done correctly. When we discuss real estate, maybe we’re also discussing quick claim deeds to assign properties to LLCs.
There’s a couple of different things that are going to cause consequences that we just want to make sure we’re [00:18:00] aware of. So yeah, when we talk about real estate with our clients, we’re discussing LLCs, we’re discussing how many partners are in those LLCs? Are there holding entities to those LLCs? How many properties should we have in an LLC? But that kind of sets the foundation for where we go based on what the individual’s tax plan is.
Mike Morawski: You always say that relationship with the accounting side of your business is a personal relationship, I don’t think that some of it might be a generic answer, but most of it is on that individual basis, what’s your tax consequence and what are you trying to accomplish? Hey, someone asked a question about when you initiate an LLC and open an LLC, you have the ability to elect whether it’s an escort or whether it’s a C course. Can you talk about that for a minute? And what makes one better than the other? Or why would you choose a C over an S?
Brady Slack: The answer is entirely dependent [00:19:00] on what the activity is and what the end goal of that activity is. For our clients, most often times we are utilizing an S corporation for a personal management or consulting company, or an operational business that does not include any partners besides maybe family members.
Brady Slack: Okay, and even then we’ll have a conversation about holding entities that own the operational business. C corporations are a little bit more unique to where they have their own separate tax rate. So we get into conversations with C corporations when they’re our potential large tax liabilities, maybe gross profits in excess of seven to $10 million in most cases. Or a business is accelerating very quickly and wants to bring on investors wants to go through an initial public offering, because there’s a little bit different rules around those.
So again, I think for the purposes of this conversation, very rarely do we get outside the realm of an LLC when we’re talking real estate.
Mike Morawski: Interesting. Let’s talk about cost segregation, how that works, and talk about [00:21:00] the depreciation around that or utilizing the depreciation in your investment.
Brady Slack: Yeah. So cost segregation is a tool that is used to recover the cost of an asset for a deduction purpose. And what a cost segregation does is allocates the value of different assets within a piece of real estate because some of those assets might be able to be used in an expense manner that is bonus or accelerated, meaning I can take more of that expense in sooner years.
And it really is a tool to allow us to not have to pay taxes on any of the cash flow and maybe even utilize a greater expense to offset other incomes that we might accumulate during the year.
Mike Morawski: Interesting. How does depreciation work for an investor?
Brady Slack: Mike, do want to answer that because I think you have a good answer when you answer that one.
Michael Scicluna: So your question was, how does depreciation work for an investor. So essentially depreciation is a cashless expense. It’s not something that [00:22:00] you actually spend money in order to see that expense on your books. The important thing to know about depreciation as well is that it’s not an expense that stays there forever.
It actually expires after a certain amount of time and you can end up paying taxes on that money. Depending on what you’re depreciating the asset will kind of determine how long that depreciation can stay. And then when you go to sell that asset if you’ve depreciated the asset completely then you’ll essentially you’ve set up a new basis. And so let’s say, I buy a vehicle for fifty thousand dollars I’m choosing a vehicle’s a lot easier with those numbers, depreciated over five years if I depreciate the full thing my basis is now fifty thousand dollars. If I only depreciated half of it, then my basis would now be $25, 000.
And that’s then when I pay tax on the sale of an asset. So depreciation is an incredibly powerful tool, especially when it comes to real estate. And the reason for real estate specifically getting such a great advantage in depreciation is because of the ways that you [00:23:00] can wrap up the sale of an asset into the purchase of a new asset and then offset those taxes and restart your depreciation without necessarily paying taxes on the sale of the asset that you’ve already depreciated down to the maximum ability.
Mike Morawski: Great answer. That’s for sure. So I know that right now we’re in this period of time where we get to take bonus depreciation or accelerated depreciation. I go in, I do a cost segregation study. I can really accelerate my depreciation for my investors year one, year two. And that’s going away or it’s winding down over the next few years. Do you think it’s completely going to go away or do you think they’ll restructure the tax law? And talk about that a little bit. You’re smiling.
Brady Slack: Yeah, so we need to remember that when the tax law, the tax cuts and jobs act was enacted, it was enacted to a point to where at on January 1st, [00:24:00] 2025, if there was no new tax law implemented, the old tax law would revert back to enactment.
So what happens with bonus depreciation is there’s a sunset to bonus depreciation this year, 2023 is an 80 percent allocable bonus depreciation. Next year is a 60 percent allocable bonus depreciation and then starting January 1st, 2025, it reverts back to a 50 percent bonus depreciation.
And there were rules with bonus depreciation as it relates to real estate to where it had to be new property that could elect to do bonus depreciation. Now, when we talk about whether or not that will be renewed or restructured or what’s going to happen with the new tax law, I think it’s also very important to highlight that next year is an election year.
Our current president is up for reelection. There are individuals who are in the house and in the Senate who are also up for reelections. And typically tax law is a [00:25:00] driving force that they try and utilize to get reelected. So the other aspect that I also try and encourage individuals to realize is that they want to push tax law through that is going to benefit themselves and the people that are funding their campaigns.
As bad as that sounds, that’s just the reality of it. And a lot of their constituents have greatly benefited from the tax laws that have been in place for the last couple of years. I think I would have a hard time believing that they don’t try and renew different aspects of what this conversation is about depreciation only because there’s been a lot of people that have benefited from it.
But again, a lot of that’s just speculation because I don’t know what’s going to happen with that and who’s going to get elected and what their new tax law is going to be. And so it’s really kind of up in the air, but I would imagine that there’s some major tax legislation that’s presented in past, moving into quarters three and four of next year, or even quarters one and two of 2025 when someone else is reelected [00:26:00] or elected.
Mike Morawski: I was watching this comedian last night and somebody from the audience goes, Hey, what are you going to do if Trump gets reelected? And the guy goes, what am I going to do? And he goes over and he sits down on his chair and he says, I’m going to take advantage of the tax breaks. I thought, Oh, that’s classic. What a great line.
Brady Slack: Yeah. Very witty.
Mike Morawski: How about the clawback piece? So I’m doing a multifamily syndication right now, 277 units. We’re going to do a cost segregation study. There’s that 80% bonus depreciation, year one. My investors have a basis of about 40% on their depreciation. They’ll be able to take year one. What about the clawback? Talk about that and how that works or comes into play.
Brady Slack: Yes, I think, Mike actually already talked about this. You’re talking a little bit about depreciation recapture, where if I’ve utilized some of that depreciation, and then I sell the asset, I do have to pay taxes on that [00:27:00] recapture.
Now, that’s where we talked previously about doing a 1031 exchange, and Mike highlighted this as well already, where if I do a 1031 exchange, I don’t have to pay taxes on that recapture. I only have to pay them if I sell that property. So that’s where that 1031 comes into play, where take advantage of the depreciation. Don’t worry about the recapture because you can just roll that over into the next property.
Mike Morawski: Interesting. Do you have to pay taxes then on all of it? Or does it step down also over time? So here I’ll give you an example. If I hold a property for five years, my investors year one, take that 40% depreciated value, and I sell the property at year five, are they paying taxes on all that depreciation they took over time? Or does it get less?
Brady Slack: Yeah, really good question. And again, Mike already highlighted this in his example with the car, but what depreciation does when I take a depreciation Dutch deduction, it reduces my [00:28:00] basis in the asset. So like Mike was saying, if I buy a car for $50, 000, my basis is $50, 000. Unless I utilize depreciation, in which case that depreciation is going to reduce the amount of my basis depending on how much depreciation I utilize.
So if for example, you have investors who have utilized that depreciation, they will be required to pay recapture. And for those that have not utilized that depreciation or they haven’t appreciated the full amount. Whatever has not reduced their basis in the asset is not going to have to be recaptured.
Mike Morawski: Again, it’s a specific per deal, per investor conversation, right?
Brady Slack: Correct.
Michael Scicluna: And to clarify on that basis, what you’re looking at is the difference between the basis at the time that you sell it and the amount that you sell it for. So if you have a property, let’s say you bought it for $500, 000, you depreciate it down to $400, 000. So you’ve taken $100, 000 worth of depreciation. So the [00:29:00] basis is now $400, 000. If you then go and sell that property for 500, 000, you’re not paying taxes on $100, 000. If you were to sell it for $600, 000, you’d pay taxes on $200, 000 and so on and so forth.
If you took no depreciation, then your basis would stay at $500, 000. If you sell it for $500, 000, there’d be no tax. So I just want everyone to understand that when your basis changes and you end up in a bracket where you will be paying taxes on the gain on this asset. It’s not necessarily a bad thing.
And Brady always says, don’t let the tax tail wag the dog. If you’re like, Oh no, I don’t want to pay taxes on this. So I don’t know if I should sell it right now. The question shouldn’t be whether or not you’re going to pay taxes. The question should be what’s my gain on this asset going to be and how am I going to use those funds to grow my wealth to reinvest to purchase new properties. And that’s where if you do want to cash out and then go use the cash in something other than real estate, a 1031 exchange is not the way to go. But if your end goal, your plan is to [00:30:00] just keep investing in real estate and growing your portfolio, then understanding how to use that 1031 exchange and planning ahead for the 1031 exchange, essentially.
You just keep pushing back that tax, the potential for tax indefinitely. And if you plan it right, you can make that part of your retirement plan, a way to pass on wealth to your children where you would never pay taxes on it. And there’s also ways to stop your children paying taxes on it as well, if you really plan correctly.
So, it is a tax deferral. And so understand that if you get out of the real estate game, you’ve deferred the taxes. But you can stay in the real estate game and continue to defer that tax eventually to the point that you will not have to pay taxes on it. As long as no tax laws change.
Mike Morawski: Yeah. We know that changes like the weather.
Michael Scicluna: Yeah yeah. You got to plan with what you know right now. And the thing is people have been doing this for long enough that as Brady said, that the people that make these laws. They do it to benefit themselves and the people that are lining their pockets and it’s a sad reality, but it is the [00:31:00] reality. And, if you do what the rich do, then you’ll become rich, like the rich are.
Mike Morawski: And that’s exactly why they got rich is because they benefited from or take advantage of the tax code and those things in the tax code. Sometimes I have a lot of new listeners and a lot of people that are maybe new investors, passive investors coming in cause they might be somebody who’s looking at one of our deals and just getting a little more knowledge. Explain what a K1 is and how that gets used?
Brady Slack: Yeah. Mike, I’ve never been asked that question. That’s a good question. So we talked a little bit about C corporations, S corporations and LLCs. LLCs and S corporations are referred to as pass through entities. Okay, meaning the businesses do not pay taxes. The owners of those businesses pay the taxes based on whatever their ownership percentage of the net profits are. Now, because those businesses do not pay taxes, [00:32:00] there has to be a way for those businesses to transmit that data to a personal or an individual, or maybe even another entity, if we have some holding structures to show what their ownership percentage of that net profit or net loss is.
And the form by which you do that is form K one, either from an S corporation or a partnership. Okay, so if you and I, Mike, go into business together, whether we purchase real estate or we own a business together, and that business is an S corporation or a partnership, and we have a net profit that we both own 50 percent of $100, 000, there will be a tax form K 1, that comes to both of us from that business, showing that we each made $50, 000 from the activities of that business.
And that’s the form that you will use to then report your earnings or your share, your lion’s share of the loss on your personal tax return so that you can either pay taxes on it or utilize that [00:33:00] loss to maybe help offset other incomes.
Mike Morawski: Okay. Interesting. So I hope that was understandable enough for my investors cause that question comes up a lot. How do I know at the end? And I say, well, you get a K one. What’s a K one, it’s a tax reporting form. It’ll tell you the passive losses, your income on that. And I love what you said at the beginning that you should always show a loss, right?
Brady Slack: Yeah.
Mike Morawski: I think it’s like any business, especially when we take over some of these multifamily deals, they’re already losing money in most cases. And we’re coming in trying to re engineer it, but still yet trying to not make it profitable.
Brady Slack: Yeah. I’m going to let Mike talk because I know exactly what he’s going to say.
Mike Morawski: Okay.
Michael Scicluna: Yeah. Real estate gives you a very unique opportunity that most other businesses cannot take advantage of like real estate because of depreciation. So going back to depreciation being a cashless expense, when you go to a [00:34:00] bank and you say that you want to get a loan, the bank is going to say, we want to see your tax returns. You could show them your accrual basis books and say, I filed on a cash basis and I’m being savvy with my money and I want to save taxes.
So I specifically structured things so that I would show a loss on a cash basis. I look at my books on accrual, like the company’s doing really well. Banks will just go, we don’t care about how good your books look on accrual. If your cash basis is showing a net loss. When all the profit is not large enough.
We’re not going to give you the loan that you want. It’s incredibly frustrating I’ve dealt with it with so many companies. However, if you’re in real estate and you’re taking a loss every year, like Mike you and Brady have both already talked about. That loss is or should be majority coming from that depreciation. So going back to this bank, let’s say we go to the bank and you’ve got a large multifamily property and let’s say, that you’re bringing in 500, 000 a year, your expenses are 200, 000 and you’re taking [00:35:00] 500, 000 in depreciation.
So you’re showing a loss of 200, 000. What the bank will do is they will actually ignore any depreciation or amortization on your tax forms and say, okay, we’re actually showing a net profit before depreciation. This is EBITDA, if you’ve ever heard that phrase before.
Mike Morawski: Yep.
Michael Scicluna: So EBITDA, they’ll look at that and they’ll say, okay, your EBITDA was actually 300, 000. So this is where real estate is incredibly powerful. You get the best of both worlds. On the one side, you get to give a nice middle finger to the IRS and not pay any taxes.
Mike Morawski: Hey, this is being recorded. Take it easy.
Michael Scicluna: Yeah. On the other, it’s funny. We work in with the IRS, but, we don’t work for the IRS. So you can save a lot on taxes and many real estate professionals will actually end up paying nothing in taxes, despite making a very good income. But on the other side, you still have the capability through the revenue that you’re generating, the money that you’re making to go out and get loans to then continue to grow and expand your business.[00:36:00]
So depreciation, cost segregation, that is your best friend in the real estate game. A lot of people will say, I could get a better return if I invest in this business or if I go on the stock market or start an Amazon FBA, whatever they’re going to do. That may be true in some circumstances.
When you’re just looking at the cash on cash return on a monthly basis, you may be able to get better in other areas. But the long term benefits, the tax benefits and the ability to expand and grow through going to banks and being able to show that real income EBITDA without the depreciation.
Those benefits is what I would say more business savvy and financial savvy people go for. And that’s why, no matter what business you’re in having some real estate is a great way for you to actually keep the rest of everything going while saving taxes and using that as a strategy.
Mike Morawski: Nice. Awesome. Well, fellas, we’ve kind of gone over a little bit here this morning. [00:37:00] Any last thoughts or comments that you can think of or something somebody should know?
Brady Slack: I will say this because we’ve talked a lot about the aspects of limited partner, general partner. Real estate is a great investment. They always say 99 percent of millionaires own real estate. And that’s a big reason why millionaires are millionaires is because of real estate.
But I will say this for the average individual who might be looking to invest into real estate or looking to get into real estate. One, I think you should just do it, but two, I also think you need to be calculated about it. And coming into a syndication like what you’re doing, Mike, is a great opportunity to do so because you get your feet wet, you learn the ropes of investing into real estate.
You learn what can go wrong in real estate, even though you don’t have a direct tie to what’s going on. And that will allow you to maybe even potentially do further deals, maybe even on your own or more intimately with another partner, that have different tax consequences. So syndicating real estate is a fantastic way to get your feet [00:38:00] wet and learn the ropes so that you can minimize your mistakes.
Mike Morawski: I really appreciate you guys being here this morning. That was well spoken. Mike, thanks for stopping by. I don’t know if it was planned or not, but your input was good. I appreciate this morning. I’m going to move you guys to the back room and say goodbye. If you stand by.
Brady Slack: Thank you, Mike.
Mike Morawski: I’ll be right there. Brady, tell people how they can get ahold of you real quick.
Brady Slack: Yeah. So down in the banner is my email firstname.lastname@example.org. The easiest way to connect with us or our team. If you’re interested in getting a consultation is by going to my Instagram @The Brady Slack.
You can click on the link in my bio, which provides you with a couple of different ways to connect with us, listen to podcasts, or schedule a consultation with my team and we’re happy to help.
Mike Morawski: Awesome. Thanks. Thanks again, Mike, Brady.
Michael Scicluna: Thanks Mike.
Mike Morawski: You guys have a great week. Hey everybody. That was eyeopening and enlightening, and sometimes I think the accounting pieces is a warm piece but you know this morning was a lot of insight and [00:39:00] a lot of knowledge and real estate investing can benefit you and again those three buckets, How do we provide cashflow? How do we provide long term wealth? And then the tax planning and solution side of it. If Brady can be of any questions to you or Mike, please reach out to them and see what they can do in your world and maybe give you some planning or advice or tax preparation, and if I can be of help, or you’re looking for an investment opportunity, reach out to me and I’ll get some information in your hands. Have a great week.
Kristen: Thank you Mike, and thank you for joining us for another great episode of Insider Secrets. As always, Insider Secrets is brought to you by My Core Intentions. Wherever you hang out on social media, you will find Mike and My Core Intentions. Please like and follow us to get the most up to date real estate investing trends.
Visit mycoreintentions.com where you can get expert coaching on all things real estate investing and [00:40:00] property management. If you’re looking to become an expert, Mike’s coaching will help you scale your real estate investment business. We’re looking forward to having you back again next week for more Insider Secrets.