November 5, 2020

JF2256: 5 Benefits of Passively Investing in Apartments | Actively Passive Investing Show With Theo Hicks & Travis Watts

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Today Theo and Travis will be sharing the 5 benefits of passive investing in apartments starting with how you can save on taxes. 

We also have a Syndication School series about the “How To’s” of apartment syndications and be sure to download your FREE document by visiting Thank you for listening and I will talk to you tomorrow.

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Theo Hicks: Hello, Best Ever listeners, and welcome back to another edition of the Actively Passive Investing Show. I’m back with Travis Watts, who’s doing a little dance, if you’re watching this on YouTube. Travis, how are you doing today?

Travis Watts: Doing great, man. I’m dancing, you can tell.

Theo Hicks: I think he’s dancing because he’s super-excited to talk about taxes today; that’s why he’s dancing. As you can tell by the title of this episode, we’re going to talk about some of the takeaways that Travis got from the book Tax-Free Wealth, as well as I’m sure other things he’s learned as it relates to taxes and real estate investing, which as most people know, is one of the main reasons why people prefer to invest in real estate – because of the tax benefits. Hopefully that’s not taking away one of your points… But before we jump into your takeaways, as always, do you wanna tell us — this is gonna be loosely based on a blog post you wrote… So do you wanna tell us why you wrote this blog post, the story behind how you came across this book, things like that?

Travis Watts: Sure, happy to just give a real quick recap here. So the reason I’m so excited about this – one, yes, I am kind of passionate about takes, and I’ll get into why that is, and what impact I can have on everybody’s life… It’s just one of those under-served niches out there. Everyone talks about real estate investing, and how to make money, and all this… But what about taxes? That’s rarely a conversation piece. To that point, a couple disclaimers. One, obviously Theo and I are not CPAs, we’re not licensed tax professionals. What we’re doing in this blog is we’re recapping the book called Tax-Free Wealth, which was written by Tom Wheelwright. Tom is a licensed CPA. He is the Rich Dad advisor to Robert Kiyosaki, author of Rich Dad, Poor Dad. He owns a couple different companies, probably more companies than I even know about… But two big ones are called Wealth Ability and Provision, so basically CPA firms and consulting on taxes.

So I’m not affiliated, this is not a sales pitch for any of these folks or programs, or anything; it’s not to sell books. I’ll tell you why I wrote it – every week I talk to investors; every week on a podcast or through investors I’m asked “What books are you reading? What books have you read?” What good business books would you recommend? What books have changed your life?” etc. Great questions, by the way… And this is one of them.

I know, Theo, we talked last time or a couple episodes ago about the cashflow quadrant, which is a Robert Kiyosaki book… And that really wasn’t about the book per se, it was about the concept of what the cashflow quadrant is. This one’s similar, but more practical takeaways, more exclusively honing in. This is like level two of that conversation. If we really wanna dive into the taxes, this is where we’re gonna do that. So that’s why I wrote it.

I’ve got five takeaways that I wanna share with everybody, that I think will be useful, and that’s kind of how I’ve laid this conversation out. Do you have any thoughts before we get started?

Theo Hicks: Nope. Let’s jump into those takeaways.

Travis Watts: Alright… So first takeaway – and by the way, these are just my takeaways, that I got from the book, personally. I bought this book hardback a few times, and most recently audio format… It’s one that you wanna keep going back to, and maybe supplemental to working with your own CPA, just for some thoughts and abstract ideas.

So takeaway number one is focus on    passive income. Of course that’s gonna be one of my takeaways, because I’m an advocate for passive income, and passive investing… But here’s the deal – the reason that the wealthy pay little in tax, sometimes nothing, is because they’re not earning their money in the way that most people earn money. And what I mean by that more specifically is most of the population in the United States and worldwide is working for money; they’re trading their time in exchange for money, which comes in the United States in the form of W-2 income… Which is taxed at the highest tax brackets that there are.

So you can go all the way up to — what was it, 37% or something like that right now in the tax code, if you’re a high income earner who’s pulling a salary or earned income as an employee. As we talked about on the cashflow quadrant, the employee is taxed quite high.

So you take an example like — let’s say you live out in California, they have a state income tax of 13.3%, then let’s say you’re in the highest bracket federally, 37%, so you’re paying 50% of your income in taxes. So this is not what most of the rich and the wealthy do, because who wants to pay 50% away in taxes? And that’s only just federal and state. There’s local tax, and there’s tax on gasoline, there’s property tax, there’s sales tax… There are so many other taxes out there, so quite frankly, that percentage is a lot higher… But generally speaking, that’s to paint a picture there.

So for a quick reference on the cashflow quadrant, anyone that didn’t hear that episode or has no idea what I’m talking about, go back and check that out real quick. It’s the ESBI (Employee, Small Business, Big Business, Investor). It’s the four ways you can earn income. We want  to be on the B and I side; we wanna be in a tax-favored situation. This is not exclusively offered to the rich and the wealthy. That’s the one big point I wanna make. That gets spun in the media all the time that way – “Look at this new tax plan. Look how much these billionaires saved on taxes.” Well, you don’t have to be a billionaire to take advantage of the tax code, and that’s what I wanna get into – some practical takeaways.

So to your point, Theo, real estate, as we know, has great tax advantages. Again, I’m not a licensed CPA or tax professional. I wouldn’t go as far as to say tax-free income per se, but heavily tax-advantaged nonetheless.

Municipal bonds can be 100% tax-free, at least at the federal or the state level; I’ll get into that a little bit more in a second… And then second, long-term capital gains, meaning if you own real estate, or stocks, or assets more than 12 months and then you sell them at a gain, that’s taxed more favorably. So those living off of stocks, bonds, mutual funds and portfolio income and passive income are gonna have tax-favored situations. Again, this applies to myself, I’m sure it applies to you, Theo, it applies to just any main street investor. You don’t have to be a billionaire to be doing this stuff.

And of course, we have vehicles too, that Tom talks about, like the Roth IRA, which came out in (I think it as) 1997. That – you’re putting money in there, and then it’s kind of a tax-deferral, and then when you pull it out later, it’s tax-free, that kind of stuff.

And then of course, I mention California being a high-tax state. You could move to a tax-free state. You could live in Texas, you could live in Florida, and have no state income tax.

So this book that he wrote is all of the different ways  for mainly business owners, real estate investors, entrepreneurs, to find ways, options, strategies to reduce your taxable income. That’s the whole point.

And most CPAs – and I’m speaking mainly for my own experience, but it’s just true with everybody else I speak to – they just don’t have a lot of emphasis on the proactive side of doing your taxes. Most CPAs are just the type that’s “Send me your tax forms at the end of the year, I’ll compile them and tell you what you owe.” But where’s the proactive approach? What about setting up your small businesses, setting up your home offices? Should you itemize your vehicle deduction, should you do mileage? There’s  a lot of proactive strategy to this, and this $20 book is a fantastic resource for helping you discover what that might be. And what I did – I read this book in 2015 originally, or 2014 – I took pages from the book; I sat down — this is when I used to go to my CPA face-to-face… And I would sit down and I would show them the chapter, and I would say “See… This is a CPA that wrote this, and he says that blah-blah-blah…” And then we would talk through it – how can I do that in my tax situation? That was the proactive side of it.

So everybody’s got a different approach to it.

So that was a long-winded first takeaway… And that’s the longest one, by the way. But those are just some of the high levels of why the so-called rich and wealthy pay less in tax, and some vehicle strategies and types of investing that they do. They’re living off their investments, basically; they’re not trading their time for money… Which is the first chapter in Rich  Dad, Poor Dad – The Rich Don’t Work For Money. That’s the whole foundational concept here. Any thoughts, Theo?

Theo Hicks: Yeah, this reminds me of something… I interviewed one of Joe’s friends, [unintelligible [00:11:32].08] on the podcast…

Travis Watts: Yeah.

Theo Hicks: And she wrote a book, and one of the chapters in the book was “The air at the Twin Towers is okay”, or something. In this book she was saying how – I guess where the Twin Towers had fallen; I promise this is gonna be relevant to what we’re talking about. The experts were saying that the air quality was fine, whereas in reality it wasn’t. She knows a lot of people that got sick, that were in area, from the air. And her whole point was is that just because someone has “expert” next to their name doesn’t necessarily mean that they’re going to have — not necessarily your best interest in mind, but they’re going to be able to help you more than you can help yourself, in a sense.

So what you’re talking about here is how you have the CPA, with the CPA next to their name; it’s supposed to be the tax expert. But not every single CPA is going to tell you that you could take more advantage of the tax code than you actually are. So that’s something that you can’t just necessarily rely on your CPA just to say “Hey, these are all the different ways you can reduce your taxes based off of whatever you’re doing right now.” Instead, you need to be the person that is taking charge of that, and reading books like what Travis is talking about, and then going to the expert CPA and saying “Hey, Mr. CPA, this book told me that I can save taxes by doing XYZ. Is this possible?” And then you have that conversation with them.

So I guess this is the long way of saying that don’t just rely on a real estate expert, whether it be a CPA, or a real estate agent, to essentially do all the work for you. You might be able to find one that does that, and that’s amazing, but make sure that you are thinking about yourself, and then being proactive and going to these experts, and then letting them do what they’re good at, which is actually doing the taxes, but finding those loopholes – or those tax shelters, reducing your taxes, tax  breaks, whatever you wanna call them – yourself, and then bringing those to the CPA.

Travis Watts: You bring up a great point. I totally agree, by the way… And a real quick, short side-note – when  I worked in the oil industry previously years and years ago, I ended up doing an overseas project, and I had to become a citizen overseas… And 100% of my income at that time (W2-wise) was earned overseas. When I would come home, I wasn’t earning anything through that company or elsewhere W2-wise. Well, my CPA was telling me this, that and the other about paying in to federal, and state, and whatnot… So I did those things. And I later discovered that there’s actually specialty firms that specialize in overseas oil and gas workers, where they know the tax code to a T, they know all of the — I hate to call this stuff loopholes, because we’re gonna get into that in a second. It’s not really loopholes, it’s just what the tax code is; it’s what it’s written, and it’s actually a list of incentives…

But regardless, I ended up switching to that firm to get just a  second opinion on my 2-3 years of taxes, and it turns out I had severely overpaid in many different ways and many different areas… So I had to reverse those, I had to amend my taxes, it was  a pain in the butt, it cost me money, but I ended up getting a lot of money back that I shouldn’t have paid in in the first place. And to that point, takeaway number two is very short, and to the point. Tom says – notorious, just like Kiyosaki, for making bold statements – “The current tax code contains over 5,800 pages, 30 of which address how to pay taxes, and the rest are how to reduce your taxes.” So he describes the tax code as basically “This is a book or a  list of incentives to reduce your taxes”, which is quite astonishing and counter-intuitive to how so many people think of taxes… But again, so many people are working for W-2 income, where a lot of these aren’t available, if that’s all you do, is have a W-2 income and you do nothing else. There’s very few deductions you can get from that.

So let’s dive into that, what exactly he’s talking about. I’m gonna put all this under takeaway three. He says: “Entrepreneurs and investors get the breaks.” Okay, so why is that? The government needs things done. We need housing in our country, we need exploration of oil and gas. We need solar energy. We need  a lot of this stuff. Well, the government isn’t in the business of doing it themselves, or else they would just do it themselves and there wouldn’t be a need for it. So how do you get people to focus on those things? How do you get people engaged to actually do that, to go drill for oil, or to create solar energy, or cars like Tesla, and everything that we’re seeing coming out. You give tax breaks, tax incentives.

So business owners and entrepreneurs – they create jobs. Does the government need jobs? Would they like to tax more employees? Absolutely. Real estate investors – they create housing. Like I said, we need housing in this country, absolutely. More specifically, we need affordable housing in this country. Abso-freakin-lutely. So you invest in affordable housing, you can invest in energy, solar, oil and gas… Even things like your own house. Just home ownership is something the government incentivizes and values for Americans. So can you write off your mortgage interests, or property taxes? Yes.

I used to buy homes that were distressed, move into them as an owner-occupant, fix them up, live in it for two years and sell it, and there was a tax-free situation there. A tax-free gain. I don’t know if I picked that up from — no, I was doing that before I read Tax-Free Wealth.

But anyway, that’s one thing I guess my CPA had pointed out… And of course, there’s a threshold of 250k or something that you can qualify to not pay tax on those gains if you’ve lived in it for two years… And all these things. Again, I’m not a tax professional, but these are strategies that I implemented for Tax-Free Wealth, in addition to everything else I was working on.

Donating to charity – we get deductions for that. The government and the IRS are not this evil entity. They’re incentivizing good things, too. Having children, adopting children… There’s a $14,000 tax credit in 2020 if you adopt a child. So it’s just what the government values and needs done, basically… And if you’re gonna focus that way, and say “Sure, I’m  willing to help out, participate and do what needs to be done, you will get tax breaks.” That’s the point of this book. And that’s takeaway number 3. Do you have any thoughts on that, Theo?

Theo Hicks: Yeah, one thing I talk a lot about on Syndication School  – and this will apply to this as well… When you’re bringing on team members, you wanna make sure that for each of those categories the person or company specializes in the specific thing you’re trying to do. So if for example you are a passive real estate investor, then you aren’t gonna want to use your general [unintelligible [00:18:22].15] type of CPA. You’re not gonna want to use a CPA that specializes in IRAs, or something. You wanna find a CPA that works with other passive investors. Ideally, ones that work with other passive apartment investors. The more specific you can be, the less you need to – as I mentioned earlier – read the 5,800 pages of the tax code to figure out which ones apply and which ones don’t apply to you, or reading a bunch of different books… Which I guess is something you can do if you can’t find a very specific CPA.

I guess before I wasn’t saying that you can’t rely on experts at all… You just need to find the right expert that is specializing in what you’re specifically trying to do. So yeah, as you mentioned, if you want to reduce your taxes, it’s not like you can go to your CPA and make up something… Say “Hey, [00:19:09].20]” What’s there is what’s there, and as you mentioned, is available to everyone; you just need to find the right person to tell you what you need to do in order to take advantage of that.

Travis Watts: A hundred percent. I couldn’t agree more. And here’s another thing to piggyback on what you’ve just said… Not only find a CPA that specializes in what you’re doing; that’s great, but the way I look at that too is there could be a lot of theory to that. So if they specialize in something but they don’t do it themselves, it’s a little bit weakened of a case.

So I try to find a CPA that actually does themselves what I do. Why? Naturally, they’re gonna study it because of self-interest. If they’re gonna be a passive investor – or an active investor, it’s a better example – they’re gonna be studying the benefits of cost segregation and bonus depreciation. They’re gonna be making sure that they do everything themselves… And then in the process they’re learning, and then they’re gonna relay that to you. It’s another thing, just like the teacher philosophy; if you’ve never done it yourself, then maybe not as strong of a case. But as you were speaking, I pulled up something here on, which is just the long-term capital gains tax rates for 2020. I just wanna give one more practical example before I move on…

Again, you don’t have to be a billionaire, you don’t have to be necessarily rich, or wealthy, or whatever you wanna call it to do this stuff… Long-term capital gains – let’s say that you own a stock portfolio. You buy index funds, or something like that; or real estate. So if you buy those assets and you hold them more than 12 months and then you sell them at a profit – what it’s saying here is 0% tax rate for up to $40,000 for an individual filer. The married couple is probably double that (80k).

And then it moves to a 15% bracket up to 441k/year. So you can see there – either that’s gonna be tax-free wealth, or that’s gonna be 15% tax, versus 40% or 50% in the other ways of earning income. So we’ve talked about the FIRE movement here before – this is what a lot of FIRE movement individuals are doing (Financial Independence, Retire Early). Primarily, they’re index fund investors; so they’re stocking away money for a number of years into that, they’re holding it more than 12 months, and then when they “retire”, they’re selling up to (let’s call it) $40,000 of their portfolio to live on, and they’re paying 0% in tax. So that’s tax-free wealth. That’s just one strategy of so many… But I just wanted to paint a more realistic picture to that.

Takeaway number four is also very short… I’m trying to put this all in our 20, 30-minute timeframe.   Let’s say that you save $25,000 in taxes because you’ve found a good CPA, you ran a plan, a new strategy, you switched some things up, you took action… So Tom’s big concept here is that the reason you would potentially wanna pay less in tax is so that you can then take that savings and go reinvest it in more investments. So now you have $25,000 saved, you can go put $25,000 into real estate. You can go buy a single-family home, you can go take part potentially in a syndication, you can go buy stocks with that… So you can compound the wealth effect and the growth in tax-favorable ways, and keep that snowball running. So that was just something that clicked with me.

Take-away number five (I’m just kind of running through these) hiring a competent CPA, like we discussed, he thinks of it this way, which I think is 100% accurate – it’s a direct return on investment. If you pay your current CPA $500 to  run your taxes, and it’s just like you mentioned, I don’t wanna even mention brand names, but just a generic place to go, and it just kind of is what it is. Well, if you paid $5,000 for a consultation or a good CPA to run a full tax strategy for you, and you ended up saving $10,000, look at it like an investment. That’s 100% return on investment, that could happen in one year. Where else are you gonna get that kind of ROI on an investment?

You could take 5k and put it in the stock market or real estate and maybe get a 10% return – that’s $500, not $5,000. So it’s like a 10x multiple if you think about it in terms of “This is an investment, not a cost to me.” So bottom line is look at it that way, and if you’ve never put any emphasis or time into a tax strategy, or considered this, consider that before you consider investing that money, is basically the bottom line there. And it may just be a one-time deal. You pay 5k or 10k, you understand how it works, you have a strategy… You don’t have to pay that every year. Maybe you move on then and you continue that tax savings and it compounds.

I’m kind of wrapping up here – Robert Kiyosaki’s got a great quote; he says “Taxes are most people’s single largest expense.” And I was thinking about that when I used to work in the oil industry when I was a highly-paid W-2, and looking at some of those pay stubs, I did pay more in taxes on a pay stub than I paid for my housing; probably my housing and my food, and my transportation. It was ridiculous. So for me, at that time when that’s how I earned my income solely – well, not solely, but mostly, 80% – that was my biggest expense. And it is most people’s biggest expense. And if you’re gonna go work in the corporate world and climb the corporate ladder and make more and more and more W-2 income, this will absolutely become an issue for you long-term. So the sooner you can jump on this, the better. That’s my conclusion to this. Any thoughts?

Theo Hicks: Yeah, so on point number four – it reminded me of when I first got into real estate… I was trying to convince one of my friends — because he is the one that introduced it to me, and then he had stopped, and I wanted him to get back into it so we could do it together, motivate each other… And I created this Excel spreadsheet where I had 401K on one side, and then investing in real estate rentals on the other side… And I remember I did it, I nerded out, so I added in that compound effect that you were talking about, realizing that with a 401K it’s just like money going in and that’s it, whereas with real estate you’ve got money going in, but you also have money going out, that then goes back in. It’s like house money, in a sense, like if you’re a gambler and you’re reinvesting that house money. You go to the casino, you win $100, and then you leave, and you come back with that $100 and it’s all house money; and you invest it and maybe make $400. You’re never going back to your first investment.

So I calculated that I could invest 30k upfront for real estate – it might have been one time, or it might have been every five years; I can’t exactly remember. But after 20 or 30 years, the difference between the 401K and the real estate – it was insane how different it was because of the fact that you’ve got that money coming in. I didn’t even take into account the tax part either. If you’re adding that in there, it’s even better.

So that was point number four. Once it compounds and you add that up over a long period of time, after a year it doesn’t look that big, but after 20 years it’s like “Whoa.”

And then your fifth point – it’s an interesting perspective when you think about it as an investment, not a cost, and kind of apply that to other things as well. Whenever you’re buying something, is it gonna be something that you’re not gonna get any money or anything out of it, or are you putting money into it to get more money out? Or it could be experiences too, obviously, but… The way you applied it to the tax accountant – it’s interesting. I get a tax accountant, 5k, and I might get 20k back, as opposed to me investing $500 with some other no-name brand and getting no money back, or $500, or something.

So yeah, this was a very solid episode. Is there anything else you wanna mention before we wrap up?

Travis Watts: Just bottom line, it’s worth paying a little bit of attention to dedicate a couple weeks of your life, a month of your life, read a book like this… If not this book, then seek out a CPA that specializes in what you do; get a second opinion on your last three years’ tax returns that are still amendable if need be, and just figure it out. That alone is not that invasive of a process, and if you did nothing else but that, sometimes a second CPA opinion will see things the other didn’t, for whatever reason.

The tax code, as many of you listening know, is not just black and white. There’s a lot of grey area, there’s  a lot of opinions, there’s a lot of what’s considered necessary or essential for this, that or the other… So there’s just different ways to go about it, basically… And  that’s fully intentional, by the way. The IRS doesn’t wanna be so black and white. They wanna give some leeway for different situations that you couldn’t really comprehend or think of upfront.

So the sooner you do this – I don’t care what age you are, anybody listening – the more ROI you’re going to have. If you’re 20 and you figure this stuff out, you’re gonna have a whole working career of tax savings, and that number is gonna end up being huge in the long run. If you’re 80 years old today, it’s still probably worth looking into, but probably not a lot you can do about it… But the ROI won’t be obviously nearly as high. So just get started as soon as you can, that’s my advice. The advice I can give is self-educate on taxes.

Theo Hicks: Alright, Travis, well thanks again for joining us and giving us your wisdom on the taxes and how we can reduce our taxes by investing in real estate. Best Ever listeners, as always, thank you for listening. Have a best ever day, and we’ll see you next week.

Travis Watts: Thanks, Theo. Thanks, everybody.

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