Buck: Welcome back to the show everyone. Today my guest on Wealth Formula Podcast of course he is no stranger to this show, to me, to you. He is the Michael Jordan of taxes and CPAs out there his name is Tom Wheelwright Tom is the author of tax-free wealth he is Rich Dad advisor to Robert Kiyosaki in the subject of tax and he’s also my CPA which is probably what he’s most famous for, just kidding. All right but always a pleasure Tom I have to tell you it is really always a pleasure I have so much respect for you and you know you’re just an all-around good guy with great ethics on top of being super duper smart and so I want to thank you again for being on our show.
Tom: Oh thanks. Thanks for having me Buck.
Buck: And so again we are on the subject of taxes and you know listen there’s so much going on out there. We want to talk about it. You and I talked about a very specific issue which in some regard seems basic but it’s not because people don’t take this as seriously as they need to which is the idea of creating passive income. However before we do that we got some questions related to current events which I thought might be useful to just address with you. First of all Tom, wondering is there anything that we need to know in terms of the current legislation is with regard to PPP all that stuff is there any changes since we last had an update?
Tom: Well since we last had an update of course Trump has pulled the plug on the negotiations and so what that means is that we may not know, I mean right now we have to assume that the PPP will be taxable. That’s what we have to assume because that’s what the IRS has said is that the expenses won’t be deductible which basically makes the PPP taxable. We have to assume that. The house and the senate both seem to want it to be non-taxable but until they get a bill or get their act together that’s not going to happen. The good news is we don’t really have to know until the middle of next year because you have until september to file your business tax return this year’s tax next year so you’ve got a little time. We’re also waiting on guidance on forgiveness of the PPP loans. Most banks are saying no we’re not going to take you we’re not going to try this even we’re not going to take this on so we’re still waiting on that too so it’s basically we’re in a hold pattern.
Buck: I think, though the good news on this is that the consensus at least and that I’m gathering from what you’re saying from others are saying is that there is just a general idea in congress that you know it is the right thing to do right? I mean it’s silly to go back and create all these additional burdens for business and in a time where we’re really sort of teetering.
Tom: Well that that’s what congress says but now the administration of course some of it may depend on who wins the election. I think a Biden win is more likely to favor forgiveness, not forgiveness but actually favor non-taxable PPP loans than a Trump win because Trump has said he thinks it should be taxable. So the administration is saying we think it should be taxable and everything and the congress is saying we think it shouldn’t.
Buck: Well that’s a very interesting thing because usually you would put the republican party on the side of small business but in this case it definitely is not really the case. So speaking of Trump, any comments on this 750 tax bill other than well he’s a real estate investor and he’s got a ton of depreciation and well somebody else I know who is on this podcast who’s not you has got a similar situation right so I mean not nearly to the scale but the reality is there’s a tremendous advantage to being a real estate investor. Is there anything other than that? I mean is this even news?
Tom: You know to me the question is why did you pay 750 in tax? You paid too much.
Buck: He needs a new CPA I mean seriously
Tom: what’s going on here? You know my guess is if he paid 750 that there was some other tax on there you know some kind of tax that wasn’t income tax and that’s why I paid 750. You know because your your income tax return shows self-employment tax and medical medicare tax and it shows a bunch of other taxes. So my guess is because it was two years and exactly 750 dollars it was probably some other tax as opposed to you know purely income tax. To me to most CPAs most CPAs this is not news. This is like well yeah of course he’s got, first of all he’s got a bunch of real estate but even bigger than that is he’s got a bunch of debt. So that means he’s getting deductions for the money he puts in because he put all of the money right. I mean think about this if he put 400 million dollars from the apprentice which is what the New York Times said into his golf courses, he probably leveraged that you know three or four to one yeah right, and so he gets the deduction not just for the money he put in but he gets the money for the deduction for the money the bank puts in right. So it would I mean it’s not at all surprising and you know some of the things they’re trying to raise like the payment to Ivanka, I’m going if he truly if he paid Ivanka seven hundred thousand dollars, I mean she could end up paying more tax than he would have had he not paid her right. So to me there’s no there there.
Buck: yeah exactly and that’s kind of the interesting thing for us in our world we kind of live in this sort of unique spot where we don’t you know the old saying Tom about the things that are guarantees in life right death and taxes and we’re on the side that says wait I don’t think taxes are necessarily a guarantee in life, I mean certain levels are but you can mitigate, you can certainly potentially as we’ve seen with real estate investors typically you know it’s very possible to eliminate at least the federal side.
Tom: Well not only that but consider that not only can you eliminate them now I mean typically the question is who’s paying the tax right not is tax being paid. I’m like if Trump pays an employee the employee’s paying the tax right. Or the question is when do you pay the tax. Do you pay the tax now or do you pay it later. That’s what happens in a 401k for example or a lot of real estate but the thing about real estate is you can actually set it up so that you never pay tax and real estate is pretty much the only area you can do that.
Buck: Yeah absolutely. Okay one last question then we’re going to move on to the meat of this interview, which is okay so getting back to this side you know the election is just what three weeks away something like that here’s a chance I mean there’s a good chance that Biden wins this I mean who knows and the polls have them way ahead but I’m not really paying attention to polls this time around. I think it’s who knows what’s going to happen. But there is a decent chance he wins and a lot of people certainly in my part of the world in the real estate world are freaking out a lot a little bit about it, they you know and I’m not sure if there’s as much to freak out about as much as you know there is proposed legislation versus what is likely to happen. I was wondering if you would if you would please give us a sense of what the proposed legislation from Biden and affecting real estate investors would be and what’s realistic about it happening or not?
Tom: Yeah I’m glad you pose it that way Buck because there’s a massive difference between proposed and realistic. In this case remember presidents don’t make tax law. Congress makes tax law okay so all the president does is sign it or not sign it, that’s really the only impact the president has, they can propose it but the reality is it’s the house and the senate that determine whether there’s a change in tax law. So I would say you know he’s proposing raising rates, capital gains rates over a million dollars, he’s proposing raising income tax rates over four hundred thousand dollars, he’s proposing taking off the cap on social security over four hundred thousand dollars, he’s talking about drastically reducing the estate tax exclusion from its current 11 plus million dollars to three and a half million dollars, he’s talking about an increase in corporate tax rates from 21 percent to 28. So when he says, by the way so when he or Kamala Harris say in their debates that they’re gonna repeal the Trump tax act day one, first of all they have no authority to do that so that’s baloney right, okay second of all they don’t really mean that because as you know as Mike Pence as Vice President Pence really pressed Harris last night in the debate you know he goes wait a minute you’re saying you’re gonna roll it back but then you’re saying you’re not going to raise taxes on people under 400 000 which is it? Right because if you if you rolled it back all the way you would raise taxes because everybody got a tax break in the 2017 act so either they are my guess is they’re not rolling it all the way back because Biden’s already said he’s not going to go to a 35 corporate tax rate he wants a 28, well that’s not rolling it back okay that’s not completely you know going back to the way it was before. The other thing he’s not proposing, he’s not proposing getting rid of the qualified business income deduction the 20 pass-through deduction unless you’re over 400 000. You’re under 400 000 he wants to keep it. He’s not proposing there’s actually a lot of changes he’s not proposing even right so let’s talk about for a second what’s likely okay. What’s likely is rates will go up okay that’s likely. And when rates when I’m talking about rates I mean rates on high income, okay rates over 400 000, and he’ll add a couple of different levels so my guess is he’ll add a rate over a million and maybe a rate over 5 million like Hillary Clinton had proposed. My guess is he will get the capital gains rate increase. The question is what I don’t think he’ll get though is an increase on capital gains from business and real estate okay. So capital gains remember there’s two different types of capital gains there’s business and real estate capital gains and there’s stock capital gains. I think where he’ll end up is just stock capital gains very much like the carried interest rules only apply to stock capital gains, they don’t apply to business and real estate capital gains.
Buck: Can you elaborate on that? Because I don’t think a lot of people really know you know the difference between capital gains in real estate versus stock and sort of the implications of what you just said.
Tom: Yeah so it’s actually a really big implication when you think about it.
Buck: Let me pause for a moment here and just let everybody know that Tom is also doing a little whiteboard here so those of you who are listening and would like to sort of go back and and potentially re-watch this you can you know go to youtube and we have a Wealth Formula channel on youtube and watch this there as well because there may be some things that are really important here that you may want to go back and look at. But sorry go ahead Tom.
Tom: Yeah for sure and I’ll do my best to explain it verbally as well. So with a business or real estate those gains are what we call section 1231 gains okay and a 12231. The reason it’s important now is that 1231 gains are different and 1231 losses aren’t the same. So 1231 loss so 1231 gain becomes a capital gain but a 1231 loss becomes an ordinary loss okay so capital capital losses only offset 3000 of income or capital gains but at 1231 loss is an ordinary loss at 12 31 gain becomes a capital gain but it becomes a capital gain it doesn’t start out as a capital gain it starts out as a 12 31 gain and then basically if there’s a net gain then it’s taxed at capital gains rates as a long-term capital gain so that’s why the 1231 is important when they when the irs wrote they carried interest regulations they wrote them to only apply to pure capital gains and not and specifically exempted 1231 gains okay and so that’s why I say that when when Biden says he’s gonna tax capital gains it may just be stock market capital gains it may be we don’t know but it may be. Now those are things that are likely to happen. What’s not likely to happen, oh one other thing, this is important for real estate investors eliminating bonus depreciation on real estate on used property and real estate likely in my mind that it’s actually really easy. We’re the only country in the world that allows bonus depreciation on used real estate and in fact we’re really one of the few countries in the world that allows any depreciation on used real estate. So from a pure policy standpoint really easy to get rid of bonus depreciation on real estate. That being said all he do is go back to the the rules pre-Trump which is the five-year 15-year you know 27.5 39-year year categorizations and even before bonus depreciation of course many of my clients who were real estate investors paid zero tax so and remember Trump’s tax returns that the New York Times reviewed are pre 2018. So those zero amounts weren’t based on bonus depreciation, those zero amounts were based on the the normal depreciation rates.
Buck: So even more zero now Tom that’s what I would probably guess.
Tom: Yeah that’s really what it is and that’s really all it is.
Buck: So let me ask you a question on that because the bonus depreciation issue comes up a lot in our accredited investor group where we you know we always do these cost segregation analysis on the properties that we acquire and pass along bonus you know we’re able to take those five years roll them up into one and then pass them on to investors so that has been something people have enjoyed. If this expires, when do you think, is that something that becomes effective like if Biden’s elected and takes office in january of next year, do you think this becomes legislation that’s likely to affect 2021. In other words there probably will be no bonus depreciation in 2021.
Tom: So here’s how tax legislation works timing wise and and you can go back to the Trump tax law to see an example of this. So remember bonus depreciation the increase to 100 and the increase to allowing unused property happened on september 27th 2017. Okay now why that day that’s the day it was proposed that’s the day it was first proposed. So until it’s first proposed in legislation it’s just rhetoric okay. So here’s the question so the question is what will Biden want to do and I hope they ask him this question frankly in a debate what will he want to do during his first hundred days. For example if he thinks he can get health care passed in the first hundred days okay then he’s going to have to raise revenue to do that and if he does then raising tax rates is probably the likely thing that’ll happen. Will he actually get rid of bonus depreciation at that time? I don’t know okay that may be saved for a later bill where he’s trying to do all of his social maneuvering right he’s trying to do in his tax bill he uses by the way he doesn’t use any of the money to pay down the debt set okay let’s be clear. The democrats do not believe that deficits are a problem. They have they have fundamentally embraced modern monetary theory which says deficits don’t matter. So that’s a really important thing to remember is that they the reason for example they’re trying to get a 2.2 trillion dollar bill and they’re going we don’t understand republicans why don’t you want to give us the 2.2 trillion and not all the republicans but some of the republicans in the senate say wait we don’t want to just throw money at this and have this gigantic deficit and knowing that a lot of the money’s not going to be used the way you know it’s supposed to because it wasn’t, I mean a lot of it is pork, well because there are republicans who still believe that deficits an issue the democratic party has taken the party line their party line is deficits don’t matter. So we have to consider that when considering you know what’s going to happen in the future if we have a democratic president and congress. So going back to the tax, the timing of it I think you’re going to see this staged, some things aren’t going to happen: are we going to lose 1031 exchanges. No, I do not see that. It would devastate the real estate market; it takes all the liquidity out of the real estate market. I do not see that happening. Okay are we going to see a decrease in the estate tax exclusion? Probably. Are we going to see an elimination of the step up and basis at death? No we’re not, that was tried before in 1980 it failed miserably okay Jimmy Carter tried it, it failed miserably and they went back to step up in basis. It’s a terrible idea to have a low estate tax exclusion and no step up in basis. So they’re going to do, they probably will reduce the estate tax exclusion maybe not to three and a half maybe to five and a half which was the Obama level 2015. But you won’t see as much change in real estate as you might think. The biggest change is going to be the bonus depreciation other than that, I don’t think you see a lot of change.
Buck: Yeah so what’s interesting to me about this is if you look in the context you know obviously the 1031 exchange issue you brought up, that has been you know that’s been something that’s been sort of tried in the past, it’s failed, there’s lots of reasons why that it makes good sense to keep that particular law in place. So okay if that doesn’t happen, well listen 1031 exchanges don’t really affect most passive investors anyway because when we do syndications we don’t do 1031 exchanges we basically are just doing right you know we’re just taking capital gains. Where it does affect our investors is this ability to potentially sort of ride this golden hamster wheel by taking their gains and then rolling it into something else and getting bonus depreciation. So to me the bonus depreciation is pretty much the only thing that limited partners in real estate really need to, that’s probably the big thing that’s going to change for them, is that fair?
Tom: Well that would be fair. The other the other thing that they’ll want to be looking at is this question of capital gains okay because if capital gains over a million dollars are recognized at ordinary income rates, then there are times when you’re going to have a capital gain of over a million dollars especially if you let’s say you had multiple properties sell in the same year and so you had let’s say you you invest in three or four syndications and the developer sees a crash coming, the developer sells those off, big capital gains, and if congress passes this and says look real estate gains are taxed like regular capital gains over a million dollars, then you’re going to see that’s actually something to pay attention to as well.
Buck: Got it yeah all right. And then the last question somebody asked me this and you’re bringing up the distinction of the 1231 gains versus ordinary, you know your typical stock capital gains made me remember this so let me ask you this now. So a lot of times we have you know 1231 losses because of you know depreciation et cetera, but let’s say do those losses can real estate losses offset stock capital gains?
Tom: Well real estate losses again they’re ordinary loss so they can offset any kind of income any income.
Buck: Right so that’s what I thought, that’s what I thought. I just I’ve had this question a few times.
Tom: Now remember of course which I know we’re going to get to, we got a passive versus investment category okay. Stock capital gains are investment income they never can be passive income ever okay their investment income, so they’re not eligible for passive income treatment so the only time you’d be able to offset stock capital gains is if you are a real estate professional.
Buck: Okay so now that we’ve had our you know almost 20 minutes of by the way let’s start with this, I appreciate that Tom there’s a lot of great information there. But the first time we the last time that we talked and we plan on doing the show you know we talked about something that again I think the terms are thrown around a lot but I really want to dive into this because it is such a critical issue and one that you know I think you know you’re famous for saying if you want to change your tax then you have to change your facts and one of them is to you know start making more of your income passive. So why don’t we start with this very simple you know define passive income, tell us why it’s the best kind of income we can have and if you want to back up even further, because I know you’ve got your your white board there
Tom: I’m gonna start really basic here and really simple. So the first thing you have to know is that only business and rental income can ever be passive. Investment income we basically have four you think about it we have four types of income. First of all you have earned income, that’s your regular business if your schedule C that’s subject to social security taxes, that’s your w-2 income, that’s earned income, that’s taxed at the highest rate. Then what you have is the next type is ordinary income and ordinary income actually has to be broken down into two types of income. One is business income which is ordinary income and one is non-business income for example income from a pension plan or a private sharing plan or 401k retirement income, that’s ordinary income tax ordinary income rates, it’s never business income okay. So then we have what we call investment income. Investment income are things like interest, dividends, capital gains, okay and I’m not talking about capital gains from real estate that’s a 1231 game that’s actually a business income, I’m talking about all you do is invest okay it’s a pure investment dividends interest capital gains from stock for example, those are investment income all right. And then what we have is we have this category that we call passive, but passive is almost not its own category and the reason is that passive only relates to business income, only okay. It never relates to investment income and never relates to non-business income and it never relates to earned income okay, so it’s only business income that it relates to that’s really important to understand and rental real estate is a business for these purposes okay. So that means you’re you’re regular like you’re a doctor and you have your company your PA or your LLC, that income is going to be business income. You have income you know your dentist or you’re a or your manufacturer or you’re an online retailer I mean these are all business incomes okay. So you’re in you’re in a trade or business. Stock investment not business income, that’s investment income even if you’re a professional stock investor okay so even if you’re a professional stock trader. Okay so now that you’ve got that piece now you can go to the next piece. So business income is broken down into two pieces so you have business income as a category by itself and again we’re going to include we’re going to include real estate in business income. Now if you’re a real estate developer that’s actually a different type of that’s a regular business income versus real estate rental which is kind of a subset of this okay, but business income basically can be broken down into active and passive. If all you have is income from all of your businesses, this is a distinction that has no implications at all. Okay the only implications is when you have a passive loss because a passive loss cannot offset active income. An active loss can offset any kind of income including capital gains and investment income, earned income. Active loss can offset any other kind of income all right so that’s really important. So active income is the best and so when we talk about real estate professional what we’ve done is we’ve converted passive into active by being a real estate professional that’s all we’ve done. Now that’s great because now your losses are unlimited right they can offset anything so that’s why real estate professional can be so good but of course a lot of people are always going to be passive investors. I’m one of them okay with respect to a syndication, I’m never going to be a real estate professional I have a full-time business, multiple full-time businesses, my wife has a full-time business, neither one of us want to be a real estate professional, that’s not going to happen. That doesn’t mean we can’t use our passive losses and that’s some that is the biggest mistake I hear from CPAs and tax advisors who are doing tax returns for real estate that have real estate losses and they’re going well it’s a passive loss so you can’t use it that is not the rule. The rule is a passive loss can only offset passive income. So think about why capital losses. Capital losses can only offset capital gains passive losses can only offset passive income: it’s a bucket.
Buck: Yeah and just to your point let me interrupt for a moment because we have you know my listeners who’ve become your clients. We have people out there or you know of you or Wealthability in general who’ve had substantial passive income and didn’t even know it because their CPAs didn’t tell them, they’ve had ancillary medical services like surgery centers infusion centers dialysis whatever making hundreds of thousands in some case millions of dollars where it has been clearly it’s passive right but their CPAs have not given them that knowledge and the significance of this is as you mentioned, if you’ve got all this passive income you have a real opportunity at least until this bonus depreciation thing goes away to really knock out a lot of it through passive investments in real estate where these huge losses are you know flowing through k-1s, they don’t just get suspended you can actually use them is that right?
Tom: Right so here’s what happened to a passive loss if you have no passive income. What happens to a passive loss is it gets carried over forever okay so you never lose it until the property is sold. When the property is sold all those passive losses are freed up okay even if there’s no gain all the losses are freed up so just know that you’ve not lost it even if you don’t use it currently it’s not lost, it’s just a carryover kind of like if you have too much general contribution right in one year you can carry it over to the next year the difference is general contributions only carry over for five years passive losses carry over forever okay forever. Now this is where this is where I get frustrated because you’re right there are a lot of people have multiple businesses and the rules for what’s passive and active they’re not simple okay there’s actually seven different rules, seven different ways you can make a business active okay seven different ways okay not one seven. The main one is you spend more than 500 hours a year in it okay, but you can actually have multiple businesses where you only spend 100 hours a year and still active okay so just know that that’s in your mind all you need to know is you need to know what’s possible so that you can go to an advisor who really understands this because real estate is a specialty from a tax standpoint so don’t not just any you know business is not regular business not a specialty okay I’m sorry but the business deductions for a doctor are pretty much exactly the same as the business deductions for an online retailer okay, they’re not a lot different outside of the inventory right, however okay when you when you get to this area you’re going okay so we’ve got multiple businesses and some some of those businesses we’re not the only owner of you know we participate with other people and we don’t really do anything we just put in money or we might put in a little bit of intellectual property we might very well be passive in those businesses like you say Buck and one of the first things we do when we look at a tax return for a new client what the very one of the very first things we do is say well wait a minute are there are there businesses here that could be passive okay that have not been treated as passive in the past okay, and if there are then sometimes we can even get a refund so we did that with one one client recently where we just filed a refund claim because they were passive in their business so they had real estate losses should have been offset so we filed an amended return got back 40 50 grand. Other times it’s okay we don’t need to file an amended return but guess what going forward you’re good they’re going to start investing in real estate passively so now we need to make sure that it’s marked properly okay. So we have to go through that analysis now let’s say that okay we got that taken care of now let’s say we’ve got active business income and we’ve still got losses that we’re not being able to use, now what do we do? It’s not that hard.
Buck: Losses meaning from other sources outside of a business?
Tom: Passive losses, we have passive losses like from real estate in real estate but we don’t have passive income right okay so how so the question is, passive losses can only offset passive income and if that’s the case one of the ways to do to fix that is we’ll become a real estate professional or your spouse becomes a real estate professional and that does cure that okay. But there’s another solution that most unfortunately most tax advisors never explore and that’s the idea of converting or changing the nature of your active income and actually converting it to passive income. Because if you can change the nature of your income and you’re like wait a minute I have to work in the business
Buck: Yeah by the way let me let me just emphasize this if you get nothing else out of this show today this is what Tom and I really want to pound into because this is where this really could be really life-changing for you in terms of your economics so pay attention to this it is something that everybody should listen to be and very closely because I don’t care what you do for a living how you’re making money but there’s a possibility that you could be structuring things a little bit differently here to save some money. So Tom go ahead with that.
Tom: Okay so we get down the road here and we decide we need we’re gonna to have passive losses we’re not going to be a real estate professional, we’ve already looked to see if we have businesses that are already passive because of the amount of time we spend in them, we’re not being able to use all of our passive losses so then we look at it we go wait a minute okay even though we’re not going to change how much time we spent okay in the business, is there a way to have at least some of this income be passive and that’s what I want to show you. And the answer is in many cases not all cases but in many cases in many cases the answer is yes and here’s what happens. So let’s suppose that you own a business here okay and let’s say that business is being taxed as an S-corporation, that’s a flow through business meaning the income is being taxed to you, it’s not being taxed to the business, it’s not a corporate it’s not a regular corporation, so you’re paying tax personally on that income. This would normally be this is your rate of the business let’s say it’s your practice for example okay this is your business and in this case in most for most of us that’s going to be active income. Now let’s say you’ve been listening to bucks podcast for the last several years and you go wait a minute what we want to do over here is we’re going to have same taxpayer and we’re going to have some real estate right and I’m going to draw this, by the way when I draw diagrams they’re always the same from the standpoint that a triangle is always a partnership and a square is always a corporation and a circle is always an individual it’s just helpful to know when you’re going back to reference this if you’re watching this on video I’m drawing this and so you’ll see that I’ve got these these are LLC’s and so that’s what these are and you know you’ve got property one property two say or in property three or these are you know investments they can be passive investments that’s fine this is your holding company right here up above which is a frequent this is just a common ownership structure okay you don’t have to do it this way but it’s a common way to do it. Okay now right here let’s say that the business has positive income of seven hundred thousand dollars okay and then let’s say okay let’s say this is Ivanka’s business she got paid 700 000 from the Trump company and then we have losses over here of let’s say 300 000. Okay so we have three hundred thousand dollars of losses and we have seven hundred thousand dollars of income. Well if you don’t do anything else that three hundred thousand dollars of loss is going to carry forward and you’re going to pay tax on seven hundred thousand dollars of income okay, you don’t get to net the two because one’s passive and one’s active okay. So what do you do? Well and I say I’m gonna preface this don’t be saying I can’t do that because there are ways to do this okay just bear with me for a minute okay, because there are ways to do this. So let’s say that we take and we form and we form a trust for our children. We form a trust for our children and we put we we put into that trust okay we want our children to end up with our assets but we don’t want them to have any control over it right now so we put into that trust ownership some percentage of the business. So we put that in other words we don’t own 100 percent now, now some of it’s owned by the trust okay and we’re gonna set this up preferably, doesn’t have to be, but preferably so that the child is actually taxed on it okay. So I know this sounds complicated I’m gonna tell you we do this all day long so you need to have the right advisors you need to have people who know how to do this when you do I mean as you know as Buck knows Robert Kiyosaki my friend is always saying investing is a team sport right business is a team sport so we get help with this isn’t something you do on your own. Now let’s say we get some percentage of that let’s say we give 50 okay to put it into trust of our business and then let’s say over here we put 90 percent of the real estate into the trust. So I put 50 of the business 90 of the real estate. So what happens? Well okay so that means that the child is going to be taxed on 50 of the business income okay which is 350 000 and they get 90% of the real estate loss which is 270000 and that means that now this, these are both passive to the trust they’re passive so the loss can offset the income and now you’re only carrying over thirty thousand dollars instead of carrying over three hundred thousand dollars and that two hundred seventy thousand dollars and a forty percent tax bracket is some serious money to you that’s over a hundred thousand dollars or close to a hundred thousand dollars. So what all we’ve done is change the ownership, assuming your children aren’t active in the business okay assuming they’re not active in the business, we set this up properly there are things we have they’re all sorts of I’s that we have to dot and t’s we have to cross but when we do this and it is allowed by the law to do it as long as you follow the rules then we’re basically getting a current benefit of the 270000 instead of waiting until we sell the property to get that benefit.
Buck: So there’s the additional thing here Tom that I know people are thinking about right now which is I’m a doctor and in my state they only allow doctors to be the owner the primary you know the single owner of the professional medical organization whether that’s an LLC or a PLLC or whatever and so in that case we still have options though right? I mean talk a little bit about some of the angles around that.
Tom: We do. So for the physician practice itself, it may have to be owned by you, I get that, in some states it’s just 51 has to be owned by you I know that okay and in some states it can be any amount so you do need to check your state okay, first of all. Second of all you’re you probably do a lot of things in your practice that you could outsource you do a lot of things in your practice that you could outsource somebody else you could outsource the for example if you wanted to you could outsource the accounting you can outsource the billing okay all of those things you could actually set up I mean technically you can do this you could set up another company okay and you could actually have the trust own that company entirely right and have and that be a separate company and that’s say the billing company for example or an MCO or something like that and it can actually provide services to the physician company and that’s allowed to my understanding
Buck: Oh yeah absolutely and one other thing that I’ve seen in here just for context is you know there’s often in our physician offices there’s a lot of equipment you know hundreds of thousands of dollars of equipment that equipment equipment could be owned by that other company in which case you are paying for that equipment that money flows into there. So I’m bringing up this example because again there’s always this yeah but you can’t do that, there is lots of different ways to do that so yes sorry go go ahead keep going.
Tom: Yeah just just to give this perspective you know I travel around the world with Mr. Kiyosaki during non-pandemic times yeah and when I travel it doesn’t matter where I go I mean literally Moscow, Kazakhstan, I’ve gotten this Kyrgyzstan, I got this South America, Chile, I got this, I’m thinking of specific instances now where just without exception but somebody comes up to me and says great information you can’t do that here and really what they’re saying is if you say you can’t do this here what you’re really saying is, I don’t know how to do that here okay so understand, I can’t do surgery, I can’t. So I could say well you can’t do surgery here because I can’t do it. I can do this I do this all day long and and and if it comes under audit it’s not a big deal, by the way we make sure all our i’s are done t’s are crossed I mean we’re really careful. Buck knows this. We spend a lot of we spent a lot more time on tax returns than most people do, we really do but this is why okay because if a client is audited we want to make sure that everything ties out and that there’s no questions all right. And you do it by making sure it’s all right now would you do this if you only had thirty thousand dollars of passive losses of course not it would be cost prohibitive to set it up. But if you’re a regular investor if you’re investing a 100-200000 in passive real estate every year why would you not go through this.
Buck: Yeah for sure and and to that point. There’s another category of of people I just want to address too because again we’ve addressed people who have essentially private practices a way to manipulate you know legally but to to change their facts right, but there is another group. And so for example we have people in our investor group who are a husband and wife, full-time employed physician. So when you see something like that obviously every situation is different but what are some of the potential ideas that pop into your head about that where you’re like literally, there’s no business owned here this is pure w-2 from husband and wife as a surgeon and anaesthesiologist.
Tom: You are you are seriously limiting yourself, seriously.
Buck: Well no I get it but what would be some of the things.
Tom: Here are some things here are some things you can do okay, first of all first thing I would say is set up a business okay that’s the easy answer okay, start a business, do something that’s that is business related that you can have a home office, that you can you know deduct vehicle, meals et cetera et cetera okay do those things. I mean we all know that business owners get treated differently than employees okay, so that’s to me that’s rule number one always think about that. Number two is are there some investments that don’t have these restrictions? There are. Okay the most notable is oil and gas okay. Oil and gas investments do not have the passive loss restrictions if you own it the way that the government says to okay. So you can invest in oil and gas get big deductions and you can be an employee okay, so that’s a different type of investment okay so that’s another way to look at it. There are there are some tax benefits from other more sophisticated things like you could you could have a charitable contribution okay so there are terrible contributions that give you big tax benefits Remember, the tax law is a series of incentives and its incentives to do certain things from an economic standpoint from an energy standpoint from a social standpoint okay, all you have to do and this is why I wrote Tax Free Wealth, is really to walk through what the incentives are so that you can choose which incentives am I interested in now does that mean that everybody’s going to to do that? No, but I do have for example but I have a client been a client for many many many years and they pay very little tax and husband and wife are both surgeons and they’re both employees and they pay very little tax. Well the reason they pay very little tax is because they do some charitable contributions and they get big tax benefits for their charitable contributions. So it really depends on where you want your money to go okay and depends on you know how you want you know what incentives, what facts are you willing to change. Our job is to tell you what facts you can change and your job is to decide what you actually want.
Buck: The part of what I was sort of getting at there too Tom was that you know even in a situation where you’ve got you know say you’ve got a surgeon and an anesthesiologist okay well what if is there a way have you looked at I mean I’m just thinking out loud about okay well maybe if you’re employed is there a way that you can become an independent contractor instead of be employed and have you know your your salary or whatever you know you’re getting paid get paid to your business instead of to you directly as a w-2. So those kinds of things I think a lot of people get trapped and they don’t even explore those ideas right and that’s kind of, do you see that a lot?
Tom: I do you know there’s a line that you go down right and so for me okay if I’m doing your tax return I have to sign under penalties of perjury that that return is complete and accurate to the best of my knowledge. So I cannot sign a return that takes a position that I feel does not have a reasonable chance of winning in court. Okay so if I looked at that situation it depends on the situation so I’m not saying never right, but if I looked a situation where I’m at w-2 and now I’m just getting that as an independent contractor and now I give that an ownership of that business to my child, I might have a challenge with that one. Okay so it would depend on the facts and circumstances right. That’s the thing, all tax law is dependent on facts right so you know whatever we can do I mean let’s say for example you’re an anaesthetic physiologist and you decide wait a minute I’m going to even employ my children there’s another way to do it just employ your children and let them you know do some work for you and pay them and they’re taxed at a low rate and you get a tax deduction if you’re an independent contractor right. Or let’s say that you become an independent contractor and you go hey I kind of like being an independent contractor I’m going to be an independent contractor for multiple hospitals or multiple places and then I can make more money and maybe I can set this up so that I can get some of these tax benefits. Buck, you make a really good point but a lot of times we we actually hinder ourselves or, frankly our advisors hinder us and say you can’t do that. Okay where the real question should be how can I do it okay that’s a much better question and your advisor that’s the question you should be asking your advisor: how can I do this? How can I take this deduction? How can I make this income passive? How can I get benefit for this deduction now it’s always how can I you know not can I so I’d stay away from the can I and get to the how can I.
Buck: Yeah and I would just say that if you have a CPA now and you ask these questions and the answer is well you just can’t, then I think you need a new CPA I really do. I’m not saying that you know there’s a definitive answer to every situation, but you want to have somebody who’s actually working with you. It is critically important that you make this as active of a positioning in your life as you’re making your investments because your overall profit you know is not only what you’re making from your investments and from work but what you actually get to keep, so this is really important stuff. Tom, do you have any do you have anything else to add in terms of you know other thoughts people ought to be thinking in terms of passive income?
Tom: Well let me just add one more thought here and and I would encourage everybody to watch the video for this one, I’m going to explain it but I would very much encourage you to see what this means okay. So let’s say that you have the entire tax law and let’s say that what I’ve drawn here this goal post is the entire tax law all right. So here here we have the tax law and let’s say that you have a tax advisor that knows this much about the tax law, just a little tiny bit about the tax law, which is frankly unfortunately most tax advisors which is why I created my network of tax advisers and CPAs because I want to train them to be better I think they’re good people I think they just don’t understand, okay. What happens is that anything that is outside of what they know would be aggressive and as we all know it doesn’t matter if it’s aggressive to you, if it feels aggressive to them. Because it’s aggressive to them they’re going to say you can’t do that right. Okay but most of what I hear about oh that’s aggressive is because they just don’t understand the law right and that’s because they don’t understand what you can and can’t do because they never spend the time to read the law all right. Now let’s say on the other hand that you have a a CPA or a firm that actually knows most of the law particularly when it comes to real estate and business okay and that’s that’s what they know then what that means is everything that they know everything that they know would be conservative right it would be conservative to them because they know how to do it. So things that we do I will tell you I teach classes all over the country all over the world I get people I get people all the time saying well my CPA says that’s really aggressive. I’m going well it probably is to them okay, it’s perspective to me it may be very conservative because I understand how the law works and I know how the irs is going to look at this and what they’re going to deal with and I’ve read the court cases and read all of it. Okay so it’s you know when you say our are you aggressive or conservative, I will always tell people I’m the most conservative accountant I know and that’s because I will never do something that’s outside of what I know, but if I don’t know something I’m gonna learn it and so if somebody tells me well by the way there’s another way to do this like like Buck says well what if you know let’s say that was new to me and Buck says well what if we just become an independent contractor and then we do that and going oh let me look at the law let me see what ways we can do that because I’d like to make that conservative approach okay because without knowing any any different I would say well that’s aggressive most accountants say that’s too aggressive you can never do that and I would just say well let me look at the law to see if if I can make it conservative to see if I can take that position and feel conservative about it because I will admit my number one goal Buck is to never be anybody’s girlfriend in prison. I’m not gonna go to prison for you, we’re very careful with his return, we’re very careful with all returns but that’s a very important distinction when you’re looking at things like this because you’re going to hear when you talk to your accountant. Now this is important because when you talk to your accountant some of them will say what I understand okay then you need to say next okay or some are going to say you can’t do that and then you’re going to say next okay but someone will say god never thought about that before maybe you could do that that’s the accountant you want because then they can research it and if they say well I don’t really understand this you probably need somebody else to do this great you know Buck can refer you you can come to Wealthability whatever but you know just make sure that your accountant is actually asking the right questions that’s really I guess that’s really what what it comes down to.
Buck: So I’m going to make a few comments here and to sort of finish this off is I will ordinarily you know you may not have somebody admit this because this you know how crazy you know people get about this but Tom is my CPA. Tom you know I paid zero federal taxes in 2019, I made quite a bit of money and that’s a fact and I’m not worried about it because everything we did was legal, because Tom doesn’t want to end up in the big house and you know have his other paranoia has come to light. This is something that you know I wouldn’t have thought really possible a few years ago it is possible I’m not saying that that’s everybody’s goal but I think mitigation is a real goal that everybody should have, is optimizing legally what you can do. Tom has a podcast called Wealthability and you should listen to that. He also has a network this network of CPAs is also called Wealthability. Wealthability we we have a very close relationship with them we send a lot of people to wealth ability because of these kinds of concepts I am as you know everything that we had for the most part do within our Investor Club is tax efficient investing whether that’s real estate whether that is you know our new you know atm fund things like that and so this is all part and parcel, I highly recommend that you contact Wealthability, tell them that you listen to this podcast, that you’re a listener and you want to change your facts. Mention me by the way because it is important for them to understand that you do have a background in this stuff. You’re not coming cold turkey and that you’re sophisticated as one of our listeners. Tom do you have any comments on that?
Tom: Yeah I really do but we we love we love the people you refer for that specific reason. Understand that when we work with clients we’re partnering with you okay, we’re not taking it on you know it’s not like turn it over to us because I can’t change your facts I can tell you what facts to change I can tell you how to change them I can report them on the tax return but I can actually do the work. So my job is to tell you basically what you could do what’s possible and your job is to actually go do it and so it is a partnership and it’s not for everybody okay, I find that everybody comes from Buck though what I love about them Buck is that they’ve got some financial education because it does take an understanding of kind of some of the basics because otherwise it’s it’s going to be a long road I mean you know having some of those basics and actually I would go back all of your Wealth Formula Podcast you know if if you’re just starting in here I would go back and listen to all of them buck’s a great educator he gets great guests on on his platform and we literally we love the clients that come from Buck because we know they’re going to be educated, they have a really sound base of financial literacy.
Buck: And they’ll ask lots of questions and they will for sure and these CPAs are not the type who are just gonna say you can’t do that and you’re being you know overly aggressive etc we’re we’re really about trying to turn this into a fluid partnership which is really I think the ultimate goal and why I like Tom’s group so much. Tom it’s Wealthability.com right? So go to wealthability.com again let them know that you’re you know when you’re one of our community members and and that you heard this and the types of things that you’re interested in and you can talk to one of the representatives over there to get into the network. Tom I want to thank you again for being on Wealth Formula Podcast it it’s always incredible to me that we’ve been on so many times here but we always have these conversations that I end up feeling like I just learned you know even more so I appreciate that and as always I would love to have you back in the near future.
Tom: Always love doing it but thank you.
Buck: We’ll be right back