262: Ask Buck! Q2 2021
Buck: Welcome back to the show everyone let’s get to it without further ado, the first question is from Brian and here it is. A nice recorded question.
Brian: Hi Buck this is Brian from Salt Lake City first of all thank you so much for your podcast I’m really enjoying it and looking forward to an upcoming investment with your team with Western Wealth Capital. My question for today is I’m expecting a significant liquidity event in a positive way for my business and I’ve heard a little bit about this Malta pension plan opportunity. I’d always thought I’d be doing a CRT or a charitable remainder trust but with the Malta plan apparently, there’s significant opportunity to have tax-free wealth into the future. Wondering if you had any references or people that might be able to weigh in on this. Thanks again for everything. I look forward to hearing from you.
Buck: Brian great question and as I always do, I’m gonna start off by reminding you that I’m not a lawyer, I’m not a CPA, I don’t even play one on TV. I am just a guy with his own opinions that may or may not be based in reality but anyway so I do happen to know or think I know a little bit about Brian’s situation and he is selling a business and I say that because that’s really important because not all capital gains are created equally and so let’s take this opportunity to just go back and review that a little bit. For example you know we often talk about the use of real estate depreciation to offset passive income right? And so you may ask, and I should say reasonably, so well wait a second aren’t stocks bonds and mutual funds, aren’t they considered passive income? So if I’ve got you know passive losses from real estate, should I be able to offset that? Well the answer, and again to my understanding, is no capital gains from stocks are considered portfolio income. They’re not considered the “passive income” so you cannot use depreciation from real estate to offset portfolio income if you are not a real estate professional. Now I digress a bit because I know Brian is selling a business, but I thought it would be important, this sort of holistically. And so Brian’s selling a business and what I will say is that some in our group have gone down another route which is the real estate professional status rabbit hole when they sell their business and have benefited from that transition, and let me just say that here’s how I have seen that work: you see someone has a business and that person is also active in real estate or suddenly becomes very active in real estate and when they sell the business they make sure that they also qualify immediately after that as real estate professional status for the year in which they sell that property. They then take the proceeds of the business sale and invest it into as much real estate as possible in hopes of essentially taking the depreciation from those investments and using those against capital gains. Now again you can do that theoretically because once you’re a real estate professional, your real estate depreciation is not passive depreciation. because you’re a real estate professional all of your losses are activated and so the depreciation is active and that can therefore offset all types of income including active income. Again I’m not a CPA or a lawyer but this is my understanding. Now I know that, again, it is not your question Brian, but so many people in our group have done this successfully that I had to bring it up. Now of course there are other options out there as well, before I get to your specific question, another option would be to do an installment sale, you know basically, there are these companies out there that’ll act as intermediaries during your sale they take the proceeds from the sale of your business and then what they do is essentially loan you like 93/94% of the full amount over 30 years and they charge you that 67 percent upfront for that debt. Of course, the reason they’re doing that is because that income, that capital gains income would then not be seen as income because you’re taking it as debt and debt is not taxable. And then of course eventually 30 years later you may have to pay tax or you may find another creative way to defer that until you die. Anyway, I will say that the installment seal is actually pretty non-controversial if you do it the right way. It’s not something that I think that I know a lot of people who do it and it’s not that risky, I would say in my opinion. Now what you’re bringing up is something different. We’ve never talked about it on the show. It’s the multi-pension plan. Now it’s a lot more complicated, and again I’m not a tax professional, but in a nutshell, the idea is to utilize a treaty between the US and Malta that allows us to use each other’s pension structure and basically have pensions in each other’s country I guess. Now money does not leave the US when you create a multi-pension plan but the entity holding it is domiciled in Malta and that’s why it’s a multi-pension plan. Now in theory anything can be transferred into a multi-pension plan but stock, real estate, cash, cryptocurrency, which may be where you might see some of this stuff happening and once it’s transferred over at the age of 50 you can pay yourself 50% of that money tax-free then every I think every couple years. After that, you can keep paying yourself 50% tax-free until the money is essentially all used up and voila you have a liquidity event without any taxation on it. And so that sounds awesome and in addition to that of course, the money that’s sitting there in the multi-pension plan can be invested in stuff. So it’s not like you are just sitting in cash all these years either. So sounds awesome, sounds great, but of course, as always the devil is in the details and for those who I’ve talked to about this, the professionals who actually execute it, it isn’t cheap, okay. So from the people I’ve talked to, the minimum cost for something like this is about three hundred thousand dollars just to set it up, minimum of that. And then there’s ongoing assets under management fees and transaction fees every time there’s more money coming in. Now, if anyone has found someone to do this for less money who’s actually reputable and knows what they’re doing, let me know. But that’s kind of what I’ve been hearing on this. But my understanding is that really the absolute minimum liquidation event for something like this to even make sense would be at least five million dollars and obviously, you know the larger liquidation events are going to create better opportunities and make it more cost-effective. But the other issue I would just you know I think it’s wise to bring up is bottom line is that I don’t know how much risk there is in doing something like this. I know the law is there, from what I understand the law is there and it’s pretty clear I would take this very seriously before you get in there, and do a lot of due diligence, and I’m certainly no expert on this you know because I’m all for being on the the cutting edge of things, but I also you know I don’t want to be on the bleeding edge of them right? So to be honest, I don’t know enough about it to consider whether I would do it myself, but I’m certainly open to learning more, but you know again what is the risk, the risk that it gets turned over and this big plan that you had for all these capital gains gets turned over and you have penalties and you know that’s much worse than doing something that maybe you have to pay a little bit more in or like an installment sale or something like that? But then you have maybe you’re paying a little bit more, maybe you’re paying a few percent but the reality is that it’s a lot less controversial or it’s at least more known than some of the other more exotic stuff like this. Now again, I don’t know. Who knows? Maybe I’ll end up doing a Malta multi-pension plan for some liquidation event down the line. But what I will say and I will say to all of you is whenever you hear stuff like this of course it doesn’t mean that there’s anything that it’s a breaking law or anything but it’s not only whether or not it’s legal but you got to just make sure you know you do your own due diligence on the people involved and you know all of the laws and what the risks are to you and make that decision. So hopefully I answered that question. If nothing else, I very much doubt that most people out there have ever heard of a multi-pension plan so go ahead and start looking it up.
Next question is from Evan
Evan: Hey Buck my name is Evan. I’m an attorney in San Luis Obispo in Santa Barbara. My question is about bonus depreciation and depreciation recapture. I understand that bonus depreciation can have a lot of benefits but I get confused when I start to think about how you recapture the depreciation when you sell the asset it almost seems like somewhat of a Ponzi Scheme where you get the benefit of the depreciation but then you use it to pay off other things and then, later on, you still owe the benefit if that makes any sense so I’m wondering if you can explain a little bit more about how bonus depreciation is still extremely beneficial even though you have to recapture that at the time that you sell the asset. Thank you.
Buck: Well Evan, thanks for the question. Boy, I definitely do not like the words Ponzi Scheme for recapture, but I see what you’re saying. It’s sort of recapturing the same law, but again let me try to explain to you because hopefully, it’ll make sense. And again I’m not a CPA or a lawyer like you, but here’s my understanding. So this is not financial advice, but you know we use these kinds of concepts in our group all the time. Let’s talk about this first on a very basic level. Say I was able to invest a hundred thousand dollars into something today and take a hundred percent bonus depreciation on it this year, so that’s a hundred thousand dollar tax deduction for me this year. So if I made 400,000 this year for example but I invested it in something that provided me that 100,000 deduction, my taxable income would be not the 400,000 that I would have theoretically made but the 300,000 after that after that depreciation is applied, so I am not taxed on 100,000 that you know I made that would have been taxed at ordinary income. So let’s just say that I’m paying 40% on ordinary income all in. Well so if that’s the case, I just saved forty thousand dollars right? So hopefully that part makes sense. It’s very basic. You got forty thousand dollars. So if you use that depreciation by applying it to other passive income then one day the property sold without tax deferral of any kind then we do have to pay recapture. You’re absolutely right about that. But a couple of reasons why this is still beneficial, now as we mentioned we used that theoretical tax bracket of 40 percent so that you saved initially on that hundred thousand. So that tax on the ordinary income was 40% but here’s the thing, the recapture is at 25% typically. Now 25 recapture as opposed to paying 40%. So right there you have a tax arbitrage of 15%. So if I held on to that asset for 10 years, there’s also you know you get that benefit of the arbitrage, but now you also have the time value of money right, because now you’re paying for these taxes owed in the future. When that money has been, the value of that money has been diluted by inflation as well. So anyway that’s basically in a nutshell why it is still valuable, and that’s assuming you didn’t just do what we call the golden hamster wheel. That’s kind of our you know little shuffle the name was brought to you by Tim Hamby, an orthopedic surgeon in Indiana and a member of our Wealth Formula Network and I like the name so I rip it off all the time. So the golden hamster wheel right? So here’s how that works. So say you invest a bunch in real estate and you’re in several opportunities, you know fifty thousand hundred thousand dollars at a time, like people in our investor group and you’re not a real estate professional, so you’re not necessarily using up all that depreciation that you’re accumulating, but you do have some passive income. So you’re using some of it. Well here’s what happens: so you use what you can and then you have these recapture moments and so on that particular property you may have capital gains and recapture. But the idea is that you’ll have these passive losses sitting in the wing that you’ve not used up to sort of again kick that need to pay taxes on those gains and recapture down a little bit further. So that’s why we call it sort of a hamster wheel because it incentivizes you to continue to invest in real estate so that these losses continue and you keep pushing the recapture back and capital gains back into other losses that you’ve accumulated by investing in other real estate. So it’s a hamster wheel yes, but it’s a very nice hamster wheel and so we like that hamster wheel and we do it and we use it all the time and essentially that’s why we call it the golden hamster wheel. Now of course someday at some point you may have to pay something or the other. Possibility is that you die and your heirs don’t have to pay it. These are all things that happen, resets at death and things like that but in a nutshell that is effectively what the golden hamster wheel is, but again I just want to point out that even if you did not use the golden hamster wheel, you’re using tax arbitrage and the time value of money to benefit from the depreciation upfront even if you are paying recapture. Okay, hopefully, that made sense it was a mouthful right.
Buck: Okay next question here from Matt
Matt: My question is this, let’s say if we have a construction company, if we sell a depreciating asset and we have capital gains, can we invest it back into real estate commodities or some form of investment to avoid capital gains, or do we have to reinvest it back in our company to form our depreciation?
Buck: Well sounds like a lot of people are out there selling businesses, and again, I’m not a CPA or tax attorney or an attorney of any kind, but let’s just review what we’ve talked about already. So we talked about converting about the possibility of if you’re active in real estate or your spouse is, to take advantage of the real estate professional status. Invest you know those capital gains proceeds into real estate and then take advantage of depreciation that then becomes activated. That’s one thing that we’ve talked about. We also talked about installment sales which you know a lot of people do. We’ve even talked about some more exotic stuff like multi-pension plans. Obviously, the traditional way to defer taxes on a sale of a business would be a 1031 exchange which is a kind of exchange. A business would likely not be able to be transferred for real estate but you can probably get a lot of other good ideas on different kinds of businesses or whatever that you could exchange it for from a good accountant. However, remember, you know you have to set up most of this stuff ahead of time. A 1031 exchange can be done after the fact. You have to have an intermediary. The same thing goes for the installment sales and I forgot about this other option too that Brett Schwartz back a few weeks ago brought on the show which was the deferred sales trust which is an interesting option as well. I don’t know that much about it but I know as much as you do if you listen to that podcast, but you know that’s another option. But again these things have to all be done at the time of sale, if not you know you’re kind of screwed in a way unless you again you’re doing a real estate professional thing and now you’re just deploying capital and getting activated depreciation. So anyway yeah yeah so those again are your options and again, just forgot to mention Brett Schwartz and the deferred sales trust might be worth going back and listening to that podcast that I did with him as well.
Alright, next question.
Max: Hey Buck this is Max thanks for the opportunity to ask a question. Love your show, get loads of value from it every week. Keep it up. And so my question is tied to the grouping of various real estate investments syndications rental properties etc. into what is considered a single real estate activity from which I can also group all the losses across all those and apply that larger loss amount to capital gains w-2 and other income you know assuming you qualify for real estate professional status. This seems like a very good strategy and one that would almost be the default for an active investor who qualifies for real estate professional status and has that blend of investments where in reality they may only be able to materially participate in a subset of those properties, a handful but then can group them and include losses from all of it including you know the losses from syndications so hopefully the above makes sense and some of the assumptions I’m making are correct. But my question here is what are the pros and cons of that strategy of grouping all real estate activities as a single activity? How difficult is that to accomplish and I guess are there any gotchas to be aware of. Thank you very much.
Buck: Max, again I’ll start out by saying that I’m not a tax professional, CPA, lawyer or any of those fancy types so I’m not going to give you any advice here but I’ll give you my layperson’s perspective and opinion. You know first of all, as long as you follow the law, it’s not that difficult to do what you’re saying. You have to document you know no less than 750 hours per year in a diary of real estate activity where you’re really doing real estate activity and you can’t have another vocation in which you spend more than 750 hours per year. So you know I actually am a real estate professional myself and that’s what I do. Now the rest of it you know I would highly suggest you speak to your CPA about really you know the nuts and bolts of what that activity is because listen, I could tell you, and I’m not going to because I’m not crazy enough to give you financial advice but I could tell you a bunch of stuff, but at the end of the day, your CPA is going to be the one who defends you in any kind of audit. So he or she needs to be comfortable with your strategy, that this is a legitimate strategy, you’re not playing in the gray area, you’re following the law, but again for real estate investors, this is sort of like you said the default holy grail if that’s what you do invest in real estate for a living, you should theoretically be able to use all of your real estate losses against any other form of your of active income or the active income of your spouse if you’re filing jointly and that’s why this thing is so darn powerful. Like I said, it also works when one of the spouses is the w-2 wage earner and the other one is the real estate professional. We see that a lot in our group. Filing together you can take advantage of those losses theoretically if one of the spouses is a real estate professional so not a bad way to go. So other than that I don’t have much to add. I do think, again this real estate professional says for those of you contemplating it, I mean shoot if you’re doing real estate. It’s funny, there’s some people who’ve got a spouse who’s making a lot less money than he or she, and it might actually be of greater value to take the tax deduction monetarily than have that spouse working on the real estate stuff full-time than have a salary that’s not significant. Anyway, hopefully that addresses your questions somewhat. Let’s see here, we’ve got time for maybe a couple more. By the way, if you notice I’m doing all the questions right now that are audio because I like the audio ones the best and I also have a ton more questions here so if I didn’t get to your question, it’s not like I’m not going to do it, it’s just not doing it on this show. We’ll probably have at least two more of these in a row.
Okay, next question from Eric, is a written one. He says hey Buck, what is the best entity for me to hold my syndication investments in? Thanks for all the great education. It has really changed my life. Well, that’s great to hear. I’m glad that it has changed your life. That’s good to hear because it means somebody’s actually learning something and doing something with it so that’s great to hear. Thanks for that message, Eric. So again it’s funny, it seems like if I was an attorney or a CPA I could probably cut off about 20 minutes of this show, but I’ll say it again, I’m not an attorney, but I’m going to tell you what I do or people that I know in our investor club typically do. So the best entity to hold syndication investments and typically what investors in our group who are very active in this space are doing is they’re creating an LLC and often you know those LLCs are in areas that have strong laws for asset protection such as Wyoming or Arizona for example. These laws relate to something called charging orders, which I won’t get into, but the bottom line is it just provides better distance between you, yourself, and your entity even though it’s a flow-through entity. It provides you some layer of asset protection. So what they’re typically doing is they’ll have one LLC and maybe it’s a manager-managed LLC in Wyoming and then they invest and that sort of acts as a piggy bank out of which they invest into you know limited partnerships and then they get cash flow back or capital gains back from the money that’s made from those investments. The reason why it’s okay theoretically to have so many investments flowing from one entity is because they’re all investments into limited partnerships. So limited partnership by definition means you don’t really have any liability from the investment. So if you are a limited partner you invest in an apartment deal and you know somebody suing the general partner or something related to that asset, you don’t have liability so there really is nothing to protect that from the apartment building itself. So then the question is well shoot, if that’s the case why do I need an entity at all? And the reason that people do entities typically there is to actually protect the investments from personal liability. Say for example you’re driving down the street or your kid’s driving the street and they hit somebody and break their leg and they get sued, you get sued and now there’s personal liability. Well what the LLC has done if it’s got good charging orders is give you some level of asset protection against the personal liability. You’re getting sued but your investments are not, just in your name where they are you know prime for the taking. If you get sued and you lose some kind of a lawsuit and so if they’re in an entity, it makes it much more difficult to get to. So that’s why people are doing that. So they have like a holding company, again it might be in Arizona, it might be in Wyoming and then they’re deploying capital out of there and then they are you know just using one entity to deploy in and out of. It’s like a big piggy bank. One other thing I’ll point out is I personally like the manager-managed LLCs because you know you may start out doing this where you are the member of the LLC or somebody else and your family is or whatever and you’re the manager but at some point, you may want to move that entity over to like a trust owning it and so it makes it easy if you’re just a manager already and it’s a manager-managed LLC then all you’re doing is changing the members and so that’s the way I’ve seen it done. Again, I can’t give you any sort of advice on whether it’s the right or wrong thing but that’s what I do and that’s what most people in our group who are active investors are doing.
Alright, I’m going to do one more question here. This person doesn’t want to be named and he says, Hi Buck hope your family is doing well. I appreciate your efforts in educating us and enjoy listening to your podcasts and the questions you pose to them. I was wondering about the issue of recapture of depreciation on the sale of property, which of course we talked about a little bit earlier so you have some background on that. He says, I recently spoke with a syndicator who stated that their company does things a little differently. Instead of paying a preferred return of seven to ten percent, they guarantee a pref return of 15 per year, including the depreciation part, then in year three to five, they refinance and pay off the investors, their capital investment, and they keep the property long term, but the investors are done, that way there’s no depreciation recapture for the investor. I proposed that one could reinvest the gains in a new property and offset the income, but the reply was then we are stuck continuing to reinvest until we die. To me investing with your group makes sense and the returns seem way better, I just didn’t have enough knowledge to intelligently counter their argument. I’m not sure if I’m stating this clearly but if you were able to make out the gist of this conversation, please let me know your thoughts and strategies around this depreciation recapture. So if what you’re saying is true, and this is what the person told you, I would just turn around and run the other way okay, because it so doesn’t make any sense. First of all, they say they guarantee a preferred return of 15 per year including depreciation. So if somebody’s saying they guarantee something, run away. It’s illegal to even say you’re guaranteeing something. The only thing that you can say, guarantee that legally say is guaranteed return is US treasury. So that’s one thing. Now the other thing is a year three to five, they refinance them, pay off the investors their capital and they keep their property long term. Well, a couple of things there. So basically they’re just using you for debt and they’re going to pay you off, they pay you a little bit of return, and then they’re going to take all of that deal on the upside of the deal. so all you did is was stay there for the risk during the stabilization period. Stupid. Then the last thing I’ll say that makes me think you gotta run the other way is this idea that if you got depreciation that you would not have to pay recapture. Again, I’m no CPA, but I’m also not an idiot and if you’re getting paid off and you got profit and you took depreciation, you absolutely need to pay recapture and that’s going to be based on the new basis. So if they refi-ed the property, that property has got new value to it. Well there you go, that’s capital gains, right? So it’s got new bases right there and so they’re resetting depreciation for themselves, but the reality is that you don’t get to permanently keep that depreciation and not pay recapture. Now I don’t know, frankly, if you’ve got the story right here. What they could be saying, and I don’t know if this is the case, I’ve seen some people do this, is they say well we’ll plan on paying you 15 per year maybe, it’s some kind of a pref but we’re not giving you any upside. Maybe that’s what they’re saying. But in that case, that’s just debt. You wouldn’t be able to take depreciation. Anyway, the whole thing sounds very, very shady and there’s no shortage of shady players in this space. So if it’s the way you make it sound, I would suggest turning around and running the other way. Anyway, that’s a mouthful. Hopefully, it made sense. So I think that’s about all I have time for today so let me take a break and I’ll be right back in a minute.