Tax Reduction Podcast

Episode 41. Real Estate Investing Tax Strategies

• Boris Musheyev • Episode 41

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Did your accountant tell you to "just buy real estate and do cost segregation" to save on taxes? Then they're giving you incomplete real estate tax advice. In this podcast, I explain why buying rental property and doing cost segregation won't actually save you money on taxes without the right real estate investment tax strategy.

Here's what happens to business owners and entrepreneurs: You hit six figures in ordinary income, your accountant says buy real estate for tax benefits. So you purchase investment property, do cost segregation accelerated depreciation that lets you write off some of the purchase price through bonus depreciation. Sounds great, except those real estate losses are passive losses. Your business income is ordinary income. Passive activity losses can't offset ordinary income unless you qualify for real estate professional status, short term rental strategy, or self rental strategy. Your accountant probably didn't mention passive vs ordinary income rules.

I break down how to convert passive losses to active losses through real estate professional tax status including 500 hours material participation test and how to qualify your spouse as real estate professional. I also cover short term rental tax strategy for properties that meet IRS definition like Airbnb, plus self rental tax requirements when renting to your own business. I explain why you should never buy real estate in S Corporation and how becoming a passive partner in deals helps accelerate real estate tax deductions when you start buying properties.

Bonus depreciation 2025 is back making cost segregation depreciation and real estate depreciation more powerful for real estate investing tax benefits. No more falling for the "just buy real estate" lie when there's so much more to making rental property tax strategies and investment property tax deductions actually work for your situation.

I've put together this FREE resource for you:

7 Write-Offs Every S-Corporation Business Owner MUST Know
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*Disclaimer This material & presentation content is for informational and educational purposes only. This material and presentation content is designed to provide general information regarding the subject matter covered. It is not intended to serve as legal, tax, or other financial advice related to individual situations. Because each individual’s legal, tax, and financial situation is different, specific advice should be tailored to the particular circumstances. For this ...

Speaker 1:

Business owners. They become very profitable and they're doing really well in the business and you start making seven figures. What's the next thing that you learn about then you can start doing to reduce down your tax liability? That is to invest in real estate. Now a lot of business owners watch a lot of content online and they're told hey, buy real estate, do cost segregation, you can write it off. That is not true.

Speaker 1:

Now a lot of people think that if I'm a real estate professional, I need a real estate license. Nope, you do not need real estate license. This is where a lot of people actually trip. Okay, and they're being lied to. They're saying, hey, do cost segregation, your spouse can basically be a real estate professional, but you also have to meet material participation. If you are investing in real estate, do it right and do it with a tax strategy. Investing is nice. Doing cost segregation is nice. Generating paper loss super nice. What's not nice is that when you're told to do all of this without a tax strategy, Welcome to the Tax Reduction Podcast for Money-Making Entrepreneurs with Boris Mushaev.

Speaker 2:

Boris has helped entrepreneurs across the United States collectively save millions of dollars in taxes with the power of tax planning and advisory. The only way you, the business owner, can save money on taxes is by using proactive tax strategies, and this podcast is all about saving you money on taxes. Boris will share with you in-depth and easy-to-understand tax reduction strategies that you can implement in your business within 30 days or less. Let's jump into today's episode.

Speaker 1:

Hey, boris Mushaev here. So look, if you want to invest in real estate to save money on taxes, just investing real estate and doing cost segregation deduction is not going to save you money on taxes. Okay, despite what your accountant, or whoever it is that you listen to says, you actually need a tax strategy when you invest in real estate. I'm going to break down for you what type of a tax strategy you need, how to actually qualify for these tax strategies, using IRS laws themselves and be able to maximize your deductions when you invest in real estate. So don't listen to all the lies out there. So let's play nice and let's get into a tax strategy. So I wanna bring this example. So a lot of times, business owners they become very profitable and they're doing really well in the business and you start making seven figures. What's the next thing that you learn about? Then you can start doing to reduce down your tax liability. That is to invest in real estate. So you go out and buy a property worth a million dollars okay, purchase price, but after you deduct the land, because the land cannot be depreciated after you deduct the land, you're left with $800,000. That is the depreciation. So what happens is that if you do cost segregation study. For those of you that don't know what cost segregation is, it is accelerated depreciation that allows you to write off about 25% of the purchase price net of land, so that will produce $200,000 in additional deduction. This $200,000 that you're going to do cost segregation to accelerate your depreciation and take as a deduction may not be deductible right away for you in the first year if you do not have a tax strategy. And a lot of business owners are told or they watch a lot of content online and they're told hey, buy real estate, do cost segregation, you can write it off. That is not true. The reason it is not true? Because you have to understand there's mainly two types of incomes. That is on your tax return, right? So business income usually. So I'm doing this for business owners, right? Typically business owners are the ones that are generating a lot of profit and they want to reduce down their tax liability by investing in real estate generally.

Speaker 1:

There's two types of income incomes that can be reported on your tax return. There is an ordinary income, which is also your business income. So let's assume this is a million dollars. Okay, you make a million dollars in your business. Then there is a passive income. And let's assume you have $125,000. I don't know why I picked $125,000, okay, but that's passive income. Okay, two types of income. The thing is, there's really no difference between them when it comes to taxation. Both of them get taxed at the same income tax rate. Right, we're assuming this is not capital gains.

Speaker 1:

Okay, this is passive income. That could be from your real estate, commercial real estate. This could be in the businesses that you have invested and you became a passive partner, which, by the way, if you have a business that you are going to be opening or investing, where you have an opportunity to become a passive partner, you should absolutely speak to your tax advisor how to do that, because that will help you accelerate deductions when you start buying real estate. But that's a topic for another day. If you are a profitable business owner, you do not have a tax advisor. Get yourself a tax advisor, otherwise you will continue overpaying in taxes.

Speaker 1:

Okay, but let's come back to this example. So we've got ordinary income and passive income. Okay, this $125,000, it's passive income and ordinary. They're all both taxed at the same rate. So if you are at 35% tax bracket, guess what? You're going to pay 35% on both, regardless what type of income it is. Now here's the kicker Real estate losses, right?

Speaker 1:

In our case, let's say, cost segregation gave you $200,000 in losses. Real estate losses are considered passive. Okay, because generally real estate income is considered a passive income. So all the activities from real estate. If you're not a real estate professional, they're considered passive, so are the losses. So in this case, let's imagine that you actually have a, or let's assume, imagine what a creative way of being an accountant.

Speaker 1:

Okay, let's assume you have $125,000 in passive loss right here. This $125,000 now cannot be deducted against a million dollars ordinary income. So let's just say that. You know let's use our number of 200,000 from the example before Right, so you made, you did a cost segregation study, you accelerated depreciation. The $200,000 cannot be deducted against ordinary income.

Speaker 1:

Well, what happens to this $200,000? It just gets carried over. Okay, it gets carried over. So I'm going to put FY, not FU FY. Okay, it's getting carried over to future years. Okay, now you still end up paying taxes on a million dollars. So if you do the cost segregation and you paid a lot of money to get it done and now to find out you cannot deduct it, so let's talk about a strategy when is passive losses or when are passive losses actually not passive losses? How can we turn it into not passive losses or actually take it as a deduction? There's three scenarios. We're going to talk about the real estate professional. We're going to talk about short-term rentals and we're going to talk about self-rentals. We're going to cover it all after this break.

Speaker 2:

If you have a tax preparer and you do not have a tax advisor, the only way you can save money on taxes is by using proactive tax planning strategies that only a tax advisor can give you. Bora's put together a free PDF for you, the business owner Seven tax write-offs every S-corporation business owner must know. In this PDF you can find seven tax strategies that you can start using in your business to instantly start saving money on taxes. Click on the link in the description below for a free download.

Speaker 1:

All right, let's talk about a real estate professional. Okay, by the way, this cost segregation thing I don't think I mentioned it earlier Because we passed, or the government passed, one big beautiful bill. Bonus depreciation is back, which is why real estate deduction becomes a lot more important or a lot more bigger, I should say and investing becomes a lot more important, okay, so. Okay, investing in real estate, doing cost segregation, is a great tax strategy, but, like I said before, you need a strategy behind it to be able to actually materialize your deductions and your losses. One of the ways you can do that is becoming a real estate professional, either you or your spouse Now, this is you, or I'm going to put spouse. Now, here's the thing you, as a business owner, are generating a million dollars. Okay, so you need to actively participate as a real estate professional, but you're not because you're in business. Okay, real estate professional, you just have to meet the IRS definition. That means more than 50% of your time has to be spent doing real estate, investing in real estate, taking care of your tenants, anything that is real estate invested. Okay, I'm not going to get into details of all the to-dos that you have to do, but more than 50% of your time. Additionally, it has to be at least 750 hours. So in our tax advisory firm, when a lot of clients come to us, mainly we have one spouse that runs the business, another spouse does not. So what? We say, hey, can this spouse be involved in your real estate? Like, yeah, absolutely, my spouse actually does work in real estate. She takes care of the tenants and so forth. Great, we can qualify that spouse as a real estate professional because that spouse doesn't have any other job. So for sure, more than 50% of that spouse's time is being met for this rule. Okay, then that spouse has to do at least 750 hours a week. I mean, excuse me, a year. If I'm not mistaken, it comes out to about 14 hours a week. 14 to 15 hours, okay, and you are now qualified as a real estate professional. That could become huge for you, because now, if you invest in this real estate, this $200,000 can be tax deductible. Why? Because your spouse is a real estate professional.

Speaker 1:

Now a lot of people think that if I'm a real estate professional, I need a real estate license. Nope, you do not need real estate license, you just need to meet the IRS definition of being a real estate professional. Now you also need what's called 500-hour material participation. So what does that mean? Let's say you own three properties right here, right? So let's say your spouse or you together, your spouse is a real estate professional, but now you have to meet material participation. This is where a lot of people actually trip, okay, and they're being lied to. They're saying, hey, do cost segregation. Your spouse can basically be a real estate professional, but you also have to meet material participation. It's not enough that you are a real estate professional. Okay, you also need what is material participation?

Speaker 1:

I keep talking about it. Let's just get to it, right? That means if you combine your hours spent on this property not you doing real estate overall, but on one property at least 500 hours. So obviously, if you've got a residential home, one residential home, and you're spending 500 hours a year on it, it's probably not a very good profitable venture and IRS is not stupid, right? So if you've got one property like yeah, my spouse doesn't work, they do 750 hours looking for properties, driving around and we only have one property and they materially participate there, that's probably not going to fly with the IRS. But if you already have two or three properties, you can combine the hours spent on each property. So let's say property one 300 hours, 100 hours and 200 hours. Together that's 600 hours. You can group them. Okay, you can group them. Irs allows you to group your activity.

Speaker 1:

Here's the kicker, here's the best part about it. Right? Again, a strategy. What if you, the business owner, did 200 hours here and the spouse did the other two, 400 hours? Does that still qualify as material participation? And the answer is yes, okay. So that is the cool part about this. But you cannot combine both spouses hours for real estate professional, but you can combine it for material participation. So if you are investing in real estate, do it right and do it with a tax strategy. Okay, because investing is nice, doing cost segregation is nice. Generating paper loss super nice. What's not nice is that when you're told to do all of this without a tax strategy. So real estate professional is a tax strategy number one.

Speaker 1:

Let's move on to a tax strategy number two. If, for whatever reason, your spouse says you know what, I'm not going driving around looking at properties, I'm not doing any of the real estate stuff, you go ahead and work in the business. Buy me all the nice things I don't want nothing to do with it. I don't care. If you want to invest in real estate, you go ahead and do it, and I want nothing to do with it. Then you're like Boris, what do I do now? I'm stuck with this $200,000 loss that is being carried to the future years, but I want to deduct it. What do I do? Let's talk about another strategy that you can use to write off your paper losses, and that is a short-term rental strategy.

Speaker 1:

So if you meet the IRS definition of a short-term rental strategy, that means your average stay per tenant is seven days or less. What does that mean? So let's say you've got tenant number one two days, tenant number two 10 days. The average is six days. That already meets this test, okay. And you have to actively participate in your short term rental a hundred hours. So that's very easy to meet. That's there you go, and that's there you go, and that's how you meet that 100-hour test. Okay, that is active participation. Then we've got you have to work there more than another person. So let's say you've got a property manager that manages your entire property. Then you'll probably fail this test, okay. So we don't want to meet, we don't want to fail this test. We want to meet this test at least the first year. Follow me on this. So let's say you have no property manager and you are doing everything, so you are at short-term rental by the IRS definition. So put out the property on Airbnb, vrbo, whatever you want.

Speaker 1:

Now any losses generated from short-term rental doing cost segregation are ordinary losses, because IRS does not consider short-term rental as passive. Why? Because they're classifying it quote-unquote. This is like you're treating it as a hotel. Right, you have an active business. It's an active trade or business. So the income generated from this is ordinary because you're actively participating. It's seven days or less. You're operating as if you are a hotel and you're actively participating more than any other person that is also helping you with a property. So IRS says you know what? This is no longer passive, this is ordinary. Now short-term rental this becomes ordinary and now the $200,000 can be deducted against your million dollar business profit. Okay, that's a short-term rental.

Speaker 1:

Now you might be thinking, boris, well, I don't want to deal with tenants, airbnb and all of those tenants. Cool, that's fine, but there is a still strategy. What if your first year you treat this property as a short-term rental? You meet all the rules. You put it out on Airbnb. You do not rent it for more than seven days. You actually actively participate in it. Make money, rent it out to tenants on Airbnb. Do all of that stuff your first year, do cost segregation, generate the $200,000, get your deduction the second year. You know what? I don't want to be actively participating in this anymore. I want to focus more on my business. Great, you can turn this back into a passive activity, which is the regular rental. But remember, in the first year you participated, you met all the rules, you worked. It was treated as a hotel. The losses that are generated are ordinary losses and can be deducted. Because now you've done this beautiful thing that's called cost segregation 100% depreciation from one big, beautiful bill. All right, that is that strategy.

Speaker 1:

Now let's talk about another strategy. I love this, right, this is amazing. Now, this is for those businesses that actually own their own commercial building in which their business is situated. Right, so there's two ways you can have a property for your business. So let's say, you have an S corporation, okay, so you've got an S corporation, okay, that owns your business, right, so I'm just gonna well, it does own the business. I'm just gonna write business activity, right. So you've got business activity and the S corporation buys real estate.

Speaker 1:

So I normally never recommend and if you're working with a proper tax advisor and an accountant, they should tell you that you're working with a proper tax advisor and an accountant they should tell you that you should not be buying any real estate in an S corporation. There's some. Sometimes you may need to do this for a completely different reason, but honestly, you do not want to have a real estate in an S corporation. So what a lot of my clients do and what I recommend to them instead is that when we have an S corporation and you want to buy a building for your business, just put it into an LLC. I'm going to put it a triangle. This is an LLC. Okay. Now this between S corp and LLC, right? S corporation will pay rent to your building. Now there is a relationship. Okay. Now what happens is that they become under IRS rules and under IRS eyes, this becomes one activity. Okay, I kid you not. This is all in the IRS tax code, right? Irs is if you are renting your own building to your business, you become one activity.

Speaker 1:

Any losses generated from doing cost segregation can be deducted against your S-corporation, but you have to meet what's called an economic test. Now, what is an economic test? This is really important, by the way, business owners that are watching. That means either you or your spouse have to own the business 100% and you or your spouse have to own your rental property 100%. Did I say 1% here? I don't remember what I said. 100% and 100%. Now if it's you and your partner owns this and you and your partner owns this, you still meet the test. Now you also have to be your own tenant 100%. If you're not your own tenant 100% let's say there is 50% you and 50% another tenant and you do meet economic tests then only 50% of losses generated in the LLC let's say doing cost segregation can be deducted against you as corporation profit.

Speaker 1:

In most cases, my clients that we work with they're like all right now, I understand the scenario. Maybe I'd rather invest in a building. I have an opportunity to invest where I am the only tenant, so I can do this, and actually we have few clients right now using this strategy and we are doing exactly this for them. So this is another strategy. So when you combine this, there is no passive losses generated from this building. Why? Because we're combining it and, by the way, if your accountant does not know this and if you have the situation, you should let them know. Hey, do this for me and attach a statement to the tax return letting the IRS know that we're combining, grouping, in other words, both activities. So these are the three real estate tax strategies that you can use.

Speaker 1:

Obviously, if you're doing the cost segregation, investing a lot more in a lot more buildings, you don't want to deal with the short-term rental, you don't have the self-rental, the real estate professional, qualifying your spouse is the biggest play for you, especially doing the material participation. Again, if you've got one property, okay, if you have only one property, you did the cost segregation and you're like, hey, I've got this residential property, two-bedroom home and I want to do the cost segregation. My spouse is going to be a real estate professional. He's probably not going to pass the IRS smell test, all right. So be careful who you work with, be careful how you do this. I love the fact that you would want to invest in real estate. That is a solid strategy, right, I mean that is a solid play, I should say. But you need a tax strategy behind this and hopefully this was helpful. Thank you so much and until the next time.

Speaker 2:

That's it for today's episode. Be sure to check out the description below for some free tax reduction resources that Boris put together for you. If you're ready to work with a tax advisor on your tax planning, be sure to schedule your call by heading over to wwwtaxplanningcallcom. That's wwwtaxplanningcallcom. And be sure to subscribe to our podcast to be notified when the next strategy is.