283: Ask Buck 9/25/21
Buck: Welcome back to the show. Everyone. I am here myself without a guest today because I am doing an episode of Ask Buck. So lots of really, really interesting questions. And I think it’s an opportunity for us to learn together and let me start this week. I’m going to start. I prefer these questions that are recorded, so I’m going to do as many as we can within, you know, a reasonable amount of time and then move on to the rest of the next week.
Let me start out with a question from George.
George: Hello, Buck. George from North Texas. I’m invested in two of your Western Wealth deals. Question about some legislation working its way through the House right now that I heard about that would make it illegal to use an IRA or self directed IRA to invest in any private placement or single member LLC. And furthermore, would that require anyone who has ever done so to liquidate that private placement investment within two years. Wondering one, if you’re aware of this and to whether that would affect our ability to participate in Western Wealth opportunities in the future or affect existing Western Wealth investments. Appreciate your thoughts on this and thank you for your podcast.
Buck: George. Great question. Yes, I am aware of the legislation. So first of all, let’s start with this. Everything that we’re seeing right now is legislation, right? It is not law, and we need to see what actually does become law. So that’s first and foremost.
I’m going to start a lot of these questions with the same reminder, which is that I am not a CPA and I’m not a lawyer. So don’t take any of this as legal or financial advice. You are right, though, in that if this law that is currently being proposed in its current form, if that were to happen, you would no longer be able to invest in private placements with your self directed IRA effectively. It targets anything where there’s a minimum investment or requires you to be accredited so effectively. That is pretty much everything that is a private placement in any sort of way.
So yeah, absolutely. That is a concern. As for current investments that you already have deployed right now, the legislation says that you would have to have that liquidated by 2024. And as you might imagine, that’s not a lot of time for liquidation to occur in the type of stuff that we do now, I will say that I have to imagine there will be a way for people not to be penalized for lack of liquidation in this. I can’t imagine that there would be no way to deal with that kind of stuff.
So we’ll see what the law says. You know what this is. Round one, and who knows where it ends up. By the end, it could be dropped completely. And if it doesn’t, well, there are some potential workarounds which we’re not going to get into today, but things that involve selling your shares. So there’s also ways to get valuations on those and potentially, you know, sell them from your IRA to, you know, someone else or maybe yourself or whatever. But we’re not going to talk about that so much right now because it is so early and we don’t really know where the law is going to end up. T
he bigger question is, does this build pass? And the thing is a lot of times you look at the stuff and you think, well, you know what that’s just posturing for negotiations, because that’s asking for way too much. And there’s no way that’s going to get through.
But this one is a little bit tricky. I have to tell you. And the reason is if you think about it, who benefits from this law, who benefits from this going through? Because I mean, it’s so strange, right? Why would you not be able to control your own money? Why does anybody care about that? And why should the government have a hand in that? These are all very good questions.
But if you look at who would ultimately benefit from your inability to self direct it’s Wall Street, right. Because effectively, it creates a situation where if you can’t invest into alternatives as they call them, then you’re going to have to invest into the publicly traded markets and buy equities and bonds. And that dumps in more and more money into Wall Street. So the point of me bringing all this up is that a lot of times I’m like, well, we’ll see where it goes. And I’m not too worried about that because there’s going to be a lot of political lobbyists and stuff will probably get in the way.
But the lobbyists here are probably on the side of Wall Street, and that’s what worries me about it. Now, one thing I should point out, which was pointed out in our Wealth Formula Network group by one of our esteemed members there, which I thought was very important, is that right now the self directed IRA are specifically the target. The legislation does not refer to solo 401K, these things QRP or whatever you want to call them. And so they are not currently affected by this legislation, as it stands.
So those of you who are using solo 401 KS would theoretically not be affected. And there’s precedence for that. So if you look at laws regarding self directed IRA versus solo 401 KS, they’re different, right? If you have a solo 401K, you’re not subject to the Udi and U bit and all that stuff, so they can have different rules. And I think the 401ks being in the purview of corporate America might make a difference.
And so I guess the question is, what do you do? And again, I’m not a CPA. I’m not going to give you any advice. But if it were me and I don’t have an IRA or 401K, but if I had an IRA, I’d be trying to figure out right now, how could I if I needed to convert my self-directed IRA into a solo 401K. How could I do that? And there’s plenty of options out there that people talk about all the time.
And just to be clear, I’m not saying to do that. But it’s something that you may want to do a little research on from my understanding. Again, my little knowledge in this area is that if you have a self directed IRA array, if it’s not a Roth conversion already, that it’s actually not terribly difficult to get into a type of solar 401K model, look into it.
But finally, again, I would just say also beyond the fact that this is not tax and legal advice, I wouldn’t panic just yet. There’s a lot of scary stuff in this legislation. It’s going to need to be ironed out. We just need to see what actually comes to fruition.
All right. Good question, though. Next question is from Jason.
Jason: Hey, Buck, I have a single family rental home that I was thinking about selling and taking the proceeds and putting into a passive multi family. The question I had is, can I do that in a 1031 exchange, or should I just sell it and pay the taxes before a potential multi family investment? And then third, I was also thinking about just refinancing and increasing my cash flow and hanging on for the long haul. Just wanted to get your thoughts and a lot of moving parts, but I appreciate the help. Thank you.
Buck: Great question. Again, Jason, as far as the whole refi option, obviously, it’s a personal preference. If you like the asset, keep it refi. That’s certainly not a bad way to go. But right now, as far as the 1031 exchange issue, the good news is we still have this benefit right now of 100% of 100% bonus depreciation. So when you put together these cost segregation analysis along with bonus depreciation, it actually sometimes be pretty clear that you don’t really need the 1031.
Again reminding you that I’m not a CPA or a lawyer or financial advisor. Let’s just do a little taste study, though, because I think that’s pretty close for me to do. So let’s say you bought a house and it was a hundred thousand dollar house and you did what you normally would do. Hopefully you do. You take some depreciation on that say you took $20,000 in the depreciation. So far, your basis is now $80,000, and upon sale, you would be responsible for not only the capital gains, but the recapture of depreciation.
Recapture is typically at a tax rate of 25% on that dollars of recapture, $20,000 of basis that you took in depreciation, you would have to pay about $5,000 in and recapture. Now you sell the house and say you sold it for 150,000. Nice profit. Right. So you have $50,000 of capital gains, too. So if you do nothing else, you would have that $50,000 of capital gains that you’d have to pay on. And then you would have. And so that’s a cap gains rate of at a tax rate of, you know, about $10,000. So you got that $10,000 of capital gains tax and then the recapture we calculated came out to about 5000.
So with recapture and capital gains, you’d have about $15,000 of taxes to pay if you did nothing else. So obviously the traditional thing in real estate is to do it. 1031 exchange like exchange. You don’t pay anything and we go off into the sunset and keep doing that until you die. And then there’s a reset of basis. But now let’s say okay, you can’t do a 1031 and you want to do a limited partnership and that kind of thing.
So let’s say instead of doing nothing and just eating the tax, you put that capital gains and principle in total $150,000, the $100,000 from before the $50,000 of profit back into a limited partnership in multifamily real estate. Now let’s be conservative. And this is just based on what we’ve seen within our group. Let’s say that you get 70% depreciation from that investment because of the cost segregation and bonus depreciation.
So that’s been my experience. That’s been anywhere from 70% all the way up to 100%. But let’s use 70% there. So you invested your $150,000 and you got 70% depreciation, you get a K1and that shows a loss. Now because of that $1,000. Now guess what. your total capital gains and recapture was only $25,000.
So in this example, any gains you would have would be offset by depreciation losses from your investment into your limited partnership investment, and you’d have still some suspended losses that you could still use for other stuff. But again, I’m not a CPA, and all I’m doing is running the numbers on a theoretical example. So depending on your depreciation and gains and leverage certainly plays a part in this. The numbers could vary, and you certainly want to consult with your tax professional in this matter as well. But you know what? Run the numbers and use just a simple modeling. And I think you’d get a pretty good idea. But the bottom line is that at least while we have 100% bonus depreciation that we can take on our cost segregation analysis, selling something and investing looks like it could be a good option or even better than a 1031 exchange.
Alright, let’s get on to the next question. It’s from Jimmy.
Jimmy: I just got a quick question for you regarding routines. Do you practice any particular daily routines that are intended to put you in an optimal mental, physical or emotional state? I’m thinking, for example, like how Elrod’s Miracle Morning routine that Robert Kiyosaki has talked about that has elements of meditation, affirmation and visualization exercise, reading journaling or anything sort of in these categories. That’s something that you do on a daily basis. And if you do that sort of stuff, do you get up earlier? Are you an early riser? You more like a night owl? Or somewhere between? Thanks for your time and all you do to share your knowledge with us.
Buck: Jimmy, well, I’m definitely not a night owl. I tend to turn into a pumpkin at about 10:00 at the latest. And also, although I wish I could say I did do something special, I don’t do anything like the Hal Elod Miracle Morning, but like you said, I know a lot of people swear by it. I know Robert Kiyosaki told me he does it himself, so I think there’s probably something to it.
I do think that routine is important, but being, you know, in my case, a single dad with kids half the time. It hasn’t certainly been something that I’ve been able to implement very well, especially as of the recent year or two here. But I do wake up early. I generally wake up at 07:00 a.m. at the latest. And my six year old will sometimes wake me up at 05:00 a.m.
So I guess you will sometimes make me more productive in that regard. I work out with personal trainers three times a week. I do this thing called The Genius of Flexibility. It’s kind of a little culty type thing, but it’s interesting. I’ve got like three trainers kind of in its resistance and flexibility training and a lot of strength training and stuff. It’s pretty cool. I used to hike several times per week, and I think that that’s been very useful for me, especially over the pandemic. I’m sort of burned out on that. I have a lot more weird routines with my diet and stuff.
Now I do intermittent fasting, and that’s based on the health things that are coming out about intermittent fasting. What is intermittent fasting? Well, basically, I usually eat only for about a window of about 6 hours in a day. Sometimes it’s a little, frankly, like three or 4 hours, and that seems to have some benefits in terms of weight loss and energy and things like that. I also take a lot of supplements. I become like a crazy supplement guy, but a couple of ones
that I think I would highlight here are ones that are in some of the longevity studies that are out there. Nmr, which increases NAD levels. I take a lot of vitamin D, by the way, if you’ve never gotten your vitamin D levels checked, have them checked out because everybody seems to have low vitamin D and vitamin D actually does quite a bit for your energy levels if it’s not normal. So mine was kind of really low. And so I started taking it. I noticed a big difference from that. And then there’s also a supplement called Spermidine. Now that’s a terrible name. I know, and it doesn’t do what you’d think it would do. Actually, another supplement that’s in the longevity literature, and it’s related to something called autophagy of senescent cells, which is basically like dead cells and stuff like that getting rid of those quicker, you know, by the way, I think this book from David Sinclair, I think it’s called Lifespan. It’s a really good book. I highly recommend it. Very entertaining as well, especially if you’re middle aged like me and you’re trying to figure out how to live longer and stuff like that. This guy is a really smart Harvard biologist, and he’s doing great work over there, and I follow him on Twitter and stuff too. So check that out, Lifespan now.
Although I don’t have a work routine, I will say that I think one of the things that differentiates me from a lot of people is that I am very good with time management. And honestly, I think that’s one of the most critical things out there is just being able to manage your time. However you do it. I honestly spend a lot of my time just working on my phone and I’m working from wherever I am during the day. And then I don’t feel like it spills into any hours that I don’t need it to spill into. Anyway, that’s about all I got. I wish I had something that was more useful to the audience, but if you figure out something that works for you, let me know. But I can’t really wake up any earlier and have much of a routine because of the single dad thing.
Let’s see, I think we have time for one more for this session. So let’s go with a question from John Hurwitz.
John: Hi, Buck. This is John in Santa Rosa, California. I have a question about suspended passive losses and offsetting active income. I’m aware that normally this is not the case unless you’re a real estate professional, which I’m not. So I have banked quite a bit of suspended losses, like probably many other members of the group. My understanding and my question is when an asset sells and for example, there’s a capital gain of $100,000 at that point, then the equal amount of suspended passive losses can then be released. And when they’re released, my accountant tells me they can at that point offset active income. It’s kind of like they go to their highest and best use. And instead of offsetting the capital gains from the sale, they offset active income, which is more tax beneficial to me. And then, of course, you still have to deal with the capital gains tax on the profit. But all things considered, the ability to use suspended passive losses at the time of a sale, having them be unreleased and then offset active income. I just want to get confirmation that is the case because that is not talked about very much. Thank you for all you do. And thanks for taking the time with this question.
Buck: John, thanks for that question. Really, really good question. I guess we have, like, the smartest group. I mean, even these questions that we get are just so much better than what you get on other podcasts and stuff, in my opinion.
But John, let me do this first. Let me review what you’re talking about so that everybody’s on the same page. And let me also again, tell you this disclaimer. I’m not a CPA, and I’m not a lawyer. I’m not a tax advisor, I’m not anything, just a guy with some opinions and who does little research myself.
So what John is talking about? So one of the great advantages of real estate investing, especially these days, because of cost segregation, analysis and bonus depreciation combination is there are significant paper losses vis a vis that depreciation that you can theoretically take advantage of. But one of the really important things to remember is that incomes are classified in various different buckets. Right? It’s either you’ve got passive income, you’ve got active income, and then there’s portfolio income, which is like stocks and bonds.
Now, my understanding is that you can only use portfolio lots to offset portfolio gains. And similarly, you can only use passive losses to offset passive gains. If you’re not classified as a real estate professional, as John pointed out, you can’t use real estate depreciation losses against your earned income from your job.
So many people who invest in real estate end up creating a whole wall of suspended depreciation losses that they really can’t use to offset a new passive gains. And they basically have to wait until there’s passive income to offset or there’s a liquidation of one of those passive assets. Again, let’s show a little model. So say you have $500,000 in suspended losses because you’ve been investing in all sorts of limited partnerships and they keep sending you K one, and you can’t you can’t use that against the earned income that you make. You’re making a few hundred thousand dollars a million dollars a year, whatever you can’t use that $500,000 against that earned income.
Now, all of a sudden, one of the investment properties that you have, it sells and you have a hundred thousand dollar passive gain. Now you should be able to offset those gains with the accrued losses that you have all of those suspended losses. And we have called this phenomena the golden hamster wheel. For this reason, it’s like you just build up these walls of depreciation losses, and every time there’s gains and income, you keep offsetting them and not having to pay taxes.
Now, what John is asking is actually a fairly nuanced and complicated question. He’s asking if you have that $100,000 capital gains, do the suspended losses have to offset the capital gain specifically, like surgically? Or could they or do they actually offset ordinary income for that year? Now, John, according to my CPA, because I’m not going to give you a tax advice. You are correct. So the offset is not surgically target target your capital gains. The ordinary income is always essentially offset first. And you are right. People don’t talk about this much, but it is an additional perk of that those depreciation losses that you have. So if you have $500,000 of ordinary income and say all of a sudden you have $100,000 capital gain and you have suspended losses to offset that $100,000 gain, you would pay ordinary income taxes on $400,000, not $500,000. So again, that is doing what you’re saying. It is essentially offsetting your active income there, and then you would pay a capital gains rate on $100,000. Anyway, that is a very, very good question. It’s one of those things that I think only this group come up with.
So I appreciate that question, John. And hopefully my theoretical answer from a non CPA non tax professional person like me is helpful. But yes, I concur based on what my CPA is telling me. Anyway, I think that’s it for this week. We don’t want to overdo it with questions in one week. So we’ll just have some final comments right after these messages.