How to Invest in Commercial Real Estate

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Episode 114 - Maximizing TAX BENEFITS in Commercial Real Estate!

by Criterion, Braden Cheek, Brian Duck
August 14th 2023

Today hosts Braden Cheek, Brian Duck and Joel Thompson discuss how to effectively approach taxes in commercial real estate.

Time Stamps: 00:00 - Introduction 02:13 - Details of Ongoing Proje... More

Guys, we are back with another episode of how to invest in commercial real estate. What's up? We, uh, vacation last weekend together, went down to Grand Cayman. It was awesome, re rejuvenated. We feel great. We're ready to attack the deals we got going on. Uh, Braden, we are launching a new deal. I believe next Monday. Tell everybody what we're gonna be launching so they can get on and find out about it. Yeah. So actually if you're watching this, it's too late. It already launched out, it launched out earlier this morning. So you can't get on the list. We had to have a preexisting relationship before it launched. So it's too late, but there's another one launching soon. So if you haven't signed up, make sure to go to our website and hit join our investor list. It's super easy name, email address. You can give us a phone number if you want to. You don't have to and then boom, you're on the investor list and you get access to all these opportunities. But right, if you were on the investor list because we talk about it every week shamelessly, then you got this new opportunity and we have done a ton of stuff in a was the first one is finishing up construction. It was a ground lease to Sal and Go and a five multi tenant. Uh There's five tenants in a multi tenant strip center and then we are breaking ground on another one this week.

We're finishing out the staking. They're gonna be scraping dirt uh the rest of this week and that's at the hard corner of 96 and Garnett was, and that's a Taco Casa ground lease and a pickle MS build to suit and directly south of that. We're still going. We, we have so many Lois. So we are using the shop company. Um I think they're based in Oklahoma City to do the leasing for us and we probably have 10 or 15 Lois. We've got the rest of the land going down Garnett in contract. So right now, we're just figuring out which tenants fit back together, space planning and we, and we're moving on down, right. So this opportunity is an $800,000 equity raise. We're expecting a 24.5 irr and a 1.39 equity multiple in 18 months. And we are expecting a ground lease of about $100,000 give or take and ground rent and then a two tenant, multi tenant strip center. Um We'll start construction on that, you know, before the end of the year, probably here in 60 days and we're gonna close on this deal.

Beginning of September, I think September 4th and just to orient orientate people. When is it launching? What day August, what it is launching today, which is August 14th, 14th. Yeah. And it is closing September fourth. So 1 to 3 weeks from the time. But if, if, if you're watching this now and there's still room, it is an $800,000 equity raise. The last race we did was a million four for a pre lease learning experience and it was gone up 48 hours. So if there's room left commit now. All right. So speaking of the Grand Prairie learning experience, when is that closing? Because the investors have been wiring in the money. All the documents are signed. We're ready to go. Yep, that is closing tomorrow, August 15th and again, that is a, a pre leased, um, 10,000 square foot learning experience that we're doing in Grand Prairie Texas. It is an awesome site. It is this raw piece of land surrounded by 1000 apartment units and, and a ton of little town homes and zero lot line communities. Um I, I drove it a few weeks ago last time I was in Dallas.

So super excited about that site. Um This is the first of many learning experiences we're going to do. Um One in, we're gonna need several more. I'm not gonna try to quote them now. But anyway, that is closing tomorrow. We're super excited about that deal as construction is building that one for us. Excited about that. This is our third project with the. So we're starting to use some p contractors as send and Wyatt. So we're starting to build up some relationships there. So if you're an investor and you listen to the podcast and you are located in Tulsa or Owasso or surrounding areas, go up and see what we've got going on at 96th in Garnett. Uh, if you're in Dallas or Fort Worth, we have Burleson, we have Marine Creek. We have Prenton. We have now Grand Prairie. So there's a lot of uh, opportunity if you're local to those areas to go by and take a look at the dirt yourself before you make a decision to invest or if you just wanna see what we've got going on, get more comfortable if you will. All right. So today's topic. Are we ready or not ready? Ok. The big thing that we're gonna really hit on because we have a lot of requests is your biggest expense.

And that is the taxes you pay to both, uh, state, local and federal governments. So we just thought we'd kind of recap uh, some of the tax issues that we run into with commercial real estate. First things first is our investors have been a little frustrated this year because we took a little while to get the K ones out and those listening and I'm like, damn right. It took a little while. Uh We had a little bit of an issue. Some, I would say it was our fault and some was our accountant's workload. And so we have not, uh it took us a lot longer than March 15th or April 15th or even July 15th to get some of these out. Uh So when you invest with us, uh you will get a K one at the end of the year. It is challenging with as many entities as we have to get you those K ones in time for you to file your taxes by April 15th, which is the deadline. Many of our investors just plan on uh filing extensions, but there are some that uh own businesses and they're trying to, you know, adjust or gauge what their tax bill is gonna be. So it's very frustrating to them when we don't get those K ones out in time. And so we will apologize.

Uh but we are working really hard to get an accountant hired and working with our tax accountant. We may have to split it up next year, get a couple of accountants to where we're committed to getting those K ones out sooner. I think the biggest thing, right? Just so we can all wrap our head around it. It's, it's not just one entity, one investment, one check right? There may be 30 investors, 30 K ones and then that one deal may have eight entities. So it's, there's a little bit heavy lifting there, but specifically because we know how complicated it has been this year and, and we're continuing to buy deals. We're avidly looking for an, a new account and we'll have them on board it soon and that'll be just in time for the upcoming, um, tax prep and tax season for next year. Having an accountant should enable us to get the information assembled and given to our outside accountant in a, in a much more efficient manner. You know, I might as well shamelessly plug that. We have uh not a huge following, but we're, we're gaining a following. And so if you're out there listening and, you know, someone that is looking for an accounting position that's in our area that has some experience in real estate, hit us up.

We haven't made a final decision. We're kind of interviewing right now and looking for uh an accountant to help us really grow the business. So we got the K ones aside, Brian, let's talk about what investors pay in taxes and then how uh real estate compares to other investments compares to their personal income. OK. I'd say uh to start with, we should go through a few different types of investments and then at the end, maybe we show how that uh you know how that relates to or how real estate compares to, to those investments. Yeah, so the, the different taxes and when you're investing in real estate, there's several different taxes, you know, you may have short and long term capital gains, right? So in real estate, you're saying, or in, in real estate we're investing, I think those two terms apply to investing of pretty much any kind, right? Um ok, but the, the, the one people are familiar with is their personal uh income, ordinary income taxes. So that's gonna be any income you make on your day job or on income, on investments or any business ideas or ventures you do where you make income in the year that you put in the effort or invested the money.

Right. And so if it's within 12 months or if it's a day job that's ordinary income and ordinary income is taxed about just as high as, as any tax. Right? It's the highest. Uh, so, and everybody knows that it varies with how much, uh, income you make. But, uh, the highest rate is 37%. So that's, uh, and maybe higher. That's, that's significant. So, a question for people listening is that when he says the highest rate is 37% if I make a million dollars in ordinary income from my job, am I paying 370,000 in taxes? Federal? Yes. Yes. No, you're not. You're not. It's a graduated scale. So you're paying it. That's, that's the problem that people have when they're evaluating taxes. It's a, it's a it's a schedule. Right. So the first, you know, 10,000 or 20,000, you pay a small amount and then on the next 50,000 you pay a higher amount and so you're not paying 37% on a million dollars, you may be paying 37% on, on all income over, uh, the highest tax bracket. Right. Uh, so I encourage people if you're not familiar, most people are not, well, most people aren't filing their own taxes and this is why we all get CPA S.

Right. Yeah. Is, is, look up the federal income tax schedule just so you understand. Ok, if I make a little bit more money in ordinary income, this is what happens. This is how much I'm gonna pay. This may step me into a higher tax bracket. I think most people with their biggest expense being taxes, they're totally unfamiliar with how taxes work. What the rate is. You know, if, how the scale graduates up over time. And I think you just need to educate yourself. So you understand fully the biggest bill you have in a given year. But at some point, once you get over that, whatever that rate is, when it, when it goes to 37% every dollar you're adding to it at that point is that 5%. And then of course you've got state, well, not every state but, but there's state, uh, tax to pay as well. Right in Oklahoma. The highest rate is, what, 4.75%. So, there's, so you're, you're over 40% on those last dollars, if you're in the highest tax bracket. Yeah, that's a heavy burden. And then you've got, of course, uh, social security, Medicare Medicaid, that only applies to income, you know, maybe 100 150,000.

But it still adds to the overall burden. You could be pushing 50% all in, uh, you know, if you're a really, really high earner. Uh, so then, uh, I think the next thing we could talk about is long term capital gains and dividends, right? Because typically those are, again, it's a graduating scale. The top rate is 20% on, on long term capital gains and dividends is there and you may not know the answer to this. But I believe that if you're in a lower income tax bracket, uh, the first, um, you know, you can maybe pay 0% 0% on capital gains up to a certain amount. There definitely is a range where it's where you're not paying any taxes. Ok. And so then I would, I would suggest people get familiar with that because zero is the best kind of tax you can pay. And so if you're not earning any long term capital gains money, and you're, let's say just an average wage earner, you're, you should put a lot of effort into getting some capital gain income that's gonna be taxed at zero or very low percent. That's free money. It may only be $10,000 below.

I don't know what the number is, but, I mean, I'd love to make $10,000 tax free. Yeah, that, that's right. Every dollar you save in taxes is a dollar you're putting in your pocket. And most people just don't spend, they'll spend a lot of money trying to save 30 cents on, you know, a pound on chicken that they're buying at the store. But they're not spending any time trying to save $10,000 on their tax bill a year. This is, this is why most people's personal home ends up being the best investment in their life. The average person is because they're not paying tax on that because I, I think they just moved it from 2 to 3 years. I think it's three years now that if you live in your primary home for three years, you don't have to pay taxes on the gains. Is that right? Um, and so that's a huge benefit. If you, if you moved every year and were able to sell and make a decent amount of money, that's a huge amount that you can, you can earn tax free. But for real change to every, uh, income category. Yeah, it just got, I, I believe so. I, I mean, I'm not too high up in the income category. Thank God for all this discussion is, uh, consult your tax professional for sure.

But here, here's the problem with most people in their tax professional because we're talking about that. Right. They send a bunch of shit to their accountant. The accountant sends them a bunch of shit back. It's typically signed in, in one of the exchanges and then there's a net number of I owe this or I'm doing that. I don't really know what's going on. We're here to arm you with more questions than maybe you had before or prompt you to say. Hm, that's a good point. I should ask somebody about this. You want to bring these questions to your CPA or whoever is doing your taxes. You wanna, you wanna ask, hey, why, why is this tax so much? Are, are you sure shouldn't this be treated as long term? I mean, you, you get an education, you may have to pay for a little bit of it, but I'm sure they're probably just charging you per form, which is a knock on CPA. S but I mean, they're busy. They don't have time to look at every single one of them and say, hey, if you did this, this, this and this and this and, and they don't know your situation, they're not gonna do your job for you. Uh I would say the best available advice I can give you on taxes is to read is to get there.

There are books out there how to save money on taxes. Why real estate's a good investment for taxes, how to reduce your tax bill, you know, how to use, uh, you know, how to start a side hustle to reduce your taxes. There are so many ways to reduce your taxes to take already, uh, expenses you already have and you're already paying taxes and use those, uh, as deductions to reduce your tax bill. Uh, but most people, like you say, they're just handing it over to their accountant, getting it back. What do I owe? Ok. I'm gonna send that in and that's the extent of it. So, back to capital gains, we, we were talking about short and long term capital gains typically in real estate, long term capital gains. That, that line, right, where you cross and it's long term is a year, right? Same for stocks, same for stocks, some, some, you know, anyway, same for stocks. So, um, short term is treated as ordinary income most of the time, right? Which is the highest tax, long term is taxed at, at what? That's the, that's the max 20% 20% right? Ok. So just right there, that's an automatic advantage just right there if you can make money through real estate appreciation.

Right. Buying something it appreciates the value, you sell it for something higher, you're subject to a long term capital gains tax. It's only 20% instead of up to 37 not including state. That's an immediate, almost 15% savings right there, just by saying, hey, if you make your money in real estate and you hold that real estate for at least a year, we'll give you a 15% tax break. I want to make sure everyone's appreciating and understanding that. Yeah. And most, uh, all of our deals are gonna be more than, uh, one year, right? And I mean, not all the, not always, it depends like, so right now some of our investments uh they are going to produce some short term capital gains. Those are some of the opportunities that we have. And so we're taking advantage of those. Uh But I guess if, if we make investors 2025% of their money, uh and they have to pay a little bit of tax on that. That's just the cost of doing business. We're taking the returns where we can get them, but most of our uh passive cash flow investments will all be long term capital gains. Uh And, and so they'll be, they'll take advantage of the low rates. All right. What else? Brian.

Ok. Uh I would say we should discuss 401k s and Ira S because most people are familiar with those and most people are, a lot of people are investing in those. So I'll talk about uh or a Roth Ira and 401k and then you talk about a, just a normal Ira because I think you have one of those. I don't have those. All my money is in Roth and 401k. Go ahead. Traditionally, when you roll over a 401k, it doesn't have to go to a regular IRA. It goes into a self directed Ira. But it, but it's still under the umbrella of a 401k, uh, and treated as if it's in a 401k where, what's different is if, if you, like, let's say I just have, uh, $10,000 and I go on a mutual fund site and I just buy stocks. Well, that's just, that's just a retirement account or that's just a brokerage account. Um, so 401k, you, you, uh, you, they take money out of your check without taxing you any money on that and then it goes in tax free. That's great because if you're a high earner, you, let's say you have $100 you would have 70 to put in your pocket and invest.

Instead, you invest 100 and that 100 gets to grow tax free. So every year you don't pay tax on it as it grows and you started with a 30% you know, increase in the original amount. So, uh, first dumb question just so nobody feels that. Why is that an advantage? Right? You're delaying the tax, but you're paying the tax later, right? It's an advantage because you're not paying the tax and that's allowed to go cumulatively compound on itself for 30 40 50 years in the market before you pay the tax and the tax is relatively the same. Well, most of the time you're gonna be taking these things out when you're sixties, 70 80 years old and you have no really ordinary income. And so your tax, uh, rate would be lower than during your income generating years. So it's, it's lower and it gets to go into the market and, and compound on itself. Yeah, let's say you're making and this, I know this is not everybody. Ok? I'm just picking an example. You're a high income earner and you're making $300,000 a year and I don't know what your exact tax bill will be, but let's say it's gonna be 30%. Ok? Uh so then fast forward you, you invest in your 401k, it grows compounds, tax free, tax free, tax free.

You have $3 million. Well, now you retire and you don't have that $300,000 income anymore. Ok? And you say, ok, I, you know my house is paid off, my cars are paid off. I'm just gonna start drawing 50,000 a year. Well, what's great about that is that you're gonna pay a way lower rate on that 50,000 dollars and you would have paid when the money went in and because the balance has grown to such a huge amount that the um, the interest you're earning on that amount is probably more than you wanna take. So it allows you to take an income in perpetuity without ever decreasing the balance. Because if you have, let's say you have 3 million in there and you're making 10% on that, you're making 300,000 a year. And so if you're pulling out 150,000 a year, paying a lower tax rate, uh you can do that and definitely, and your balance will still grow. So the maximum 401k contribution limit for 2023 is 22.5 1000 for an individual and 30,000 if you're 50 or older. Yeah, so you can, you can really get after it uh in your later years to catch up. And again, the other reason we encourage this is to get the free employer match, right?

Do it up to the free employer match, then maybe consider something else but that free employer match. I mean, it's free money. Now, let's say that you don't make a lot of money. You're not a big time earner. Well, so then your tax goes lower. So then a good option for you might be a Roth Ira because that you, let's say you're in a 15% tax bracket for whatever your situation is. Uh you have a lot of deductible kids. You've got some deductions here there, ok? You want, you want to do a Roth because then you're only paying 15% but it grows tax free. So you pay the tax up front, but it grows tax free and you take it out tax free. And so that way, uh, you know, it can grow to 1 million, 2 million, 3 million. Then when you start taking the money out, you can take as much as you want out and you don't pay any tax on that. So that's also a great benefit. Also if, uh, if you die and leave it to your, uh, um, Children, they can pull it out tax free as well. Yeah. So that's a great option that the limits on that, it's a lot lower. Uh, it maybe 6000 per person, 12,000 a couple or something.

It's, it's lower than the amount you can put in a 401k, but still can be valuable based on your situation. So you can, you can do a Roth 401k. You can do the 22,500 in a Roth 401k if your employer offers it. Yeah. Yes. And the Roth Ira uh ex it excludes high income earners. There's a, an annual compensation cap, like once, once you pass a certain amount, you can't contribute to a Roth. Well, I never hit that. I never hit that amount. Um All right. So, Brian, what about a traditional brokerage account or just a stock account that you're, that you're holding, talk about some of the taxes you might, uh, deal with, with that? Ok. So it, you're, you're talking about just a brokerage account, not a retirement account, right? Ok. So you're going to, um, you're gonna put some money in, you're gonna buy stocks or mutual funds and it's back to, um, short term and long term capital gains. If you buy and sell stocks and you sell it less than a year before you sold it, then you're going to pay short term capital gains. If you wait a year over or more than a year before you bought it until you sell it, then it's a long term capital gain.

And then the stock is also going to pay, well, not every stock but, uh, a lot of stocks pay a dividend, right? And, um, a dividend is considered, um, like a long term capital gain or a capital gain. Ok. Ok. And so, uh, the, the takeaway for that is really just focused on the long term versus short term. So you're either, you're gonna want to decide your strategy, either you're gonna trade stocks and deal with the short term capital gain or you're gonna wanna make sure that when you buy a stock that unless you have a really good reason, you're not gonna want to sell that stock or the mutual fund before a year because you know, all that's gonna do is add on to your, your, uh, ordinary income. And if you're already at 30 35% in order your income tax, that's what that's gonna be if you sell before a year. That's right. Ok. Next, uh, so now I think, um, well, the only other thing I might, I might consider talking about is, uh, municipal bonds and those are bonds that are, you can buy tax free. So, you might, you might only get 8% on your, on your municipal bond.

But if you're getting it tax free then that can be, you know, that 8% increase of 11 or something. Right. Are there really 8% bonds? I don't know if there's any 8% out there? I, I haven't bought a bond in a long time. I mean, we're getting close to it now. Uh, they have to raise it to be competitive with savings accounts. They have to be the savings account. Otherwise no one's gonna buy the bond that the city issues. It's probably not at eight, but, you know, it's probably not, it, it, it might be 45 for most of my lifetime with interest rates low. They've been like 34 5%. And so it's never been that attractive. But yeah, and a really high interest periods. It could, could make some sense. Right. So that's, that's all the ones I have that, that a lot of people invest in. So how might we compare that to, uh commercial real estate Brayden already made the point, um, previously. But what else, how would we compare that to investing in real estate? Well, we, we left off two of the biggest ones, right? Depreciation and depreciation, recapture. Uh, depreciation, recapture is at 25% I believe. Right. Right. And you're allowed to depreciate the property today. So you get the free write off when you're not incurring the expense.

And I'll give you an example. We bought, you know, 5 $6 million property in, in May of last year and that property lost almost $2 million last year and, and it didn't act, it wasn't an incurred expense. Right. It was depreciation when we pay that back, it's 25% which we established, you know, maximum ordinary income is 37. So 25 is looking pretty good for an expense. You don't actually have to pay out and incur that. And you know, most people who are buying real estate are doing some sort of leverage component and you're allowed to write off interest, right? So that's a massive component and you can, you can keep some of this stuff so you can keep a property 57, 10 years, you're paying down that principle that mortgage balances is lower. Your property is appreciating through rental revenue increases, you know, lease renewals, you're getting higher rent amounts. Um So you refinance that property eventually and then that's not taxable, right? Because that's a loan, not a, not a sale or a taxable event and you can continue writing off interest, you know, a lot of people on their personal home, I think you can only write off interest to $750,000 but not in commercial real estate.

You can, you can get the biggest commercial real estate loan, just write off all that interest. So I'm gonna, I'm gonna give some people some information to go research because this show we're up to up to 2025 minutes and so we're gonna wrap it up. But I, I wanna encourage you guys with this fact is can commercial real estate? Can you make millions of dollars on one property in commercial real estate and pay zero tax on it? Braden Brian. Uh I'm talking about income tax, not real estate tax. Well, are you talking about uh I think you're eventually gonna hit with, get hit with the small tax from operating rental revenue. You know, it's, it's gonna be miniscule because like I said, you're getting depreciation which may eventually run out, but you're always getting to write off the interest component as long as you keep levering up. But there's a way to get out of most of the capital gains tax. What I would say is the answer is, is yes. Uh You guys are taking it a step further. You can buy uh commercial real estate and you can make money even up to millions of dollars and pay zero tax on that for the foreseeable future.

There is, there will be a day where you'll have to make some tough decisions that you may start having to, to pay taxes. But uh you can go years with making money and making even millions of dollars and paying zero tax. And it could be a decade, it could be two decades before that catches up. I don't know of any other investment that provides that kind of money making opportunity where you can legally pay no tax. And so if you don't know how that works, then that's what we're talking about when I tell you to, to get some books, get on the internet, get on youtube, how to pay zero taxes while owning commercial real estate or whatever you want the search to be. But we're just saying we can't get into all the details and we are not perfect professionals uh in this area. So uh we wouldn't try to tell you all the nuances of that, but that's what we're talking about. No other investment provides that. And that's why real estate is one of the favorite invest investments for the rich is because they can, they can curb or even eliminate their largest expense, which is taxes all while making a ton of money.

They say 90% of millionaires are made through uh real estate. Yeah, I've heard that. So they also say 100% of billionaires are made through private equity. Well, then we need to get into that, I guess. Um All right guys, I hope that was informative. It was just a, a short sample of some tax discussions and if you have questions hit us up. We'll, we'll do the research for you if you'll tell us what questions you have. And uh until next time, how to invest in commercial. Thank you guys for subscribing to the podcast and listening. We appreciate it. Thanks.

Episode 114 - Maximizing TAX BENEFITS in Commercial Real Estate!
Episode 114 - Maximizing TAX BENEFITS in Commercial Real Estate!
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