Avery Carl [00:00:00]:
Foreign. Welcome to the Short Term show. The show about short term rentals and long term wealth with real property owners hosting real properties who are crushing it in the vacation and short term rental space. And here’s your host, Avery Carle.

Intro Speaker [00:00:24]:
Good morning short term shoppers. Welcome back to the show. Today we have a very special guest that I am very excited excited about the authority on all things tax related when it comes to real estate investing, Mr. Brandon Hall. I am so excited to share this episode with you. There is so much knowledge being dropped in this episode you do not want to miss a minute. He will answer every question you have ever thought of when it comes to real estate investing. Taxes specifically related to but not limited to short term rentals.

Avery Carl [00:00:59]:
Let’s get started. Today we have a very special guest that I think a lot of you are going to be really interested in what he has to say. We have Brandon hall of Hall CPAs. He is the real estate CPA and we’re going to talk to him about how, how short term rentals affect your taxes and his advice on how to do them. So. Hey Brandon, how’s it going?

Brandon Hall [00:01:22]:
Good. Great. Thanks for having me on Avery. I appreciate it.

Avery Carl [00:01:25]:
Yeah, absolutely. So can we start off with you just tell us a little bit about yourself and what you do about your company.

Brandon Hall [00:01:32]:
Yeah. So I run the real estate CPA. I’m the managing partner. We have about 20 staff, full time staff. We’re fully remote so we don’t do anything paper. It’s all online on the cloud, which is cool because we can service clients anywhere in the United States and world. We have about 600 clients across the United States. Every single one of them is involved in real estate in some capacity.

Brandon Hall [00:01:54]:
Either they’re investing, they’re running a fund, the syndication, they’re flipping, developing, building, real estate agent, some sort of capacity as real estate investor. So we, we, we see a lot of real estate stuff, we see a lot of good stuff, a lot of bad stuff, a lot of good advice, a lot of bad advice. And yeah, I, what else do you want to know? Is that a good intro?

Avery Carl [00:02:13]:
That is a great intro. So are you having that many clients that are all involved in some sort of real estate? Are you seeing more people adding short term rentals to their portfolios?

Brandon Hall [00:02:25]:
People with investors with full time jobs who are looking for tax benefits? Yes, we’re seeing them add short term rentals to their portfolio in the tax benefits that can come with that. Basically reduce your cost of capital, reduce your cost of acquisition, reduces your risk of owning a Short term rental. So, yeah, we are seeing a lot of people move into short term rentals, especially with COVID It’s ironic. There’s a lot of areas where short term rentals are thriving even though there’s people are relatively scared to go outside and not wear masks. But we are seeing our clients with short term rentals in good travel locations, destination locations, like absolutely crushing it. So there’s also that pull too.

Avery Carl [00:03:14]:
I have to say, I personally have benefited from that with my rentals.

Brandon Hall [00:03:19]:
I think it’s just a lot of people are like sitting at home bored. They’re not traveling nearly as much as they used to. So they’ve got money to spend. And if you’re within driving distance and it’s a cool location, you know, they’re booking, they’re booking these short term rentals. We have clients that have short term rentals booked out for like the next year and a half. It’s insane.

Avery Carl [00:03:38]:
Yeah, absolutely. I think, you know, a lot of people are like, well, I have to work from home, my kids have to go to school from home, so why don’t we go to a vacation rental at the beach or in the mountains or somewhere cool and we can just do all this from there.

Brandon Hall [00:03:50]:
Yeah, absolutely.

Avery Carl [00:03:53]:
Awesome. So the first question that I’m going to ask you is, in your opinion, is a short term rental schedule E or schedule C or is it active or passive? What’s your take on that? That’s the number one question people ask.

Brandon Hall [00:04:07]:
All right. Yeah. This is the classic question. And this is probably going to be a really long explanation. So if you’re listening to this, buckle up, here we go.

Avery Carl [00:04:16]:
We love that. Give us all the detail.

Brandon Hall [00:04:18]:
Yeah, yeah, yeah. And I’m going to include citations too, because I know that there’s a lot of, there’s a lot of CPAs and tax advisors that think it’s one way or the other, but they’re, they’re, they’re not really like looking at the actual citation. So I want to arm your listeners with the actual facts. So the way that it works, there’s two buckets of income. All income. Every single dollar that you earn can, can go into one of these two buckets. You either have passive income or you have non passive income. Passive income is from any trader business that I don’t materially participate in.

Brandon Hall [00:04:52]:
Not just rental real estate, but any trader business that I don’t materially participate in. So I could buy a stake in like a laundromat and I could earn passive income, but not materially participate so it’s just passive income. And then I could use other passive sources that create losses, like rental losses to offset that passive income. But if I materially participate in a business, then it moves from the passive bucket and it moves into the non passive bucket. The other income that I have that’s in the non passive bucket is like my W2 income, my business income, interest, dividends, sale of Bitcoin, Apple stock, that’s all in the non passive bucket. So in the passive bucket is any trade or business that I don’t materially participate in. And the non passive bucket is pretty much all of my regular income. Also in the passive bucket are rentals.

Brandon Hall [00:05:42]:
All rental real estate is considered passive by default unless I qualify as a real estate professional. So also in that passive bucket is rental real estate. So if I’m a real estate investor and I’m buying rental real estate, I hear about all these awesome tax benefits. And a lot of the tax benefits come from depreciation. So I can buy a fourplex and I can rent it out. I can earn cash flow. Let’s say I earn 10 grand of cash flow, but then I have $12,000 of depreciation. I get to tell the IRS that I actually lost $2,000.

Brandon Hall [00:06:13]:
So it’s a tax loss. Depreciation is a Vantom expense. It’s just something that tracks the deterioration of my asset over time. In that example, I don’t pay $10,000 for the depreciation. In fact, $10,000 of cash flow actually hit my pocket. So that 12,000. I think I just said 10,000 depreciation. But the 12,000 depreciation is just a shelter.

Brandon Hall [00:06:34]:
I get to, I get to write my net income down by the depreciation and then report the net result to the irs. So rental real estate generally produces a tax loss. So you get to shelter your cash flow. So you don’t pay tax on your cash flow. And then you also get this. Tell the IRS that you lost money. But the question becomes, can I use that passive loss? And the answer is no. Unless you qualify as a real estate professional or you meet one of the other passive activity losses exceptions.

Brandon Hall [00:07:01]:
Real estate professional status is the big one. And you have to work 750 hours in a real property trader business or businesses like being a real estate broker, flipper, landlord, combined, you have to hit 750 hours and you have to spend more time in real estate than anywhere else. So if I have a full time job, I can’t qualify as a real estate professional. So if I have A full time job and I’m buying rental real estate. And that rental real estate is producing great cash flow for me. But I’m also writing off a lot of depreciation. So I’m showing the IRS, or I’m telling the IRS that I have a tax loss. That tax loss is passive.

Brandon Hall [00:07:35]:
I can’t qualify as a real estate professional. So that passive loss becomes suspended and carried forward unless I have other passive income sources to offset it, which is not typically the case with our landlord clients. So I’m just stuck. I get this passive loss every single year. It becomes a suspended passive loss and I just pool this large suspended passive loss over time. And I start scratching my head wondering, well, do I get the tax benefits? And you do get the tax benefits because you’re not paying tax on the cash flow today, but you’re also not able to use that passive loss. That’s how it works. Passive versus non passive.

Brandon Hall [00:08:12]:
All rentals are by default passive unless you qualify as a real estate professional. Now full circle to short term rentals. I told you this is going to be a long explanation.

Avery Carl [00:08:20]:
I love it.

Brandon Hall [00:08:21]:
Full circle to short term rentals under Treasury Reg. Section 1469, 1 CAP T E32AMy goodness.

Avery Carl [00:08:33]:
That is the memorization.

Brandon Hall [00:08:35]:
Yeah, yeah, yeah. If you need that, you can come like, you can email me, I can send you the citation. Basically, there’s a Treasury regulation that says if you rent a rental property on average to customers seven days or less. So Avery, if you go to a property and you stay eight days and then I go to the same property and I stay six days on average, it’s seven days or less. Total rental days divided by the total number of tenants. If on average you’re renting seven days or less for a property, it’s not considered a rental activity under the passive activity loss rules. So again, the passive activity loss rules say any trade or business that you don’t materially participate in is passive. Any rental activity is passive unless you qualify as a real estate professional.

Brandon Hall [00:09:21]:
But if I don’t have a rental activity, I don’t have to worry about qualifying as a real estate professional. I just have to worry about materially participating in the activity. So now I can be a full time employee, I can have a full time W2 job, I can be running a business full time and I can buy short term rentals. And as long as I materially participate in those short term rentals, I will have a non passive activity, which is great because then I can juice depreciation with a Cost segregation study. It’s going to create a large tax loss and that tax loss will be a non passive tax loss, which means that I can use it to offset my W2 income, my business income, my gain on stock sale, bitcoin income, all of that regular income. So if I don’t materially participate in a short term rental, it’s still passive and if it creates a passive loss, that passive loss will be suspended. I can’t use passive losses to offset my W2 business income and other income. But if I do materially participate in a short term rental, and if I rent it seven days or less on average, then it’s considered not a rental activity for section 469, the passive activity loss rules.

Brandon Hall [00:10:29]:
And it just means that if I materially participate, it’s a non passive loss.

Avery Carl [00:10:34]:
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Brandon Hall [00:11:53]:
So the question you asked though was is it Schedule C or is it Schedule E? Our position is that short term rentals are by and large Schedule E activities. Just because it’s not a rental activity under that treasury regulation that I gave you does not automatically mean that it’s a service business and should be reported on Schedule C. And that’s where we feel a lot of tax advisors mess up is they say, well since that treasury regulation exists and it says it’s very clearly not a rental activity, then this must be a Schedule C activity. The problem is is that there’s absolutely no case law, there’s no support, there’s no substantiation for that Determination. There’s nothing that supports me putting my short term rental on schedule C simply because it avoids the rental activity qualification under that treasury regulation. So we report our clients short term rentals on schedule E. It can be non passive on schedule E while all of your other long term rentals are still passive. It’s a determination that you can make on a rental by rental basis on schedule E.

Brandon Hall [00:13:09]:
If you provide substantial services to your guests, that’s when it becomes a service business. That’s when you report it on schedule C. Or if you are a real estate dealer, that’s when you’re going to report it on schedule C. It becomes inventory at that point. And substantial services are services that are for the convenience of my guests. So I change the linens on a daily basis, I provide them with breakfast, I give them tours of the town, I have a bunch of surfboards and boogie boards and pool access for them. Those could all be looked at as substantial services. So you do have to be careful.

Brandon Hall [00:13:45]:
You have to think through what am I providing for the convenience of my guest and does it rise to the level of substantial services to be reported on schedule C? But most short term rentals, at least in our experience, are going to be reported on schedule E.

Avery Carl [00:14:00]:
That was a lot of information. But that’s a lot of really, really good information. I feel like people are going to be rewinding and rewinding to, to really listen to all of that. That’s really, really great information. So I want to zoom in on the real estate professional thing really quick. So who is someone who would want to try to get that real estate professional status? Because I know I get a lot of clients who come to me and you know, maybe they’re physicians and they really want to get that real estate professional status. And I know that’s really difficult to do if you have a full time job that’s outside of real estate. So somebody like me, who I’m in real estate full time, maybe that makes a little more sense.

Avery Carl [00:14:38]:
But can you just talk a little bit about who can get that, why it would be beneficial for someone to get that if they’re not actually a real estate agent or full time real estate investor.

Brandon Hall [00:14:47]:
Yeah, so. So the entire idea behind it is that if I qualify as a real estate professional, all of my rental activities will be considered non passive. So my rentals that produce losses, I can now use the losses against my W2 income and my business income without limitation. If I don’t qualify as a real estate professional, let’s say I go buy that 4 Plex it cash flows $10,000. I have 12,000 of depreciation. I report to the IRS that I have a $2,000 tax loss. If I’m not a real estate professional, that $2,000 tax loss, and assuming I don’t qualify for any sort of other exception in the rules, that $2,000 tax loss is passive. So it just becomes suspended.

Brandon Hall [00:15:29]:
It hangs out on my tax returns. I can’t use it today. I can use it at some point in the future, but I can’t use it today. So from a time value of money perspective, that’s not ideal, right? Time value of money says $1 today is worth more than a dollar tomorrow due to inflation. So if I can claim the loss today, I want to claim the loss today. So I want to qualify as a real estate professional if I can. But to your point, we too see a lot of people wanting to qualify as a real estate professional who have no chance and they are willing to take extreme risks to get it done. We wrote a 12,000 word guide on real estate professional status full of citations because we realized that people were being taught the wrong way and they were being sold that it was easier to achieve than it is in reality.

Brandon Hall [00:16:18]:
It’s actually a very difficult thing to prove and to substantiate. It’s also a highly litigated piece of the tax code. We’ve helped in quite a few real estate professional status audits and most people lose because they’re recording time. That’s not actually participation time in my activity. So like Avery, like you, you’re doing this full time, you’re a real estate professional, so you’re fine. Other people though, if you, if you are a physician and you’re working a full time job, you’re not going to be able to qualify as a real estate professional. You might be able to get your spouse to qualify, but you know, we also run into like one spouse is super into real estate and they’re the one with a full time job and the other spouse isn’t really into real estate. And so the one spouse is really the one spouse with a full time job is the one that’s really wheeling and dealing.

Brandon Hall [00:17:04]:
The other spouse is just chilling, staying at home, you know, taking care of the kids, which is definitely not chilling by the way. That’s like a full time job in and of itself. But the point is that under audit, they’ll figure out who the actual participant is. So you really shouldn’t try to game the system. But if you can qualify as A real estate professional, I can go buy a 4 Plex, maybe I spend 500k on it. I can run a cost segregation study on it. A cost segregation study basically takes that $500,000 of acquisition costs and it reallocates it between personal property, land improvements and the building itself. So I get faster depreciation schedules, but also I get 100% bonus depreciation on about 30% of the acquisition price.

Brandon Hall [00:17:45]:
So if I buy a $500,000 fourplex and then I cost segregate it, I can very easily write off $150,000 or so in the first year thanks to bonus depreciation. And that would create a really large tax loss. If I’m a real estate professional, I can use that tax loss against my income.

Avery Carl [00:18:04]:
Awesome. And let’s talk a little bit about that cost segregation. So what are the benefits of maybe a new investor? I know that cost segregations typically, and you’re, you’re the tax professional here, so correct me if I’m making an incorrect statement. Typically the higher dollar properties make more sense to do a cost seg on than like a hundred thousand dollar long term. Like for example, we just did one on a pretty large short term rental that we have here in Florida. And can you just kind of talk a little bit about which types of properties it makes more sense to do that on and what the tax benefits are are for someone who’s like a total newbie?

Brandon Hall [00:18:42]:
Yeah. So first, a cost segregation study. Well, let’s talk about how rentals are depreciated. So when you buy rental real estate, you depreciate it over 27 and a half years. There are certain carve outs for short term rentals that you might actually be depreciating over 39 years instead of 27 and a half years. But rental real estate is depreciated over 27 and a half years or 39 years. So if I buy that $500,000 fourplex, I have to strip the land value out. So I might allocate $50,000 to land and I’m left with $450,000 of value that I depreciate over 27 and a half years.

Brandon Hall [00:19:19]:
So I take 450 divided by 27 and a half and that’s my annual depreciation amount that I get to claim every single year. What a cost segregation study does is it says we’re going to look at that $500,000 fourplex and we’re going to allocate the value a little bit more accurately because $450,000 depreciated over 27 and a half years is fine. But in reality there are components within that building that are going to wear out faster than 27 and a half years. You’ve got carpet, appliances, windows, the roof, the H vac system. You’ve got land improvements like concrete and parking lots. All of those things might not last 27 and a half years. So, so what we’re going to do with a cost study is we’re going to go and identify all those components, we’re going to assign value to it, and then we’re going to be left with a five year depreciation bucket. So we might have $50,000 of value in our five year bucket.

Brandon Hall [00:20:16]:
And that’s all personal property. We’ll have some value in a seven year depreciation bucket and then we’ll have value in a 15 year depreciation bucket as well as our 27 and a half year bucket. So we’re, Once you do a cost segregation study, you’re going to have value allocated to 5 year, 7 year and 15 year components as well as the 27 and a half year building. You’ll have less in that 27 and a half year bucket though. So I’m not going to have 450k left in my 27 and a half year bucket if I’ve allocated some of that out to my five, seven and 15 year buckets. But basically what that means is I can depreciate. Let’s say that it was the $50,000, right? $50,000 over five years is a lot faster than $50,000 over 27 and a half years. I’ve increased my depreciation allowance every single year until I fully depreciate that specific bucket.

Brandon Hall [00:21:09]:
So it basically accelerates my tax loss, my ability to take my tax loss, and therefore accelerates my ability to recoup tax savings. Cause I get a refund with these tax losses. With bonus depreciation though, I can 100% expense any component with a useful life of less than 20 years. So when I do a cost segregation study, I can typically allocate 20 to 30% of the purchase price to components with a 5, 7 and 15 year life. So if I can allocate 20 to 30% of the Purchase Price to 5, 7, 15 year lives, that’s all less than 20, 20 years. So I can 100% bonus depreciate it. So I purchased a 500k duplex. I allocate 150,000 to 5 year, 7 and 15 year property and I can immediately expense the $150,000.

Brandon Hall [00:22:01]:
And that’s beneficial because now I’ve got a really large tax loss. I get to report that to the IRS and I get to recoup tax savings. So I get a big refund. And it’s really just all time value of money. So that’s what Cost Segregation Study is doing. It’s an arbitrage strategy. It allows me to recoup tax benefits today. But the caveat is it is a, we are manipulating depreciation and I do have to recapture depreciation when I sell the property at some later point.

Brandon Hall [00:22:34]:
So I will pay a tax on all the depreciation that I have taken or could have taken over the hold period whenever I sell that property. So it is a, it is a give me the savings today, let me reinvest those savings, earn money, and then I’m going to pay those savings back at some later point.

Avery Carl [00:22:52]:
So even if you don’t take all of the depreciation upfront when you go to sell it, you would still have to pay the tax on what you could have taken.

Brandon Hall [00:23:02]:
The could have taken comes in when I don’t take any depreciation at all. So sometimes we run into investors who say, hey, I heard about this depreciation recapture thing. So I’m just not going to take depreciation because I don’t need it because it’s just going to add to my suspended passive losses. And that, that’s where the could have taken comes into play. So, so you don’t, you don’t have to worry about could have taken. When you have bonus depreciation and all of that, the could have taken comes into play. If I’ve held a property for seven years and I’ve never taken a dollar of depreciation, the IRS is still going to assess a tax on you as if you had taken depreciation over that seven year time period.

Avery Carl [00:23:40]:
Gotcha, Gotcha. So let’s back up just a little bit or to the beginning for like a new investor who maybe has two or three properties and they’re trying to scale their portfolio, maybe they’re still, they haven’t utilized all of their conventional loans yet and you’re finding all these really great ways to show a loss on their income. But they say, hey Brandon, I don’t want to show all these losses. I need to be able to use this tax income to qualify for more properties. What’s the scenario then?

Brandon Hall [00:24:14]:
Well, the scenario is one of two options. So the first option is to work with A mortgage broker that understands that they can add depreciation back for the purposes of calculating dti. The second option is if you can’t find mortgage brokers that know to do that, then you might not want to be accelerating your depreciation. But typically, you know, our clients run into this every once in a while where a broker, a mortgage broker will look at the situation. I mean, these guys are just checking boxes, right? A lot of them are checking boxes and they’re just trying to push a loan through. So they see a big loss and they go, oh, sorry, can’t do it or need more explanation or this doesn’t make sense. Sometimes we’ll get pulled in like the CPA will get pulled into the conversation to explain how depreciation works and then they’ll realize, oh, we just add this back for the calculation of dti. So it’s really, in most cases it’s a non issue.

Brandon Hall [00:25:10]:
It does become an issue when you are expensing repairs. So. So if you’ve figured out a way to like expense a lot of your repair work that you’re doing, that can cause a problem with dti because that’s not something that you get to add back for the purposes of dti.

Avery Carl [00:25:29]:
Okay, awesome. So basically you’re just reiterating how important it is to find a good lender. You don’t want to just use any old lender where it’s just, you know, maybe some random loan officer that got assigned your online lead. You need to get a good recommendation from perhaps another investor for a loan officer who knows what to do with appreciation depreciation.

Brandon Hall [00:25:50]:
Yeah, yeah, absolutely. And the other thing to think about too is like if you are working with a lender who, who isn’t adding, who’s giving you a lot of grief about it. Just know that there are plenty of other lenders out there that understand how this works and work with a ton of investors and they will certainly take you on as a client. So don’t think that it’s into the, it’s the end of the world. If a mortgage broker tells you no.

Avery Carl [00:26:15]:
That’S really good advice. Not just, you know, in terms of taxes and depreciation, but with getting a loan in general. Just keep, keep going until you get a yes, basically, absolutely. Okay, I’m going to completely switch gears on you here and switch to the other question that everybody always ask. That I say you have to talk to a CPA about this. Holding the property in your personal name or in an llc. What’s the difference tax wise?

Brandon Hall [00:26:43]:
Great question. So there is no difference. You can, you can hold it in your personal name, you can put it into an llc, no tax difference whatsoever. The LLC will pass the income through to you. If it’s a single member llc, then it’s considered disregarded for tax purposes. So we would literally pretend like it doesn’t even exist. We would report the short term rental on your Schedule E just like we would if you had it in your personal name. If you have a partnership LLC now you have a separate tax return that you have to file.

Brandon Hall [00:27:14]:
So you’re going to incur additional costs to get that done every single year and that still is going to pass the income through to you. It’s just an extra step in the filing process. So no tax changes. One thing that I’ve recently become aware of is that there are professional service providers saying that, hey, if you go create a management company, so you create a property LLC that owns all the properties, then you go and you create a management llc. As long as you route all of your expenses through that management llc, you’re going to be good to go. You can deduct all of those costs. You can offset your W2 income. You don’t have to worry about the passive activity rules.

Brandon Hall [00:27:55]:
And that doesn’t work because all of those expenses are associated with the actual rental activity. They’re all still associated with that passive activity or non passive if you materially participate. But I just want to point out that simply opening up a shell company to route my expenses through is not going to provide me any additional tax benefits. Benefits. It might actually expose me to audit and very bad audit results because they might deem that you’re not even in the business to make a profit. They might just disallow all the expenses. So don’t like get trapped into. Don’t fall victim to.

Brandon Hall [00:28:32]:
If I create these cool unique entity structures, I’m going to be able to save a crap ton of money in taxes. If it sounds too good to be true, it usually is. You can use a combination of corporations to do certain things tax wise, but that’s typically a very unique situation. So we tell people, hey, just keep it simple. Do what you need to do from a liability perspective. Talk to an attorney, make sure that you’re covered from a risk perspective. But don’t go into this thinking that you’re going to save boatloads of money in taxes.

Avery Carl [00:29:08]:
Awesome advice. I see a lot of people who want to hold each property in a separate llc. Does that require a different filing for every single llc?

Brandon Hall [00:29:20]:
It Depends. So if every LLC is a partnership llc, then the default answer is yes. If you are partnering with your spouse and you live in a community property state, then you do not have to separately file for every single llc. But if you’re partnering with anybody else, then the answer is yes. You have to file a partnership tax return for every LLC that is a partnership. But if I set up 10 LLCs and they are 100% owned by me, I don’t have to separately file, at least at the federal level for that llc. But every state’s a little bit different. So always check your state.

Brandon Hall [00:29:53]:
You might have to file an annual information return. You might to file with the Secretary of State, franchise excise, that type of tax.

Avery Carl [00:30:03]:
So what does it look like then? If you have an overall holding company with a bunch of LLCs owned by the holding company, how does that look tax wise?

Brandon Hall [00:30:13]:
Yeah, so that’s actually a really efficient structure because every once in a while we run into people who have gone to let me set up 10 partnership LLCs with my spouse to own my 10 different rental properties. And I’m not in a community property state, so I have to actually file 10 separate partnership tax returns. You know, like we’re a minimum 1500 bucks for a partnership tax return, so that’s 15 grand in tax filing fees. It gets really expensive real quick. So the solution is to set up a partnership holding company that 100% owns the LLC that owns the property. So you got the property, then you have the LLC that owns the property, and that LLC that owns the property is 100% owned by your holding company. So you don’t have to worry about that 100% owned LLC because it’s disregarded for tax purposes. So it’s a really scalable model because I can have one holding company that’s a partnership llc, one partnership tax return, and then I can drop down below it a ton of single member LLC to own the actual properties, and I won’t increase my annual filing costs.

Avery Carl [00:31:23]:
Awesome. That sounds like a really great strategy. I think that a lot of people really want to use LLCs from a liability standpoint. Maybe we’ll have an attorney come on and talk about that and give some legal advice, because that’s certainly not what we’re doing here. But I think that you’re right. It can get really, really expensive if you have a hundred different LLCs that you have to file separately.

Brandon Hall [00:31:45]:
Yeah. And you know, in my work as a cpa, we get to see a bunch of different attorneys and their approach, and we get to see a lot of different entity structures. And I will say that the more complex the entity structure, the higher annual cost, either in dollars or in admin time. And you just have to understand what you’re getting into from an ongoing admin burden. We end up with a lot of clients that have really complex structures in place to 150% mitigate the risk, which is great. If that’s what you need to sleep well at night, then by all means go for it. A lot of our clients find out though that they can’t keep up with the paperwork. And it’s very convoluted and cumbersome to keep everything organized and straight so they end up not going this incredibly complex route.

Brandon Hall [00:32:39]:
So just make sure that you understand what your risk tolerance is. Work with attorneys who will consult with you on that before they, you know, throw anything in place and design the actual entity structure for you. It’s really important that you, that you identify that.

Avery Carl [00:32:56]:
That’s great advice. So we’ve gotten really, really technical and really down into the nitty gritty of this stuff. So we’re going to take a step back and ask a more broad general question. So you have a ton of clients, you have a ton of experience. In your experience, what is something that you see a lot of investors get tripped up on when they go to start adding short term rentals to their portfolio? Tax.

Brandon Hall [00:33:20]:
From a tax perspective, it’s material participation. It’s the schedule C versus schedule E. But material participation above all else. Because like I said, if you have a seven day or less on average rental period, you don’t have a rental under section 469. Which means that all I have to do in order to move it from the passive bucket to the non passive bucket is materially participate. So then the question is, well, what does material participation look like? And that’s where people try to get creative. And again, you can’t get creative here. You have to actually be participating in the short term rental activity.

Brandon Hall [00:34:05]:
If I have a property manager on my short term rental activity, I’m not going to be materially participating. There’s no way that’s going to happen. So I’ve got to self manage it. I’ve got to coordinate everything. I’ve got to be doing the repairs and the maintenance work. You know, I’ve got to spend time visiting that rental and doing that repairs and maintenance work. I’ve got to be in charge. Otherwise it’s going to be very difficult to substantiate under audit that I’ve materially participated in the activity.

Brandon Hall [00:34:33]:
And you know, sometimes we see people say, well, I’m going to do research hours or I’m going to, I’m going to listen to this podcast, I’m going to go to a, a Bigger Pockets event and all of that time is going to count towards material participation. And that’s not true. Travel time is not going to count typically towards material participation. Investor level time, unless you’re involved in the day to day activity, is not going to count towards material participation. So you’ve really got to be like actually making the property go. You’ve got to be involved in the day to day operations of the property in order to count the material participation hours. You cannot get fancy with this because the IRS will certainly strike these hours under audit and it’ll end up with you owing a lot of back taxes and penalties.

Avery Carl [00:35:20]:
So you’re saying it’s great to be creative when it comes to real estate investing and the strategies involved with that, but it’s not great to be creative when it comes to taxes?

Brandon Hall [00:35:31]:
Yeah, yeah, 100%. 100%. Look, creativity is saying I’m going to buy short term rentals because of that exception to the rules, I don’t have to worry about real estate professional status. That’s creativity. Creativity is not. Well, I logged two hours of research time or I’m logging time, quote managing my property manager, unquote time. That’s not where you get creative. You want to be able to substantiate a time log or to be able to have a time log with these actual hours.

Brandon Hall [00:36:03]:
Coordinating with the tenants, doing the marketing, doing the advertising, coordinating with your contractors and your cleaning crew, doing the repairs yourself, doing the maintenance yourself. It’s work. It’s actual work that you have to put in to get it done.

Avery Carl [00:36:19]:
So color inside the lines when it comes to your taxes. So 100%. Yeah. Don’t get in the gray area on the taxes. It’s not worth it. So we’re coming to the end of the show. We have two more questions. What Brandon, if for a brand new investor who’s coming to you saying, okay, I haven’t invested yet, but I want to make sure I set this up the right way from the get go.

Avery Carl [00:36:39]:
What advice do you have for a brand new investor coming in?

Brandon Hall [00:36:45]:
Well, don’t let the tax tail wag the dog. That’s probably not going to serve me very well in terms of growing my business. But don’t let the tax tail wag the dog. A lot of people get really caught up in the tax piece and in the legal piece and sometimes for good reason, especially on the legal side, you might be in a high risk. Maybe you’re a physician. Physicians get sued a lot. Maybe you’re in an industry where you are subject to that type of risk through your day job and you want to protect your wealth. So get the legal stuff figured out, but don’t let the tax tail wag the dog.

Brandon Hall [00:37:16]:
I mean, it’s important to understand this stuff, but we can also figure a lot of stuff out after the fact too. It’s not a huge detriment. So I like to see people take action. I like to see people get in there and do a deal and I’m not going to be the person that says just go and do it. Don’t worry about it. Figure it out later. The numbers have to make sense. You are investing your money and you’re going to be investing a lot of time to manage this thing.

Brandon Hall [00:37:42]:
So make sure that your numbers make sense. But I like to see people take action before worrying about all the other tangential items.

Avery Carl [00:37:51]:
That’s great advice. And the last question is what is your favorite book or perhaps a book recommendation or book that has impacted your mindset?

Brandon Hall [00:38:01]:
That’s a great question, I have to say. How to win friends and influence people. I read that book first when I was in college. It changed my entire world and I reread it probably once every year just to refresh on how to win friends and influence people.

Avery Carl [00:38:19]:
Awesome. That’s a great one. A lot of people really love that book. Brandon, thank you so, so much for giving us your time today and coming on the show. If anybody, all of our short term shoppers out there want to get a hold of you, where can they find you?

Brandon Hall [00:38:33]:
Yeah, well, we have a Facebook group, Tax Smart Real estate investor. So come check that out. We’re on YouTube, the real estate CPA. You can check out our channel. And then if you are interested in exploring a relationship, come to www.therealestatecpa.com and you can navigate our website and fill out a form there.

Avery Carl [00:38:54]:
Awesome. Y’ all can find him all over the place apparently. Thank you so much, Brandon for coming on.

Brandon Hall [00:39:00]:
Thanks, Avery. I really appreciate it. It was fun.

Avery Carl [00:39:02]:
Absolute.

Brandon Hall [00:39:16]:
Sam.