How the rich use real estate to lower their taxes...
Mike Henninger • September 12, 2024
It’s election year and you’re going to hear a lot of disgusting people, politicians, clamoring on and on about the “rich not paying their fair share”. This is a grotesque myth when, in fact, the rich are using the very tax code those same politicians wrote to LEGALLY lower their tax bill. Wealthy individuals often use real estate and depreciation to manage and reduce their tax liabilities….and the best part is, so can you!
Here’s how:
- Depreciation Deductions: Real estate investors can take advantage of depreciation, which allows them to deduct the cost of the property over its useful life. The IRS generally allows residential rental properties to be depreciated over 27.5 years and commercial properties over 39 years. This means that investors can deduct a portion of the property's value each year, reducing their taxable income.
- Cost Segregation: To maximize depreciation benefits, real estate investors often perform a cost segregation study. This study identifies and separates the costs associated with various components of a property (e.g., furniture, fixtures, and improvements) into shorter depreciation buckets, often 5, 7, or 15 years. This accelerates depreciation deductions, allowing investors to write off these costs more quickly and increase their tax savings. Combining this with Bonus Depreciation can provide HUGE tax savings.
- 1031 Exchanges: Investors frequently use 1031 exchanges to defer paying capital gains taxes. Under Section 1031 of the Internal Revenue Code, investors can exchange one or more investment properties for other of “like kind” without immediately recognizing a capital gain. This means they can defer taxes on the appreciation of their property until they sell the replacement property.
- Passive Activity Losses: Real estate investments are often considered passive activities. Losses from passive activities can offset income from other passive activities. For high-income earners who have other sources of passive income, real estate losses can help reduce their overall tax liability. (When discussing this with your tax advisor, ask them about REPs, lazy 1031 exchange and the short term rental loophole for ways to potentially utilize these losses against other types of income).
- Interest Deductions: Mortgage interest on investment properties is generally tax-deductible. Investors often leverage debt to finance their real estate purchases and can deduct the interest paid on these loans, reducing their taxable income.
- Property Management and Operating Expenses: Costs related to managing and maintaining rental properties—such as property management fees, repairs, insurance, and utilities—are deductible business expenses. This, in turn, reduces taxable income.
- Opportunity Zones: Investments in designated Opportunity Zones can provide significant tax benefits, including deferral of capital gains and potential exclusion of gains from the Opportunity Zone investment if held for a certain period.
As with anything IRS-related, it is crucial that you work with a tax professional to ensure you’re complying with the various details associated with any tax strategy that you’re going to employ. This is ESPECIALLY true with things like REP’s, 1031 exchanges and the STR loophole.
Having said that, by leveraging these strategies, individuals can significantly reduce their tax liabilities while building and managing their real estate portfolios. Again, these strategies can be complex and often require careful planning and consultation with tax professionals and financial advisors.
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The Power of an “on demand” Fractional CFO: Unlocking Cash Flow, Revenue, and Profit for a Successful Exit As a small business owner, you’re likely wearing multiple hats—balancing day-to-day operations, customer relationships, marketing, and everything in between. But one of the most important pieces of the puzzle often gets pushed to the back burner: financial management . You might be great at running the business, but without the right financial strategy, growth can be slow, and a successful exit can feel like an uphill battle. This is where an “on demand” fractional CFO can truly change the game. In my experience, having an “on demand” fractional CFO is like having a secret weapon in your business arsenal—one that can supercharge cash flow, drive revenue, increase profit, and position your business for a profitable exit. It's an investment that pays massive dividends when you're planning for long-term growth and eventually selling your business. Here’s how a fractional CFO can transform your business. 1. Cash Flow Mastery: The Foundation of Stability Cash flow isn’t just an accounting term; it’s the lifeblood of your business. Without a steady, predictable cash flow, even the most profitable business can quickly find itself in trouble. A fractional CFO’s job is to make sure cash is flowing smoothly and consistently—keeping operations running, covering payroll, managing debt, and making sure there’s always enough liquidity for strategic growth. They’ll dive into the numbers to help you understand where your money is coming from and, just as importantly, where it’s going. They'll set up systems to track receivables, payables, inventory, and more. With their expertise, they’ll ensure that cash flow is optimized, forecasted, and strategically managed so you can stay ahead of potential gaps and seize opportunities when they arise. Let’s face it: You can’t grow a business if you’re constantly worried about cash. A fractional CFO makes sure your business is not just surviving but thriving—setting you up to scale and increasing your chances of a profitable exit when the time comes. 2. Driving Revenue: Taking the Guesswork Out of Growth Growing your revenue is where the rubber meets the road, but it’s also where many small businesses hit a wall. You can’t just rely on random bursts of sales or hope that the market will favor you. You need a strategy—a smart, data-driven strategy to build sustainable growth. This is where your fractional CFO becomes invaluable. Utilizing deep financial insight, they’ll help you understand the levers that drive growth—whether it's optimizing your pricing, improving your sales funnel, or diversifying revenue streams. They’ll help you create solid financial models to forecast revenue, track key performance indicators, and make decisions based on hard data instead of intuition. It’s all about taking the guesswork out of growing your business. A fractional CFO will identify the areas where you can scale quickly and efficiently, ensuring that revenue growth doesn’t come at the cost of your margins. They’re constantly on the lookout for opportunities to improve profitability while driving top-line growth. That’s a powerful combination when you’re gearing up for an exit. 3. Profitability: The True Measure of Success At the end of the day, revenue is important, but it’s profit that really matters. You could have great sales, but if you’re not managing your costs effectively, you're running in circles. A fractional CFO will help you drill down into the details of your operations, identifying areas where you can streamline costs without sacrificing quality or service. They’ll optimize your cost structure, help you renegotiate contracts, and eliminate inefficiencies that might be eating away at your margins. Whether it's tweaking your pricing strategy, adjusting supplier agreements, or improving your operating model, a fractional CFO will work to boost your profitability across the board. Profit is key, not just for keeping your business healthy, but for positioning yourself for a successful exit. Buyers or investors will want to see that your business is profitable and can maintain or increase that profitability after acquisition. A fractional CFO ensures you’re maximizing your profits in preparation for a sale, making your business more appealing to potential buyers. 4. Preparing for a Profitable Exit: Making Your Business Attractive to Buyers If you're thinking about selling your business down the line, you need to start preparing now . A successful exit doesn’t happen overnight, and a fractional CFO is the person you want in your corner to help you position your business for the highest possible return. They’re the ones who’ll guide you through the entire exit strategy process, from preparing your financials to managing negotiations. They’ll ensure that your business is running at its peak with well-documented financial records, a system to track KPI’s, strong cash flow, and optimized profit margins. They’ll also help you plan for the tax implications of the sale, ensuring that you get to keep as much of the sale price as possible. Most importantly, your fractional CFO can assist in crafting a growth story that makes your business irresistible to potential buyers. They’ll help you showcase your business's strengths, growth potential, and profitability, which is what buyers are looking for. They’ll also identify any areas of concern that could hurt the sale price, allowing you to address them before you enter the market. 5. Strategic Guidance at a Fraction of the Cost One of the most powerful aspects of having an “on demand” fractional CFO is that you get all the expertise of a seasoned financial leader without the full-time salary . For many small businesses, hiring a full-time CFO is simply not feasible, but a fractional CFO gives you access to that level of expertise at a fraction of the cost. Think of them as a strategic partner who can provide high-level guidance and bring clarity to your financial decisions. Whether you’re making day-to-day financial choices or planning for long-term growth, having a fractional CFO on board means that you have someone who’s constantly looking out for your best financial interests. Conclusion: The Bottom Line The path to a profitable exit is paved with solid financial decisions, and a fractional CFO is the partner you need to make those decisions with confidence. From mastering cash flow to driving revenue and increasing profitability, they provide the financial expertise necessary to take your business to the next level. Most importantly, they help you position your business for a successful exit —one that will leave you with the financial freedom you deserve. A fractional CFO is more than just a numbers person; they’re your strategic partner, your business’s financial architect, and the key to unlocking long-term success. If you're serious about growing your business and cashing out with maximum value, having an “on demand” fractional CFO is not just an option—it’s a game-changer.
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Starting a business is an awesome endeavor. It’s one where things can happen at breakneck speed. Often, we’re so focused on running the business (and rightly so) that some of the day-to-day administrative stuff gets lost in the mix. One of those things is, “how the heck do we get money out of the business?” In this article, we will be discussing the process for sole proprietors & single member LLC’s. A sole proprietor or single-member LLC owner can withdraw money from the business in different ways. Here are a few of the main options: Sole Proprietor: Owner's Draw: The sole proprietor can take out money through an owner's draw, which is simply withdrawing money from the business account for personal use. You’d literally withdraw money from the business account and deposit it into your personal account. This is not considered a salary or wage but rather a distribution of the business profits. The draw itself is not subject to taxes. The sole proprietor pays income and self-employment tax on the net income of the business, whether or not it’s taken out as a draw. Reimbursement of Expenses: If the owner has paid for business expenses out of personal funds, they can reimburse themselves from the business account. The manner of how this happens is important. Again, the reimbursement must be made from the business account to the owner. The business then records that transaction as a deductible expense. Another very important thing to mention is that the business account should never directly pay for personal expenses of the owner. It’s a common belief that, since the owner can take out money from the business account, that paying personal expenses right out of the business account is just semantics. IT’S NOT. If you want to pay personal expenses, take a draw, deposit it into your personal account and then pay the personal expense. Single-Member LLC: Owner's Draw: Like a sole proprietorship, the owner of a single-member LLC can take an owner's draw. The LLC's profits are passed through to the owner's personal tax return regardless of whether or not the owner takes the money out or lets it sit in the bank and is reported on their 1040. The draw itself is not subject to income or payroll taxes. The owner must pay income and self-employment tax on the net income of the LLC. Salary (if elected to be treated as an S corporation**): If the single-member LLC has elected to be treated as an S corporation (by filing Form 8832 or Form 2553 for S-Corp status), the owner must take a reasonable salary. This salary is subject to income and payroll taxes that the LLC must withhold and remit via payroll tax returns. Distributions: In addition to a salary, if the LLC is treated as an S-Corporation, the owner can also take distributions of the remaining profits. These distributions are not subject to income or self-employment tax. The activity from the S corporation that affects the owners tax liability is all reported on the owner's personal tax return via Form K-1. ** There are a lot of moving parts when deciding what is “reasonable” with respect to the salary of a S corporation shareholder. Many people believe that it’s based on net income, it isn’t. It’s based on distributions….this discussion is beyond the scope of this article, so PLEASE, talk to your tax advisor.
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