New Tax Implications from the 2020 Election w/ Toby Mathis [Part 1 of 2]

Hey, simple passive cashflow listeners. Today. We have Toby Mathis here, a partner at Anderson advisors, the guys who got me to pay no taxes. Thanks again, Toby for that. although I was the one putting in a whole bunch of money into deals, par in economy through the pandemic. So I can say I earned it.

We didn’t do anything. We just point you to where they incentivize you to invest in real estate. Exactly. So today we are coming to you post election and things are pretty early still, but we’re going to be looking into the crystal ball here and make some speculations on where some of the tax laws are going.

And maybe what strategies you guys can be looking towards to maybe even we’ve got to pull the trigger before the end of the year, right? Possibly. the presidential election is looking like it’s going to be Biden. but tell us what really matters here. Is it the president or is it the Senate or the house? Yeah, Congress writes the laws, but the Senate, but the president can always, veto. So you have to be able to get over you basically, you have to have a certain alignment. Otherwise it’s going to keep you from being able to pass certain laws.

The house right now is going to stay Democrat. The Senate is a little bit up, we’re going to be at a deadlock. I think you’re putting it up right now. There’s two more runoffs. I believe in Georgia that might impact things, but it’s either going to be a standstill. if you end up with 50 50, then the vice-president decide.

So if the Biden inheritance are in the white house, then, Harris could pass a deciding vote and you could have changes if there’s not that scenario, it’s really difficult to pass anything without you’re gonna have to get the Senate on board, which means it’s gonna be hard to. Move really dramatically in any one direction.

What we know is what Biden has said he’d like to accomplish. So PRI prior to 2020, this a little bit of a history lesson for folks. so bill gets passed or tax law gets changed. it is. Birthed here in the house, primarily Democrats. So this is where, like the stimulus bill comes out, what is it like 10 million?

And then it goes to the Senate, they chop it down. prior to this, the Republicans had the edge, but it looks like it’s going to be more of a gridlock more than yeah. They both put out their own bills and then they decide that kind of goes through a committee and they decide which pieces they’re going to.

Are going to get an app. That’s where they all negotiated. So that’s why you never really know what’s going to be done until they actually pass it. Holy moly. What did you guys do? What’s the old famous one, you’ll know what’s in it when, after we pass it. So it’s kinda, or sometimes like they’ll write a bill, a Republican bill, and then all the Democrats will veto it, but then they write the same exact bill.

And then they’ll pass it. But it’d be originated from the Democrat side. Yeah. Always they call it the pork, this is what I want in order to allow you to get what you want, man. It’s usually not so good for the taxpayer. Yeah. so let’s just kinda, from what we know of the Biden, what Byron was saying prior to the election and campaigning, where are things heading in terms of taxes?

What do people need to be aware of? So the first thing to know is that the tax cut and jobs act, which they called the Trump tax cuts. A lot of it phases out in 2025 and there’s portions of it that start to phase out even now. there’s a little bits and pieces of things that are set to slowly go away like accelerated depreciation.

After next year will start to drip down. You have other things like your solar credits that are already going down, you have things like. the estate tax exclusion, that’s sitting over $11 million right now. And that’ll revert back to the pre tax cut and jobs act, level, which should somewhere in the five, five to $6 million range, depending on inflation.

So there’s things that no matter what, they’re still going to move, then you have the, Hey, these are the things I want to change. comments from the Biden team and the big one was anybody making over $400,000. They want you to be in the highest tax bracket and they want to move that highest tax bracket to 39.6.

Then they also say, Hey, if you make over a million dollars in capital gains or dividends or the combination of those two, then we want you to pay 39.6 on your capital gains, which would be almost a doubling of the capital gains rates. They also say, Hey, we don’t like this 21% tax rate on C corporations.

We want to make it a flat 28%. And if you remember prior to the tax cut and jobs act, it was graduated. it would be as low as 15. And then it would go up to 39 and back down to 35. It was this bizarre, and they’d just put flat 21%. So for a really small C Corp, it was a little bit worse, but for big companies, it was better.

That was the sort of pre page tries the big guys, right to come back. that was the push for it. There was that what they want to be is more competitive on the international, attracting companies, but their headquarters in the United States, as opposed to incentivizing them to go elsewhere.

We were not competitive as a taxi. They also had the, Hey, we’re going to cut the repatriation of your profits down significantly. I think it was 15%. I don’t know the number off the top of my head, but I know that. They reduced it, so that companies like Apple or Amazon, or some of these companies that have a lot of earnings off shore would bring them back in the United States and perhaps do local investment.

So let’s go back through these and I’m going to ask it from my own selfish perspective, which I hope that listeners are in that same situation too. But like the 2018. Jobs tax and jobs ag, I don’t know what that’s called, but it allowed for a bonus depreciation and whole bunch of passive losses that you could extract from deals that do cost segregations.

Right? That’s the one, whatever that one is. actually you don’t have to worry about the, real estate professional that was actually changed back in. I think it was 90. it’s four 69 seats. Seven, if I’m not mistaken, but that’s carved into the code already. That’s you don’t have to worry about that.

The bonus depreciation was, Hey, if you have five, seven, 15 year property, anything less than 20 years, you could choose to accelerate the depreciation. assume that you have, let’s say you have a carpeting and you put a hundred thousand dollars of carpeting into an apartment building. Normally you’d get to write off $20,000 a year as a deduction because the whole carpet will last five years.

So you’d take $20,000 each year. What accelerated depreciation allows you to do is just boom, taking them one year in order to know what portion of your property is carpet versus cabinets versus fencing versus driveway, all these different, Lifetime, of those particular assets you have to do.

What’s called a cost segregation. There’s always been cost segregation. You’ve always been able to do that, but now all of a sudden we have this huge incentive because about 30% of most buildings are five, seven, 15 year property. So all of a sudden you can accelerate your depreciation at any particular time.

You can just, you can choose five years after owning a building. Boom, I’m going to take it. And you have this acceleration, where you can really accelerate what you’re able to do. Sometimes it’s 50. Sometimes it’s a hundred percent. It depends on when you put the building into service, but you can do the acceleration and all you’re doing.

there’s nothing crazy about it. You’re just writing it off early. You’re still going to write it off over time, but it’s almost like getting a loan from uncle Sam for no interest saying, Hey, I know I’m going to get the tax benefit. Over the next 20 years. How about you? Just give it to me now, early Christmas present.

So if you guys miss it, the rule of thumb is about a third of the building gets written off in the first year, but to simplify it even more, a lot of these deals, you’re trying to max out the leverage 70, 80% loan to value. So what I’ve seen is, passive investors that put in a hundred grand, they’re getting anywhere from 60 cents to almost a dollar.

Back in that first year bonus appreciation, 60 grand or 80 grand back. depending on the deal and yeah, and it offsets not to interrupt you, but it offsets passive income. Unless you qualify as a real estate professional, there is one other one active real estate, but most people make too much. that’s the one that I’m really worried about, right? Like these, the passive loss gravy chain. Getting these super just mean that ain’t going away, that ain’t going away, what you might see as the accelerated depreciation. I think in 2023. So in three years, two years really, will start to go down to 80% and I’ll drop to 60% and then, go down from there.

I’m not certain, but I may, I haven’t looked at it so long lane. It’s probably. If it goes away completely, I’d be shocked. But sometimes it goes down to 50%, which is still pretty good. not w we do a lot of cost segregations where clients, where we will direct them to have them done. Not always do we accelerate the depreciation, especially not on the five-year property.

Sometimes you just let it spread because unlike you like, w you’re a real estate professional, you had massive amounts of deduction. But it doesn’t help you to get really dizzy zero because the lower tax rates are pretty low. Like I’m okay. Paying 12%. I’m okay. Paying 22%. What? I’m not. Okay.

Is paying 39.6% on rents. I’m not okay. Paying 37%. I’m not okay. Paying 32%. Like it’s getting too high plus by state. So sometimes it’s just about making sure that you’re hitting that number. So I tend to look at 200,000, And say, if I can keep people around $200,000 a year, that tax, it’s not going to be so extreme, you get up into the half, a million, 600,000 range, every dollar.

So much of it is being taken away from you. for every dollar you make, let’s say we had the Biden one. For every dollar you made after a million bucks, if somebody was taking 60% of it and that’s really what it gets up to, if somebody is taking that much away from you, you’re probably don’t have much incentive to make money and it’s hurting.

Cause it’s not always cash that you’re receiving. Sometimes it’s profit, that’s blowing down via K one or your investment. You don’t have the cash. Now you have to liquidate assets to pay the tax bill. And that’s what we want to make sure that you’re never in that situation. Yeah. so sometimes I think just to summarize what Toby saying, you have to be strategic on how you use those passive losses.

You don’t want to burry burn your AGI down to zero. Sometimes it’s good to pay a little bit taxes. you can’t help it because you’re the sponsor and you have, you’re leveraging up. So you’re going to get these massive. Deductions, not everybody gets that. A lot of folks that are just, they’re not going to pay any tax on rents the next 10 years, because they got a huge deduction and they may be making, $50,000 a year with rental that they’re putting in their pocket, but they don’t have to pay any tax on it.

Yeah. so like I talked to my tax guy and he burned up all my passive losses and I asked, he told me, he said, I should pay some taxes. But the conversation that we had that I got on board on was like, he was like, you’re probably better off paying no taxes and investing the money and just kick it forward.

But it depends on your situation, right? if you have a W2 job, you’re going to be okay. and if you need loans on a home or something, you need to have some income. If you don’t need that, like you’re leveraging on the asset, you don’t need the income. So you may as well not pay it, use that money to continue to invest.

Yeah. so the tax cut jobs act tax that’s phasing out the pass of losses, the accelerated bonus depreciation in the year 20, 22 and beyond. So yeah, look at that, I think 20, 22 years safe, I think it’s after 2020, I think you’re right. It, we’ve probably got a couple more years of where the getting’s good.

And that’s plenty of time for me, but what is, what are you thinking it’s coming up in the future is like the Biden clan going to be putting, getting rid of that, or I’m thinking that hopefully they can just focus on that 10 31 exchange and leave me alone and they want to get rid of the 10 31 exchange.

They want to get rid of step up in basis and that’s going to affect all of us. that’s huge. That’s huge for anybody who has substantial amount of real estate, that could be really painful. It’s going to force you to have to get rid of your real estate during your lifetime, because it’s not going to step up, which means if you’ve depreciated it accelerated the depreciation, then, you’re going to have some substantial recapture when somebody, if somebody sells it after you’ve passed.

so I’m not too pleased about that. that one, that all, isn’t the game plan. They’re like, all right, the Democrats have it. Now, if you’re a 40 years old, surely in the next 30 years, some more tax friendly leadership will get in there and swing the state taxes the other way. And that’s what you do.

Yeah. that’s the ideas right now. The law is what it is and I tell people don’t make dramatic switches until the law actually looks inevitably going to be changed. Cause even when you think, somebody gets in as president and they said, this is what I’m going to do. good luck.

Getting that through. Especially if you don’t have the, the, the house and Senate. Good luck. if you have the house and Senate fantastic. They might be able to get some things through, but even then, it’s not used to be, you can filibuster in towns, but the, It’s still not a, it’s not a guaranteed and people oftentimes campaign on things and then do something else as well.

So I tend not to make dramatic switches until I actually see laws being drafted or changed and they have support. and even if we, Biden’s Binance has won now, he’s even in the first hundred days, it’s going to take what another year, 18 months for that law to go into effect for the previous tax year, too.

So there’s. Probably about a couple of years of, turnover time I’m thinking. Yeah, good. If they could get something through in the first year. And again, the way that, the way it works is they can’t go back and change something, but they can say going forward. So if you pass away or if you remember this, but I think it was, the owner of the gang.

He was passed away during a year where there was no estate tax at all. We didn’t even have the $11 million cap Steinbrenner. This is not that long ago. Yeah. So he avoided billions of dollars. Like he, he, the joke we all had was people are going to snuff out their parents, like on December 31st, if they’re on their death, there’ll be like, let me help you along here because the, the taxes can be so extreme the following day.

it’s we’re going to have a new year’s Eve party with a bunch of pillows. It’s horrible. But that we were there was actually concerned about that and Oh boy, if somebody is on life support, they’re going to have a real incentive to pull the plug. It’s morbid, but it actually was discussed in the tax world.

There were many discussions on it. what would you do? And, So it’s not always, we think like these things have been debated for years. I remember when I first became an attorney, the estate tax exclusion was 600,000 wasn’t, was not very high in a lot of people got hit by it. And then it went up to a million and then it would defy a million.

Now it’s over 11 million and then they said, portability, most spouses can use it. It used to be way to have a, we had to use a trust to double it up. But that’s still on the table and Biden is shown all indications that he wants that to go back to the way it was before the tax cut and jobs act.

But he also wants to eliminate that step up in basis. And the step up in basis in English just means if I have a building that I’ve depreciated or a piece of real estate or stock say I’ve owned stock for 20 years. And it’s gone up in value. The day I pass my, the value steps up, or the basis steps up to the fair market value on the date that I pass.

So if I have a building that I’ve depreciated in my basis might be a little bit of land, maybe it’s a hundred thousand it’s million dollar building. Right now, if I pass the base, that steps up to a million dollars, I live in a community property state. So even my spouse could sell it the day after I die and pay zero tax, no recapture.

If that goes away, then assuming that, somebody had to sell an asset after somebody passes or wants to cause they don’t want to manage it and they sell it. no they’re going to pay recapture in capital gains. On that. So they’re going to pay up to 25% on the recapture and up to a underbite and it could be 39.6% on the capital gains.

So it’s a pretty big hit. Now the other side to that is if it’s real estate, not only does the patient have stepped up, but you can read deep, read deep, appreciate it. You know you, so you can go back and write it off again, and you lose that. So that’s flying under the radar. And that’s the one that I focus on saying that’s the one that’s going to have the biggest impact on our clients is people who aren’t investors are going to get punished.

And under that plan, and I don’t like it because before the strategy was just die and pass it off. And then your kids get the step up basis and you go wash the asset strategy was accumulate real estate and stock in capital assets. 10 31 exchange you’re real estate into more real estate leverage. Use those, use the proceeds, if you need to, for other things, and then pass away and you don’t have to worry about any tax that you could either.

depreciate it. So they’re not going to pay any tax on it in the wrench for a long time. so you’re going to have to appreciate it again after they’ve passed at that higher amount. And all of a sudden they’re getting huge tax benefits. or they sell it and they pay no tax. And so there was always that kind of, the silver lining, especially in community property States where the first spouse, everything steps up.

dad passes and mom can sell the stock and not have to worry about getting hit with capital gains. Now mom could be getting hit with as much as 39.6% federal plus the net investment income tax, which is 3.8. Plus their state taxes, which can be as high as 13%. So you could be in a scenario where you’re paying, 50, some odd percent it get, it gets a little ridiculous.

So is the solution either to wait until a different party is in there and changes the login or some kind of dynasty trust or a trust irrevocable trust that owns the assets. So it never. Ever does a step up. Yeah, it’s, that’s a tough one because yeah, because no matter what if I put it into trust, the basis is the basis I’m done.

So when they there’s really not much of a strategy on the step-up you can do, what’s called a deferred sales trust on substantial assets, or you’re spread it out over time and you allow a installment sale essentially. and then step up the basis and you sell it and avoid the tax immediately, but you spread it out over, let’s say 20 or 30 years.

So there’s still some strategies that you can do to lessen it. realistically, under those circumstances, it’s just, you’re sitting down going option a, B, C at the time. I’ve seen people make changes where they were scared to death. So I’ll give you a good example. I had a client, it was siblings.

So there was five siblings and the dad had a office building and this particular office building was in Ohio, but it has substantial value. So they were worried about the estate tax. So he started giving away interest and that building wasn’t eliminated partnership. So this is back in the day when limited partnerships ruled the world and not LLCs.

And he would give his kids these interest. So he transferred the entire building to his children before he passed. he’d own that building for going on 40 years, the basis was tiny. And then when he passed, it was in the year that they had unlimited, the unlimited, the state tax exclusion. So there wouldn’t have been an estate tax at all.

And he would’ve still been underneath the threshold. it was multimillion dollar building, but he’d given it all onto his kids. So his kids said, Hey, we’re going to sell it now. their basis was his basis, which was almost zero. So they got hit with this huge tax bill that would have been avoided, completely had he just done nothing.

And so I tend to look at attorneys that are, pushing people to do huge gifts. make big changes and I’d say, don’t do that. You don’t know what the future is going to be. You could make, you could really hurt yourself. And those kids that hurt them. They were like, there was a little bit of a dispute over whether they wanted to keep it and operate it, but it was like they didn’t have the depreciation.

So they actually had income coming in off this thing. And they were like, Oh my gosh, they had to do some fix up on it. There was some capital call issues. And so they decided they wanted to sell it. And instead of getting a dollar, they were getting, 60 cents. And, because it’s not cheap to sell a building, you’re paying the commission, you’re paying the real estate tax, the closing costs and all these things that eats away.

Plus you’re paying long-term capital gains on that thing. and you have a lot of recapture on the original building and in the improvements that they had done thereafter. it ended up really hurting and it was shocking to look at it. And, and I’m talking to the accountant who advised him the whole time.

And I could tell, he was like, Oh, that was what the dad wanted to do. And they overreacted to. Yes. Long changes, similar. you never know, right? Like a lot of this is the art form. You never know what’s going to happen. You got to play you to stand there and play goalie and you don’t know which way they’re going to kick it.

in this situation, it’s makes sense to procrastinate. And it reminds me of one of my biggest pet peeves is like my clients. They always want to file their taxes in April. what are you doing? Just wait until October. That’s when it’s really due. Sit back and wait, as long as you can.

I had a guy yell at me. He wanted one of us to file the S-corp in March and he goes, I’ve never been late. And I said, you’re not late. You’re entitled to an automatic extension. That’ll take us out to September. And he goes, I’ve never used that. I’ve never been late. And I kept saying, look, your tax payment is due on April 15th.

You had probably some quarterly taxes due, like as long as you pay in that. We’re not worried about penalties or interest, right? Their tax return itself has an initial due date of March 15th that you can automatically extend. You don’t have to ask for permission. You just say, I’m going to use my extension.

he forced us to do it. And then it goes close to September and he had made more than he realized. And he had a 401k and he had taken a really substantial salary. And I said, The sad part is we could make a pretty sizable contribution to your 401k for last year, but we can’t do that. Now. He goes, why can’t we do that now?

Because you’ve forced me, this idiot came in and told us to do this, from that point forward, we didn’t have to have that conversation anymore. Yeah. Fishy the eighth students that then thank you on it. Do that. There’s a few that sometimes you beat your head against the wall. The other one was, they’ll change K ones.

So you know, your syndicator, sometimes things change during the summer. You start finding out are their expenses and you’re going through your books and you’re sitting there and you’re like, you have a couple of choices. Like I can either fix the K one and give everybody a new K one. The problem is if they filed their taxes off the first K one that came out now they’re going to have to amend.

And so I always tell people like, wait till the last minute, so that your investments have a chance to make any changes. th the fun one was, the year that the, option reporting or the basis reporting, in brokerage houses came out and then they all use the same software and it was all incorrect.

So they sent out all these tax forms to their clients who ran out and filed their taxes. And then they corrected them about a month later after the tax deadline. And it’s you can either get audited or you can fix it. And now you’re gonna have to amend your return and you’re gonna pay to basically do your return again.

I always, I, we always try and get it out and March before the April the deadline, but I always feel like at least half the little. Probably less than half, still file it in April anyway, but there’s no reason. There’s no reason to file just, even if your return is done, just don’t file it.

Just file the extension, pay the taxes and you don’t have to worry about anything. And it gives them the opportunity to go back and revisit issues because you do have until the tax deadline. To make contribution, company contributions to retirement plans. So you never want to take that off the table.

You also have, you could be doing a cost segregation election all the way up until October 15th. So you don’t want to, that one, we could actually go back and amend, but why, like, why would you put yourself in a situation where you’re paying twice for something when you could just wait and do it once?

So going back to the whole, simple basis might be going away. And this is a bigger strategy that I’ve always said, it’s like, why would you want to own your own properties? That issue, especially if you’re not a professional operator, be a passive investor, split your net stake up into 50, a hundred thousand dollars increments and just bankroll a big Bon of passive losses and gains, never have to worry about any of these types of things one way or the other.

Yeah. th there’s something that you can do no matter what they do, because you still have exempt entities and exempt entities are like your 401k, your IRA, your Roth, IRA, Roth, 401k, but also five Oh one C3. And, Len you’ve known me enough that this comes up quite often with anybody who has substantial wealth.

That five Oh one C3 is your best friend because it gets it out of your estate when you get a tax deduction. Now. So worst case scenario, let’s just say that by, in the Senate and the house conspired to take away 10 30, one exchanges and the step-up in basis, they, increased capital gains rates.

They, they create a 39.6% top tax bracket that your dividends and capital gains can be taxed at. If you make over a million bucks, itemized deductions already gone, but w they were talking about bringing it in, but having a it’s basically, it’s only for people making less than 400,000, they have a kind of a funky calculation.

If you make over 400,000 where it goes away, I can still give things away. I can still take a charitable deduction for it, even if it’s a capital asset. And I can write a lot of that stuff off at my fair market value. Once it’s in a five Oh one C3, I’m not worried about step up or estate tax or anything again, because it’s not mine and my heirs still have access to it.

So those types of strategies will become even more important. which just means. There’s only so much stuff I need to own personally and have access to personally. Sometimes it’s better to get it into a vehicle where we never have to have these conversations ever again, the vehicle doesn’t pay tax.

And I love those because the only conversation I have with people then is how much do you want your kids to be able to take out of the business? And we know it has to be a reasonable amount, so nobody’s going to be buying Lamborghini’s off of your estate. nobody’s going to be able to go in there and just rape and pillage your estate.

The best scenario is they’re operating something that’s in your, that you created, and they’re able to take a salary for the rest of their lives. And then that can go to the next generation. So what Sylvia is talking about is creating a nonprofit. Creating that estate and being able to, what if the guy wants maybe not elaborate beanie, but he wants to take a $200,000 salary for his kids buy a Camry in the process, does that now you have to pay taxes on that.

Yeah. They pay taxes. It comes out. and I’m not talking about private foundations either here guys. there’s a lot of things that qualify as real estate, excuse me, as a charitable activity in real estate. Veterans housing, low income housing, HUD housing, moderate income, housing, housing for, you fill in the blank.

If it’s a disadvantaged group, single moms, we’ve seen it all residential assisted living. you can own a substantial amount of real estate, or if you’re actually operating a charity, doing something else it’s allowed to own passive real estate. So like the California teachers’ union owns a ton of like lots of buildings.

That’s their problem. Like they have a lot of investments and things, but what is it? Therefore, it is a retirement plan for teachers. It’s an exempt organization. So there’s lots of those. And there’s a misnomer that somehow that money is never for your benefit. Now you can take a salary, you just can’t take the profit out.

there’s a, it’s called private a newer minute. Can’t go to the benefit of any private individual, the profits. So I can’t just take it. What I can do is continue to operate it for what I set it up for. And it can, it’s going to grow and it’s going to grow extensively. And then you pay people, a reasonable salary is very subjective, depending on how much you want to do.

Yeah. Then they pay taxes. They take that out. But if they don’t need the money, which is what I see, I’ll tell you, because we’ve done over 4,000 of these it’s a one-way road. People tend to put money into the charities. They take very little out. and most of the kids that I’ve seen as we transition, because I’ve been doing this, over two decades, you start seeing a situation where the kids actually get behind it, and then they’re using it to lower their tax brackets as well.

I haven’t seen it where people are taking ridiculous amounts of money or trying to get access to money because they’re investing through that vehicle. And I like it because all of these conversations become moot. As I say, how much tax am I going to be paying none. You want to give it a house?

You’re going to write off the value of the house against your gesture, gross income. What? I’ve owned this house for 20 years and I only paid a hundred thousand for it. Now it’s worth half a million. Yeah. You get to write off the half a million. There’s an adjusted gross income limit of 30%. So maybe you’re gonna write it off over three or four years, but you’re still going to get a pretty sizable deduction.

People have a hard time getting their head around that. And then that asset is in there and it never pays tax. You don’t have to worry about who dies or any of that stuff. I just find it for again, for the affluent people that have a lot of money, that is something that they definitely should be looking at.

when you’re in real estate, like the type of real estate you do lane, the tax benefits are so ridiculously good right now. You don’t need to. But after you’ve, after you used a lot of the tax benefits for you, if they take them away, then you still have an alternative without doing anything crazy.