Saving on taxes isn’t typically top of mind for many entrepreneurs. However, you can save so much by making the most out of tax benefits at your disposal. In this episode, Jack Krupey shares how he saved six figures in taxes in 2021 by utilizing some of the strategies. He offers insight on the tax benefits of certain investments for high earning investors. Don’t miss this episode to learn all about how you can minimize tax burden and get greater returns by saving on your taxes.
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How To Make The Most Of Tax Benefits For Your Business
This is going to be a solo episode. We are going to talk a little bit about the tax benefits of syndications and a bit about my story of how I saved six figures in taxes in 2021 by utilizing some of the strategies, how I started diving into the tax benefits of syndications because I was living and working in New York City. I was a partner in a prominent reperforming mortgage fund. Things were going well, at least financially, and I was paying 50% tax on my income in that bracket.
I was looking into ways to generate more tax-efficient income. I did have an IRA, and there are things you can do with self-managed IRAs but I had not built up a significant IRA income amount, so I needed to compound my actual standard investment income that wasn’t in an IRA. I stumbled across multifamily syndications and started investing passively.
Syndications are for high-income earning people and are much more efficient than REITs. We get this question a lot. The thing about REITs is that tax structure is not taxed at the entity level. When it passes through a dividend, the dividend is taxed on the individual. Unlike owning, let’s say, an Apple stock, which is a qualified dividend. The majority of REITs are not qualified dividends, so you end up paying 29% tax on those dividends. It still may be better than 50% if you are in New York or California but it’s still not the most efficient strategy. You have the issues of market volatility.
The market had a rough week. Many REITs are down 15% to 20% along with the broader market. To talk a little bit more about what my strategy was and why we employ syndications both through our fund and individual syndication deals. Syndication is generally structured as an LLC, which is a pass-through, but in addition to passing it through the income, it also passes through the losses. Those losses included losses that are purely paper losses, such as depreciation, which is one of the most powerful tools.
I will add that these Tax Laws are really in favor of all passive investors, business owners, and real estate professionals. They do not favor higher-earning W-2 professionals or those that have an active business. There are way more loopholes when you are a full-time entrepreneur or if you own a number of passive businesses. The real reason that is the case is that passive losses, for the most part, can only offset passive income. They cannot offset W-2 or active income.
Now, if you have more passive losses that you can use, you are allowed to carry them forward. That can be a big benefit for or at least growing your cashflow passively and deferring the taxes to a later point. If you are a doctor and invest in these strategies through real estate, it’s not going to offset your ordinary income.
How it works is when you buy a building like a small single-family or rental property, typically, you would be able to take 1/27th of the value of the building and take that as a loss every single year. For most, if you own 1 or 2 rental properties, it’s usually about enough to offset the rents from owning that property. Now on larger buildings, we are typically only investing in 100-unit plus multifamily buildings or larger syndications and self-storage, mobile home park categories.
We were able to do a thing called cost segregation, and that requires an engineering study. It may cost $5,000, $10,000 or $12,000 in many cases. With this study, they looked through the building and the age of the roof, cabinets, all the fixtures, plumbing, heating, and air conditioning. They will assign a life that’s remaining for these fixtures. Often, this works out to potentially a third of the value of the improvements to the building can be accelerated.
Tax Benefits: Being able to save taxes upfront is something a lot of investors don’t factor in when they’re making their initial investment decisions.
The way the Tax Laws are now, anything with less than a fifteen-year life through bonus depreciation can be taken in year one. Often what this leads to is when you are investing into a syndication deal that’s using a traditional mortgage at 65% to 70% loan to value, it’s often working out that we are getting almost $0.100 on the dollar for an investment. In real numbers, us and many of our investors, for every $100,000 we invest, we are getting close to a $100,000 loss on paper the very first year.
How does this work for an actual tax return? Let’s say you have the ability to take all of the losses. If you are a real estate professional or you have other passive income that is typically shown on Schedule E of your tax return. If you had over $100,000 that is categorized as passive and able to be written off, and you are at a 40% or 45% tax bracket, it depends. We will use 40% as a based number, the top bracket Federal, which is 37%, and some state income tax. If you show $100,000 less in income that year, you are saving $40,000 in taxes immediately.
If you are factoring in where to invest money, if you are worried about if there’s a recession, what the stock market is going to do or what type of return you can make on an investment, sometimes the best return you make is by what you save. Factoring that into your overall investment strategy along with what the optimal returns are and what the hold period is. Being able to save taxes upfront is something a lot of investors don’t factor in when they are making their initial investment decisions.
In addition to real estate, there are a number of other asset classes that offer significant depreciation. ATM machine funds are an interesting niche, which could be a whole other topic but counterintuitive. Most people think ATM machines are a thing of the past but there is a whole subset of the country that is underbanked, and even to the extent that assistance checks are now being put onto debit cards.
A portion of the community still relies on ATMs regularly. There’s a fund that I’m involved with that has contracts with major retailers like McDonald’s and Walmart that have pretty consistent use of ATM machines. These are structured investments but the reason I bring it up is also you yield 100% depreciation benefit in year one. The difference between those and real estate is there’s not an actual recapture because it’s actual machinery. After roughly a seven-year life cycle, they are not going to be sold at a profit.
One loophole for the active earning W-2 professionals, whether you are a doctor, lawyer, a dentist or own a successful business that’s an active business, is oil and gas. I have personally invested in oil and gas deals purely as a test for some of my friends and clients that have high W-2 incomes. Also, I wanted to test it out. I don’t need the tax benefits in that way but given the inflation and what was going on in the world. A few years ago, oil had a historic low, and I do think oil prices will continue to be higher than they had historically been and that yields pretty strong returns as well.
Oil and gas could offset active W-2 income. For those that are hiring professionals, you should look into oil and gas because the same formula I used before, where if you invest $100,000 and receive close to $100,000 paper loss through depreciation, that could offset your current year’s income and may yield a large tax refund. If you are a W-2 and money is coming out of your check every week, the proper investment may lead to a large refund.
I mentioned the catch, and with real estate, there is a thing called recapture. If you take the depreciation, you are lowering your basis in the asset, often close to 0 over a 3 to 5-year period. When the property sells, you will have to recapture that depreciation because there will be a larger gain when the property sells. That gain, at least the bonus depreciation, is recaptured as ordinary income.
What you have deferred, maybe over 3 to 5 years eventually, does need to be repaid. However, there are a few ways to offset that. Number one, you can then do a 1031 tax-deferred exchange. If you sell one property and buy another property, there are steps you need to go through to do it in a compliant way. You can defer that gain indefinitely or convert it into a new property.
The other thing you could do is the new property you bought, you also accelerate that depreciation. The Tax Laws are changing with how much you could take each in the first year but it will still be an ongoing strategy that can help you minimize your tax burden. It’s something that, once you start doing it, becomes part of your tax planning every year.
Anytime you are in a project that’s likely to sell, you should be planning ahead and restructuring your purchases and your sales as efficiently as possible. That’s something we work very closely with our investors to ensure that we are helping them be as optimal as possible. That’s the tech side of it. In addition to that, these are assets that have performed very well over the past number of years.
Over the last few years, the average multi-family syndication deal, even through COVID, has yielded above 20% annual return. Past results don’t guarantee future results but given where we are in the market and inflation, real estate is a great hedge against inflation. These asset classes, just by nature of not being publicly traded and not being as accessible to probably 90% of the country, typically do perform better.
You have to be an accredited investor for a majority of these deals. They do perform better, and when you factor in the tax benefits on top of the returns are, in my opinion, tremendously better than investing, possibly in a stock market or using kind of the traditional wealth management channels. That’s about it for this episode. I encourage everyone to please subscribe and leave us a review on iTunes or your podcast platform of choice. Subscribe and like our YouTube channel. Please email us with any questions or any topics that you would like us to cover in the future. Thanks. Have a great day.
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