The Truth About Accelerated Depreciation & RE Professional Status w/ Tax Strategist Thomas Castelli

Mike DeHaan: [0:00] You are a real estate investor, you have probably heard all about subject to real estate. And also if you're a real estate investor, you probably don't really know a lot of the ins and outs of how to do subject to correctly. That is why we created our free subject to course. You can go and grab at collectingkeys.com/subtwo. We will go through all the ins and outs about how to do subject to correctly and legally so that you don't put yourself or the seller in a bad spot by kind of ignoring the small details. So if that's something that you're interested in, go to collectingkeys.com/subq, and you'll know exactly where

Dan Austin: [0:32] to go from there. It's very common for these tax software companies to actually not have like a perfect system. They can have these glitches where it just doesn't calculate things right. It ended up costing me like a thousand dollars in like interest payments, and there's nothing you can do about it, and then like the fine was like $2.50, and then the rest was just interest payments for two years, but you don't know that for two years. Yeah. That's why it accumulates. It's not like you can call them, and be like, hey, I didn't know until now. They're like, I don't care. First of all, they don't have a phone number, you can't.

Thomas Castelli: [1:01] Some of the situations we've seen, like, they could get a lot worse than that. Like, seeing people who erroneously took the real estate professional status, save like, you know, 50 k in taxes. Now, two, three years later, they have to go and they get audited. Diaries finds out that they can't use it. What ends up happening is they have to pay the 50 k back in taxes plus the penalties and interest. And the more you're saving, the more you have to pay back, the higher those interest and penalties are gonna be. So it can be quite painful. Welcome

Dan Austin: [1:28] to the

Speaker 4: [1:28] Collecting Keys podcast. The show where you'll learn how to use real estate to create massive income, not just passive income. Real estate doesn't have to be a get rich slow game. Listen to the country's top real estate operators, and you'll have all the tools you need to replace your w two income and go beyond in under twelve months. Ready to take things to the next level? Let's jump in with our hosts, Mike DeHaan and Dan Austin for today's episode of the collecting keys podcast.

Mike DeHaan: [2:04] What is going on, guys? On today's episode of the collecting keys real estate investing podcast, we have Thomas Castelli, who is a tax strategist focused on all things real estate. And we go really deep in this episode on cost segregation studies, professional real estate status, general tax strategy that you can use if you have even, you know, small real estate business. And I actually really enjoyed the show, Dan, because he did a good job of like taking these honestly pretty complex topics and making them easy to understand and not be like super dry like some of the other financial stuff we've had on the show.

Dan Austin: [2:37] You stayed engaged the entire time.

Mike DeHaan: [2:40] I did actually, which

Dan Austin: [2:41] I'm proud of you.

Mike DeHaan: [2:42] Which which every time we have like a these sort of like, I don't know, back end business, I don't know, being more of the visionary high d on the disk scale, these sort of things are just so uninteresting to me. I understand how important they are, but it is is hard for me to stay engaged with it. But he did he did a good job

Speaker 4: [3:00] though.

Dan Austin: [3:00] He did a fantastic job because obviously he has a podcast talking just about this sort

Mike DeHaan: [3:04] of stuff. Yeah. It is the Tax Smart REI podcast. Yeah.

Dan Austin: [3:08] I mean, just knows how to explain it, simplifies it, and he actually uncovered some, what I would call myth versus fact stuff, around these tax strategies, so definitely listen to it, especially as we kind of at the end come back to real estate professional, he and him and I have a really good dialogue about the details around tracking that and what that means, and I think that'll be helpful for a ton of our listeners.

Mike DeHaan: [3:27] Absolutely. Yeah. And I'm super excited too because just like when we get these high quality guests that are very skilled on like a specific part of the business, we were able to get him to come and speak to our skill community in a coaching call, which will be a couple weeks after this episode comes out. So, you know, if you want to get some easy exposure to some of the pros that we hear on the show, check out Skill. And that's a great way to get like some free, honestly, just like consulting time with some of the people that we have. Because if you go and get it on social media, which you should, you're gonna want something out of it. Part of Scale, you're gonna do it for free. So it's worth the time. For free. Yeah. Anyways, really good show here. He obviously knows his stuff too. Can usually pick up like the bullshit indicator relatively quickly Good. Some of these people, but he has it going on. No bullshit here. Yeah. Not at all. So anyways, guys, really good show. Take some notes. Reach out to Thomas afterwards and let him know about all of your tax laws. He'll be able to help you out and enjoy the show everybody with Thomas Castelli. Enjoy. Alright guys, we are here today with Thomas Castelli, who is out of New York, and he is with Hull CPA and Dual City Investments. And we are going to be doing a deep dive into taxes today. Woo hoo.

Mike DeHaan: [4:37] In tax strategies with running a real estate investing business. And so, you know, a lot of people get into real estate for tax benefits, all these different things that people say out there. But what exactly does that mean? And so we're going to do a little investigation on this today. So Thomas, appreciate you coming on the show, man.

Thomas Castelli: [4:54] Thanks for having me. It's an honor to be here today.

Mike DeHaan: [4:56] Yeah. Absolutely. So hack situation. I don't have a ton of knowledge. Dan tends to run with a lot of stuff on our side of the business, and I'm pretty dumb. And you're pretty dumb. Yeah.

Speaker 4: [5:06] So this

Mike DeHaan: [5:07] is why I work with guys like Thomas. I mean, it's not your it's not your fault, man. You got blown up too many times. You have brain injuries. But when it comes to tax things, I usually kinda get to the end of, I guess like the tax season, you know, March, April timeframe. And I'm either super super disappointed or I am super thrilled that I don't owe any owe any money. But Thomas, you have some strategies and different things around how to prevent that. So I guess at a high high view, what do you do as like a tax strategist? How do you help real estate investors?

Thomas Castelli: [5:36] Yeah. My job as a tax strategist is to look at your situation and say, okay. Well, where are you today? What's your income streams? What assets do you own? What does your current financial and tax picture look like today? And, hey, where are you looking to go in the next, say, one to three years? And the the the more farther out we can go, the the easier it gets to plan for people. But I'm looking at where you are today, where are you looking to go, and what moves, what strategies, what tactics, what deductions, what credits, and so on and so forth can we implement today so that when it comes time to file your next tax return, you're minimizing your taxes to the further furthest extent possible or reasonably possible. I don't wanna say the furthest extent possible. It's not all strategies are always worth executing. But basically, it's how can you minimize taxes for your next return? Also over the big picture, what can you do to shift your business, shift your your investments to a more tax advantage overall strategy so that you're not only doing, like, the tactical Mhmm. Like, day to day, like, little things, but also from a bigger picture, how can you shift your income sources to to more tax efficient income sources?

Mike DeHaan: [6:36] Yeah. So wait. So you're saying that there's tax things that are not worth doing, so I shouldn't every single year just go and do max depreciation and go and get a cost segregation study on everything, and takes max accelerated depreciation, and you know, go and start my money laundering business to hide how much money I'm making. I should I should probably just be a little bit more strategic than that?

Thomas Castelli: [6:58] Yes. I mean, most of the time it does make sense to do cost segregation studies specifically, but a strategy that that is sexy, for example, but to squeeze or it's just not worth the hassle is something like the Augusta rule. Right? Like, people hear about this Augusta rule, which allows you to rent your home out for fourteen days or less and not pay taxes on it. Well, that's all well and good if you're actually gonna go ahead and rent your house out for fourteen days, like a reason to do it. But what ends up happening is so many people spend so much time on these little strategies because they sound cool.

Speaker 4: [7:26] Mhmm.

Thomas Castelli: [7:27] That's just like the amount of time you spent trying to execute this small strategy that's not gonna give you that much benefit, you know, tax savings wise, you could have been out there making money, doing more deals and financing and investors, so on and so forth.

Speaker 4: [7:38] Totally.

Thomas Castelli: [7:38] So that's what I mean, like, when I say to the furthest extent possible, I mean, like, the big rocks, the things that are really gonna move the needle for you, Not the little the little deductions that are sound cool, but are not really so cool. So that clarifies kinda what I meant.

Dan Austin: [7:50] It seems like there's a lot of stuff, you know, a lot of Instagram accountants out there talking about, know Totally. Especially for the real estate folks. And it seems like to me that those only apply given specific circumstances and goals you have. Like, there's certain things that you may not need or want to do from a tax strategy standpoint, that somebody on Instagram is telling you is the best benefit of real estate, even though it's not going to fit you, because your goal is to maybe sell your property next year, or maybe to never sell your property, the opposite of whatever would be correct.

Thomas Castelli: [8:24] Yeah, you know what it is about the, here's the way, so we receive a lot of this at our firm because we consult with a lot of clients, and sometimes they'll come to us after seeing something on TikTok and being like, oh my god. I saw this really cool thing.

Dan Austin: [8:34] This hot chick told me to do this.

Thomas Castelli: [8:36] Right. Does this work for me? It's like, it doesn't always work. So kind of the way that I view the TikTok and the Instagram Reels is, first of all, what are they trying to do with those Reels? They're trying to grab your attention. Mhmm. They're trying to hold your attention so that they can get more views. So they have to do things that are polarizing, things that are sometimes controversial or a little edgy, if you will. That's what they're trying to do with their Reels. So in in most reels are not giving you the whole picture in sixty seconds. You can't possibly. Mhmm. So the way I like to tell people or the way I'd like to suggest people look at these reels and look at these, you know, YouTube shorts and whatnot is use them to, like, spark ideas. You could go have more have better conversations with your own advisers. Right? Like, if you hear about the strategy, like, okay. Cool. I heard about the strategy. I'm gonna go talk to my CPA. Does this apply to me? Because what what we often find is is the information on those TikTok reels is often incomplete.

Mike DeHaan: [9:25] Mhmm. And

Thomas Castelli: [9:25] sometimes it steals people in the wrong direction.

Mike DeHaan: [9:27] People on the internet don't lie or leave out small details that are actually important. The whole reason we have the internet is so that we can know everything instantly. Yep. You know, the a couple clicks of our of our fingers on our phone.

Dan Austin: [9:38] Yeah. Bro, my VA does my editing. He doesn't know American tax strategy.

Mike DeHaan: [9:41] Yeah. But, I mean, that that's an interesting thought though, right around, I mean, honestly, the the opportunity cost of looking at these different tax benefits. Right? This is actually a big thing that we deal with, people in our scale community, is they come in and they want to like find these really minute details about a way they can stretch their marketing dollars a little bit farther. Or they go, I'm going to go and start my own property management business, I don't have to pay a property manager 8%. Or they go and they say, I'm gonna start doing Airbnb's, gonna be able to cash flow a little bit more than a long term rental. But if you look at the actual time to do all those things, versus if you went and just did more transactions, you're gonna make so much less money, and you're probably gonna like work more, if you're being completely honest and refine it to that actual skill. And it sounds like the same thing sort of applies from a tax perspective. So when people are kinda looking at that, right, you said, like, take those ideas and go to your CPA. How do you know that your CPA knows what the hell they're talking about?

Thomas Castelli: [10:37] Right. That's a great question. I mean, the the first thing is like when so it's like hiring somebody, hiring anybody. Right? You wanna hire somebody who has the experience doing what you're doing. So for example, if I'm gonna go hire a CPA for real estate, I'm gonna go and interview first, I'm gonna search for CPAs that have real estate experience. That's gonna be like my first filter. Right? Then I'm gonna get on the phone. I'm gonna first, I'm gonna okay. Well, I'm gonna review their website, their materials, see do like, are they putting out content on strategies for real estate investors? In 2024, that's a good sign that they at least are gonna be in the industry that you're looking for.

Mike DeHaan: [11:08] Right? And

Thomas Castelli: [11:09] that they're showing some proof of what they can do. Right? And the second thing I'm do is after I decide to whittle it down to the people I'm gonna actually talk to, I'm gonna get on the phone. I'm gonna ask some questions. Okay? First of all, you know, I'm gonna ask, how many clients do you work with that are in a similar situation to me? Right? If you're the only client they have in real estate, they might not know real estate, right? But if they have a 100 clients that are in real estate and are doing something similar to you, then chances are they probably have an idea. Maybe not, but more likely than not, they do. Right? And then it's like, how can you help me specifically? What things can you do for me? What am I missing? So like, it's almost just like hiring somebody. You gotta start your search by looking for somebody who has experience, then see what their website says, then get on the phone and start having conversation and drill down. Like I just said, how can you help me? Can you help somebody in my situation?

Mike DeHaan: [11:57] Sure.

Thomas Castelli: [11:57] Testimonials case studies help too.

Mike DeHaan: [11:59] You think it's important that a CPA invest in real estate themself to understand a lot of the nuances? Or is that kinda just not as

Thomas Castelli: [12:06] I don't believe it is. I think it helps. I think it helps to be upfront. There's certainly a lot of really gifted tax professionals out there that have never invested in real estate in their life, but can tell you exactly what you need to do from a tax perspective, because that's what they specialize in, They have a lot of experience looking at real estate investor situation and saying, Hey, I've worked with a 100 clients just like you, and I reviewed the tax code ad nauseam, so I know exactly how to navigate your situation. So while it helps, it helps make the connections for sure. It's definitely not necessary.

Dan Austin: [12:40] Sure. So what are some of the like, we hear all sorts of things from the benefits of real estate from the tax advantage standpoint. Are there any things that you're doing to advise your clients? And I get it that it's gonna be, it's gonna pertain to to client specific situations, but are there any things that you are doing right now that you think are maybe unique or beneficial or that people aren't talking about?

Thomas Castelli: [13:05] Yeah. I mean, most of the stuff that we're doing at this point has been pretty fleshed out because we've we've kind of

Dan Austin: [13:10] put

Thomas Castelli: [13:11] it out there a lot. But Yeah. So it's hard to say anything that's, like, undercover. Sure. But really the big rocks for, like, say, full time investors is some

Dan Austin: [13:19] of the

Thomas Castelli: [13:19] key strategies that you're gonna wanna be aware of and kinda make sure that you're at least exploring, if not implementing. The first one's gonna be the real estate professional status.

Dan Austin: [13:27] Mhmm.

Thomas Castelli: [13:28] It's also sometimes called the reps. And to give a quick overview of what that does. Right? So way back in 1986, they had the Tax Reform Act of 1986 under Ronald Reagan that was passed. What that did is it made all rental activities passive by default. So that means and the reason for this is that you used to have, like, a physician or a lawyer, a highly compensated individual, go out, buy a rental property, do little to no work, but then take a loss, thanks to the non cash expense called depreciation. So in other words, what happened is they're showing a loss for tax purposes, and they're telling the IRS, hey, I lost money, but they're actually making money and putting cash in their pocket. And they would be able to take this loss and then offset against their income from their job or their business and reduce their tax bills. It became really controversial. So Congress made that no longer possible and said, you know what? With your losses from your rental activities, you can only use it to offset other quote unquote passive income, which is income from rentals, unless you qualify as a real estate professional. And what the real estate professional status says is if you work more than seven fifty hours, and more than half your total working time in a real property trader business, so basically in real estate, then you're able to take the losses from your rentals and use them against your, you know, quote unquote, active income, which is like saying come from a job or business or dividends and interest from notes. Those are actually in that bucket too. In a weird I don't know why they put it in there, but that's what congress did. So

Mike DeHaan: [14:52] I'm actually surprised that congress did that because I feel like they would just be abusing the fuck out of that now. Like, honestly. Like, they would just be using that to reduce all of their income just like they do with other insider trading.

Thomas Castelli: [15:02] Oh, like the real estate professional status?

Mike DeHaan: [15:04] Yeah. Well, like if they didn't have real estate professional status, right? Like, they would wanna take that away so they can just go and buy a place for Oh, reduce their income to zero if you have what I'm saying.

Thomas Castelli: [15:14] Yeah. Yeah. I see.

Dan Austin: [15:15] So one question about that then. So for many people, they're not a real estate professional, but they aspire to that, But, they might be taking very real losses that are above their passive income. So, say you make $5,000 in revenue from your rental properties, but with depreciation and maintenance and all your schedule e stuff, you've got $20,000 in losses accumulated, so you basically net $15. You can't, as a non real estate professional, you cannot take that $15,000 in loss and apply it to your active income. But if you do that, say for five years, and you're finally ready, got a $100,000 in losses that you weren't able to use, but now you've quit your job and you're a real estate professional, do those losses accumulate so that you can now use them in that first year as real estate professional?

Thomas Castelli: [16:02] Yeah. So they do accumulate. So if you can't use them in that first year, they'll be carried forward. You could check on form eighty five eighty two of your tax return just in case you wanna take a look of your form ten forty. But what happens is if in the year you become a real estate professional so the real estate professional only allows you to take losses as nonpassive or active Mhmm. In years when you have the real estate professional status. So so for example, say say you had a $20,000 loss in 2024, and you qualify as a real estate professional, you would be allowed to take that loss. Now say 20 say you weren't say you're not a real estate professional in 2024, this $20,000 loss is carried forward to 2025. In And 2025, you do become a real estate professional. That $20,000 loss from 2024 will still be passive.

Dan Austin: [16:44] Oh, dang it. I was hoping for all those people out there that were working towards it that they can use that.

Thomas Castelli: [16:49] Unfortunately, what ends up happening is it doesn't all get unlocked. The previous losses remain passive. Yeah. The way around this is to what we advise, you know, what what most people will do is say you acquire property this year in 2024. Yeah. And you know you're gonna qualify as a real estate professional in 2025 or 2026, whatever it is. What you'll do is you won't do a cost segregation study today.

Mike DeHaan: [17:11] Mhmm.

Thomas Castelli: [17:12] You will hold off. You will just use straight line twenty seven and a half year depreciation, assuming it's residential. And then you will qualify as a real estate professional in say 2025. And then you will do the cost segregation study, and you'll have that depreciation retroactively kind of caught up on your 2025 return. And that's how you can kind of navigate that situation to avoid kind of, like, getting all those losses trapped. And that's kinda just why I mentioned before, like, should you not do cost segregation studies every year? Well, in the most part, do. But in some cases, it'd be strategic for you not to do it right away Okay. Hold off. And this is pretty much one of those instances.

Dan Austin: [17:49] Well, that brings up another question that Mike and I probably both are thinking is like, outside of this scenario, when would you advise people not do a cost segregation? Like, for example, maybe you're gonna sell a property or you don't like. Yeah. When is a good example of that?

Thomas Castelli: [18:02] Yeah. So when you're flipping a property, a true flip, you're typically not gonna be it's not treating like a rental property.

Dan Austin: [18:08] It's usually

Thomas Castelli: [18:08] gonna go on schedule c and you're not gonna depreciate that property. So that's one instance where you wouldn't depreciate it. Another one is that they're gonna sell usually relatively quickly within one to three years because you're gonna have to recapture it. Yeah. It's not always like a hard no, but Yeah. Something that you may not want to do. Another instance, and and this is maybe the only other instance that comes immediately to mind around that would be, so when you use straight line depreciation, it's okay, when you depreciate a property, you're reducing your basis in the property for tax purposes. And you're what's called, it's called your adjusted basis. And when you sell your property, you're not selling the property from the market price, whatever you sell it for the sales price, minus your cost, your purchase price, you're selling it for tax purposes, your gain is going to be measured on your sales price minus the adjusted basis. So the more you depreciate your property, the bigger that gets. And depreciation recapture, that's like the gain from the depreciation you took called depreciation recapture. On straight line depreciation or just twenty seven and a half year depreciation, that is taxed at a max rate of 25%. But when you use bonus depreciation and you accelerate, you spike that depreciation expense, that portion is taxed at ordinary income rates of up to 37%. So for example, say you're in the 32% tax bracket or the 24% tax bracket today, you go ahead, you use a cost segregation study, bonus depreciation, all that good stuff, real estate professional status, perhaps, You take the losses and the deduction is gonna be at the 24 or 32% rate. But now say you sell the property, you know, five years down the line, your income is huge that year, you're in the 37% tax bracket at that year.

Thomas Castelli: [19:47] Now you're recapturing that at a higher rate, 37%. Now there's ways to mitigate that with ten thirty ones and stuff like that exit strategies. But in just a pure vanilla traditional ordinary sale, that's an instance where you not want.

Dan Austin: [20:03] So in that in that scenario where you're basically saying, if I can understand this, normal depreciation recapture, if you're just doing twenty seven and a half years, is 25% of that you pay when you sell it. If you use accelerated depreciation, the part of the depreciation that you're accelerating is at your ordinary income.

Thomas Castelli: [20:21] Exactly. Exactly.

Dan Austin: [20:22] What is the difference usually? Like, Mike and I would do a cost seg on, we've a six unit property here in town that's probably worth 1,000,000. Like, cost basis in is probably like 500,000. Yeah. Like, if we were to use accelerate do a cost seg, how much of that would go to accelerated depreciation on average? Is it all of it?

Thomas Castelli: [20:40] Yeah. No. So it definitely it depends on the properties, you know, to drill down specifically, but usually somewhere between 20 to 30% of that building is going to be eligible for depreciation. So to give you a quick example of what that what that might look like, say you had a $500,000 property. Alright, the land is never depreciated. And you usually calculate the land either by the appraisal or using the property tax card. But we'll assume it's 80% is the building. So the building is depreciated somewhere between 20 to 30% of that $400,000 will be eligible for bonus. So if we just split the difference right down the middle, we do 25%, we're looking at a $100,000 of that property will be eligible for bonus depreciation. Right? And at this point, 2024, under the current law that's currently in place, it's 60. So that would be meaning you're getting a $60,000 deduction from accelerated depreciation or bonus depreciation is a form of accelerated depreciation.

Mike DeHaan: [21:39] Interesting. Hey. We really appreciate being a listener of the collecting keys podcast. Did you know that we also are on social media and on YouTube? You should go and shoot us a follow on those as well. You can find both Dan and I on Instagram. I am at Mike underscore invests. Dan is at investor man Dan. You can also find short clips from the show at collecting keys podcast on Instagram. And if you wanna see our faces talking while listening to the show or you wanna check out some of our crazy animated adventures, we've been putting together into some funny little web cartoons that sort of show the crazy stories that guests tell on the show, then you should go over to YouTube and check out the collecting keys channel. Shoot us a subscribe over there. It really helps continue to grow our audience. We really, really appreciate it. Well, anyways, enjoy the rest of the show you guys. We appreciate you all. So it's almost like if you're planning to like make more money in the future, you almost shouldn't do it. Like, if you're gonna have like a large exit.

Thomas Castelli: [22:32] It's hard hard to say that like, as a definitive thing, it depends. Because if you're already at the 37% tax bracket, you'll be there when you sell.

Mike DeHaan: [22:41] It doesn't matter.

Thomas Castelli: [22:41] It usually makes sense to take it now. You have this tax savings, you can go reinvest. But if in a situation when you are in a lower tax bracket today, you're probably gonna sell in a higher tax bracket and, and I'll throw an and in there, and you're not planning to exit using a ten thirty one exchange, or some other tax advantage strategy, then it would typically not make sense to do the cost seg at that point.

Mike DeHaan: [23:02] That's interesting. Because like this is something that always, I don't wanna say grinds my gears, at least I don't know what you're down, but know we've talked about this before. We know a lot of people that are in like this real estate sort of fear, where they are constantly just told you have to do the 600 depreciation all the time, all the time, all the time. And like, are these guys that are like, honestly making like no money. They make like 80 to $100 a year. They get into a deal as a GP, and now they are like pushing this accelerated depreciation because they've been told they need to do that. But realistically, if they're going to be trying to grow their business, they're making a $500,000 a year five years from now. They're probably shooting themselves in the photo. Because they're going to be now paying more taxes on that accelerated appreciated amount in the future. Am I off base thinking that? But like, I guess I have always sort of viewed it as something that like you said, if you're already in the highest tax bracket, you should totally be doing it. But it seems to be this reoccurring theme where you have people that are new to the space that are bought into the accelerated depreciation doctrine, and they're, like, not understanding the true implication that it has over a long term basis.

Thomas Castelli: [24:07] Yeah. In certain situations, like, I I get it. It's a lot of people, like, beat that drum because in a lot of situations, it does make sense. So it's a good, like, general rule to say yes. But if you're not, if you don't have much use, if you can't use those losses today, and you don't have a strategic future use for these losses, then it may not make sense to go ahead and move forward with that cost segregation study and spend the $2 on the study of how much it's going to cost you, just to have the accelerated depreciation be suspended and carried forward on your tax return with no use. Having said that though, to give an example of strategic use of this, right? Another way you can use these losses from depreciation if you are on that passive side, so in other words, if you're not on that real estate professional side, is if you are selling a property, right? If you sell a property, you're gonna have a big capital gain. You can use losses from cost segregation from the bonus depreciation to offset the gain on sale of that new property.

Dan Austin: [25:00] So that can

Mike DeHaan: [25:01] actually reduce taxes there.

Dan Austin: [25:02] That's good.

Thomas Castelli: [25:03] That would be a reason why someone may choose that. But like, if you don't have, if you're in that passive bucket, and you don't have passive income or passive gains, if you will, from the sale of real estate to use to offset the losses, then you're just you're accumulating losses with no purpose for no purpose. And you're accumulating admin costs for the cost seg and to get your tax returns filed for no for no reason. So there needs to be a reason for you to do it.

Dan Austin: [25:29] That's what it seems like to with like, like what grinds my gears, kind of following Mike is, I think that there's a lot of newbie investors who have one or two single family homes, and they're listening to cost seg podcasts, like I gotta do this. And two opinions that come from me, these aren't the I'm not saying these are right, I'm just saying these are my opinions is, spend your time like, if you're going to do it, don't be trying to do it yourself, right? Because there are people that do like their own cost segregation, because you're gonna spend so much time trying to figure this thing out. The juice might not be worth the squeeze if you have a house that's worth a $100, and you're trying to pay $2, 2% of the purchase price for a cost seg study, when you don't really benefit it. And the other thing that grinds me gears is, there's a lot of people in the real estate space, that they don't even make that much money anyways. It's like, why are you so worried about saving on taxes? Go make more money. Yeah. Your tax bracket's so low now, pay tax on everything, and keep that money as already post tax.

Thomas Castelli: [26:24] Right, exactly. Know, noted is, I think there's a few things. I think people feel sophisticated when they start doing tax strategy and, like, that feel it's kinda like people starting an LLC. You're not really in business. Congratulations. You got the LLC as one part of it, but it's sexy. People love to talk about it. Right. When they make moves, like I said, they feel sophisticated is the bottom line. It's kind like an emotional thing for them. But to your point, I would agree. Like, when you're just starting out, like, yes, it's important to kinda keep be mindful and educate yourself on this and see what doesn't make sense for you to use, But your time would be better spent sometimes and your resources, your cash, your capital, better spent going on finding that next deal than worrying about the nitty gritty tax implications, especially if you're not making that much money. Now if you're making 500 k a year and you're like, okay. Great. I could qualify for real estate professional status or something like that, then by all means, this stuff can be very powerful for you.

Mike DeHaan: [27:12] Yeah. And I think another thing with that too people need to realize is there is an industry around cost segregation studies. There are entire companies that are that's all that they do. And they go and they have professional content teams, and they're on podcasts, and everything else saying, you need to do these cost segregation studies to reduce your taxes. And all the newbies go, I do. What's this guy's company? Cool. I'm gonna reach out to them, and I should just pay them. Right? Which is totally fine.

Thomas Castelli: [27:37] Right?

Mike DeHaan: [27:37] Like I mean, that's why we do this. That's why you have your your tax podcast. Right? It's generate customer, just lead generation. But understand that that is why people say things that like sound enticing to you. It is to get you to get your business, to get you to engage with them. And you need to understand the fundamentals of this business enough to know if something is actually right. Mhmm.

Thomas Castelli: [27:57] Right. Yeah. And I

Dan Austin: [27:57] think the industry around that that you're speaking to Mike, is like, there's websites where you go to, they're like, just put in your information, we'll send you a cost seg study once you get us our credit card information. Yeah. Instead of talking to a strategist that like knows, like, hey, let me talk about your situation before we actually do a strategy, because you may have these other three things are going to be just as beneficial as to in addition to a cost seg or something like that. So, yeah, don't just put your credit card information in there and get a cost seg study.

Mike DeHaan: [28:22] Yeah. So, cool. Let's swing off the cost segs a little bit. I would like to go just into general tax strategy for investors. So when you're talking to, I would say people that have professional real estate status, are doing regular transaction of real estate, wholesales, flips, they own some rentals, what are some of the really common mistakes that you see people making on a tax standpoint?

Thomas Castelli: [28:44] Common mistakes. Okay. So mistakes is not having a bookkeeping system. I know it's gonna sound boring, but a lot of people don't have bookkeeping systems. And what ends up happening is you lose out on deductions, because you have all your expenses and this spreadsheet, that spreadsheet, this shoebox, this credit card, that debit card, so on and so forth. You paid this cash. You never took a picture of the receipt. And because of that, you end up missing out on the deduction. So that's kind of the first mistake. Either put it in place yourself, your bookkeeping system, or you gotta hire somebody to do it and and make sure you have it there because that's gonna be the bones of not only how you maximize your tax benefits, but also how you evaluate whether or not you're actually performing well on your business. Your business is making money, losing money, so on and so forth. So that's the first mistake. Second mistake, I would say is not realizing that when you go from say, to the real estate game, your situation is becoming significantly more complex. So what ends up happening is you have the people who will listen to that sixty sixty second TikTok clip, they'll go and TurboTax, go grab a cost segregation study, realize, okay, qual like, they hear about the real estate professional status. They'll go click that on their they'll go put into TurboTax, click the button, which is really easy to click, and they qualify as real estate professional status and get themselves in the hot hot order by erroneously using some of the strategies that are out there.

Thomas Castelli: [29:59] So the point I'm trying to make with the mistake here is not seeking the proper guidance, and realizing, this isn't just TurboTax anymore. You can go and throw your w two into into the system, upload your brokerage statements from from whatever brokerage and call it a day. This stuff is more complex to navigate. So you wanna make sure you get the professional guidance that is gonna be appropriate for for your business. Other things is just it just so those are the two biggest mistakes. Second thing is is not engaging a CPA early enough. And I know these are kinda like people just don't wait till last minute. They'll be like looking for CPA now. But guess by tomorrow, two days from now, Friday the fifteenth, is the March 15 deadline, which is for partnerships. So all the CPAs are either booked up by now or they're heads down and, you know, cranking out work. So you need to start looking for that relationship proactively earlier

Mike DeHaan: [30:47] Really?

Thomas Castelli: [30:47] Than this time of the year. And the same goes that's just kind of another mistake. So I think it's a, like, really blatant mistakes other than people just erroneously using strategies. Like just like I said, that's the biggest one. Just not quite getting the whole picture of how these things work, and just going out and doing this stuff without without doing it properly.

Dan Austin: [31:04] I learned that the hard way. I learned a couple things. When I first started buying rental properties, I was doing my taxes myself. And side note, finding an accountant, I found the best time of year is usually like June. Oh, okay. Because right after April 15, they're just they're still cleaning up and they also are about to go sleep for like three days straight anyways from being working eighteen hour days for months. So June seems to be a good time. But when I was I found this out the hard way, so I got a I I guess it would be like a fine from the IRS and like interest payments I had to pay. So I found out TurboTax, I was kinda doing what you talked about, it's like you click this button, see what that does to change your tax liability, you're like, oh, that makes it lower. Right? You're like gamifying it. But if you read the little boxes, there's some of that stuff that is like, I didn't do the real estate professional, but it's like, do you qualify? You better meet these, because we're going to file it on your behalf, and you said you were. But what I found out is, as you click through some of those, they had a glitch, at least this year was like 2016 I did it, where it wouldn't reset certain things, And so what it did, was it under made me underpay by 50% of my Medicare wages. Nice.

Dan Austin: [32:07] And so I had to pay like several thousand dollars two years later. It's always two years later. Yeah. It's never like, hey, we gotcha. But it was like they had a glitch in there, literally in their software, and then I started Googling this, and it's very common, because the software is actually pretty complex for these tax companies, these tax software companies to actually not have like a perfect system. They can have these glitches where it just doesn't calculate things right. And I was like, good to know. It ended up costing me like a thousand dollars in like interest payments, and there's nothing you can do about it, and then like, the fine was like $2.50, and then the rest was just interest payments for two years, but you don't know that for two years, that's why it accumulates. It's not like you can call them and be like, hey, I didn't know until now, they're like, I don't care. First of all, they don't have a phone number, so you can't.

Thomas Castelli: [32:51] Yeah, and then to your point, this, now that you just mentioned that, that kinda does, you know, kinda double click in my mind, some of the situations we've seen, like they could get a lot worse than that. Like we're seeing people who have wrongly took the real estate professional status save like, you know, 50 ks in taxes. Now, two, three years later, they have to go and they get audited. The IRS finds out that they can't use it. And what ends up happening is they have to pay the 50 k back in taxes plus the penalties and interest. And the more you're saving, the more you have to pay back, the higher those interest and penalties are gonna be. So it can be quite painful. And one more thing in the mistake that I could throw in there is if you get a notice from the IRS, if you get a notice, like saying you're getting audited or they're requesting information, you should go and talk to your CPA, your EA, your tax preparer, whoever's handling your taxes as soon as possible. Right? Like, literally as soon as possible. Don't wait two days before the notice is due. The IRS usually gives you around thirty days and go to your CPA. Oh my god. I got this twenty eight days ago. I need to file it tomorrow.

Thomas Castelli: [33:48] Right? That's that's another mistake. Or worse, you start engaging the IRS yourself.

Mike DeHaan: [33:52] Yeah.

Thomas Castelli: [33:52] Because there's been audit situations where people have given where they come to us in the middle of the audit, not the beginning, but the middle, and I said, here's where we are. We gave the IRS all this information. Like, well, you gave them the information or you're done. You're toast. It's over. You know? So the the takeaway from there is if you get a notice from the IRS promptly within a few days, contact your your tax preparer and make sure you're getting the proper help to have someone navigate it. Otherwise, you get yourself in hot water. Yeah. Yeah.

Dan Austin: [34:17] There's some documents we should burn.

Thomas Castelli: [34:19] What should I

Dan Austin: [34:20] be burning?

Mike DeHaan: [34:21] Yeah. I think it's a good general rule. Just don't overshare with anything like that. Right? Totally. It's like same with if you're getting like a mortgage. You tell the loan officer what they wanna hear. Like, if you're if you get pulled over, right, just answer the police officers questions. You don't need to like tell tell them everything Yeah. Because you don't know how they're gonna take stuff. Right?

Dan Austin: [34:40] How many beers have you had? 12. Were you texting and driving? Yeah.

Mike DeHaan: [34:46] Same with the IRS, but cool. So I guess as a, you know, we kinda get into tax time here, we're kinda down to the end of the show as well. What are kind of like the main things that people can be using to look ahead aside from, you know, finding a CPA, aside from having a bookkeeper? Sort of like some general strategies they can be starting like now in like the springtime to the end of the year in like a tax advantaged position. So they're not gonna be going out to the end of the year and realizing they're gonna be owing a bunch more than they would probably do.

Thomas Castelli: [35:17] Yeah. I kinda mentioned some of these things already, so it might sound redundant. But you definitely if you don't have your bookkeeping system in place, do it now. Get it done. Don't wait till the end the year, and you have to stack everything up and go back through eight months or whatever of transactions. It's nice to be painful.

Dan Austin: [35:29] We've done that before.

Thomas Castelli: [35:31] Yes. We It can be painful. It can be painful.

Dan Austin: [35:34] It does suck.

Thomas Castelli: [35:35] So I would say do that. If you're gonna qualify for the real estate professional status, start doing that now. To qualify, not only you have to meet that seven hundred fifty hour requirement that I mentioned, but you also have to document your time. Because if you are ever audited, the IRS is gonna come to you and say, hey, prove, prove it, prove it.

Dan Austin: [35:50] That is a pain in the ass. Like, how do you recommend documenting that? I've heard horror stories on both sides of that of like, well, I documented it and they didn't like it. Like, is there like a foolproof way? Because we actually just had this question in our coaching group, and I shared with them what I do, but I don't know if it's good.

Thomas Castelli: [36:06] Yeah. So, it depends. It depends. If you're a full time real estate investor, you're truly in the business full time, this is what you do is your bread and butter, you can usually just use your calendar because your calendar if you do use the calendar because your calendar will usually be pretty detailed enough to the point where they'll be able to clearly see, you know, how much time you spend, like, is legit, like, you know, no one can know what you. But if it's not if you're not doing it full time, or you're just getting started, or you're gonna be coming close to the hours, and you're not gonna blow it out of the water, I would suggest using some type of either time tracking system like Toggle or like there's Clockify. There's a bunch of them out there, a bunch of apps

Mike DeHaan: [36:43] Yeah.

Thomas Castelli: [36:43] That could be make it really easy for you, or an Excel spreadsheet.

Dan Austin: [36:46] So would you do like like with Clockify or an Excel spreadsheet, you could say like, oh, I'm gonna do say you're a real estate agent and you do that. You push, hey, I'm gonna go on a listing appointment, push toggle on, note who you did the listing appointment with, anything like should you note details on that sort of stuff? Or is that required or not? Or is it just, hey, I got proof I did it?

Thomas Castelli: [37:08] No. So, yeah, you would wanna put on and the more detail, the better within reason of But, generally, what you'd wanna put, say, in Excel spreadsheet is you wanna have your dates, the date, the amount of hours, the time you spent. You're have a description of what you did. So for example, fixed toilet in Unit 43. Right? Right. And then what property you spent the time on, and that's usually gonna be enough. I think where the issue though, kind of drill down into kind of what you mentioned, is not all time that you think would spend account, counts towards the real estate professional stat. That's where a lot of people get tripped up. Right. So maybe that is a mistake a lot of people make.

Dan Austin: [37:42] Well, seems too like a lot of it that I've read is favored more towards property management than it would be like for Mike and I, some of the stuff we do with our real estate business, because we run multiple real estate type investment businesses, and some of that work is maybe not even on the list of things.

Thomas Castelli: [37:57] Yeah. So there's something called material participation. There's a bunch of tests. We're not we don't have to go through all of them. But and basically, long story short, they wanna see that you're spending time that's gonna impact the day to day operations of your property.

Dan Austin: [38:08] So what if you're a real estate agent and that's all you do? Are you a professional?

Thomas Castelli: [38:12] Yeah. I could definitely answer that. So there's seven real property trades or businesses. One of them is brokerage, another one's rental property management. There's there's a bunch. If you're in those real property trades or businesses, you could like say this agent, for example. You could spend say you spent two thousand hours as an agent, full time job, you qualify as a real estate professional. Check that box. But the problem with that is, is if you do not materially participate in your rental properties, they're still passive. So for example, if I'm an agent, make that, I do that, but I have, I spend no time on my on my rental properties. I have a property manager, they're handling it full time, they just give me reports. At that point, I would not be able to take the losses from my rentals. So what they're looking for is, are you materially participating in the day to day operations of your rental activities? And the way they see that is usually you don't have a property manager. Usually, you're the one either you're running point or you are the property management company, so to speak. That's usually what they're looking for. So what ends up happening is people will be a developer or they'll be a flipper or they'll be a agent, and they won't have any time spent on their rentals, and that can trip you up too.

Dan Austin: [39:18] That's super helpful. That's very,

Mike DeHaan: [39:20] very helpful. That's one of

Dan Austin: [39:21] the most confusing things that

Mike DeHaan: [39:22] we get asked all the time. It seems to be such like a gray area. And honestly, it's very almost like subjective. Like, really, like how you can view the different things and Right. You it leaves it open to like, I don't know, someone could fudge their hours, I guess.

Dan Austin: [39:38] Well, the way I was like thinking about it previously is like, would have so many Home Depot receipts I actually started tracking. Use MileIQ as the app I use, and it tracks automatically your drives and says, hey, where were you going? Was this for business or personal? When it just already knows. And then so I was like, well, you combine that with the Home Depot receipt I have, like, that's pretty good freaking proof that I went to Home Depot. Now I just need to say what property it was for. Because it would be like, hey, I am driving to Home Depot, picking up whatever two by fours, taking it to a project like that whole process that may took three hours, that there seems to be a proof without any doubt that that's what I did.

Mike DeHaan: [40:15] But then where it gets gray, right, is let's say you do that Home Depot trip on the way home, you go and pick your kid up from school, then you

Dan Austin: [40:20] go to the grocery store. Exactly. It's like what point, like you have

Mike DeHaan: [40:23] to stop it when you leave Home Depot?

Dan Austin: [40:25] Well, no. That's where you because the way my app actually works is like it knows when you stop. But then you would have to like, you still have to classify all of it, right? So it you can spend a ton of time here. I think the challenge is is like you could spend four hours a week easily just tracking your time.

Thomas Castelli: [40:40] Yeah. You have to you have to be careful. There's a balance to it. Okay. But if you do it proactively, use like an app, it's not that bad.

Mike DeHaan: [40:46] Right. Awesome. Well, we're right up on time here, Thomas. And you wanna tell everyone what you do for people in the tax strategy world and about your podcast that you run?

Thomas Castelli: [40:56] Yeah. Absolutely. So we help real estate investors reduce taxes. So it doesn't matter whether you're full time, you're passive, you're doing it part you're commercial, residential. We work with real estate investors across the spectrum. We also do tax preparation so we can file your taxes and, of course, outsource accounting. And then we have a podcast where we dive deep into all the strategies we discussed here and a lot more. That's the Tax Smart REI podcast. It's on Apple, Spotify, you know, wherever else. But that's what we do. We help people reduce taxes, streamline their accounting systems, and then we have the podcast, which helps kinda get that message out there and helps kinda clarify for people what is possible because we do go in-depth. We don't do the sixty second TikTok clips on the podcast.

Mike DeHaan: [41:33] Awesome. And then if you wanted to follow you directly or reach out to you, what's the best way to do that?

Thomas Castelli: [41:38] Yeah. The best way to do that would be to go to thomascastelli.com/links. There I just have all my links, my social. I'm gonna be really active on Twitter this year. So Twitter would probably be the best place to contact or connect with me.

Mike DeHaan: [41:50] Perfect. Yep. And we have your LinkedIn, your Twitter, your Instagram, your TikTok, your website, and your YouTube all in our notes. And so we will put all those in the show as well. Don, nice man. Thanks so much for coming on the show. We really, really appreciate your time. You're obviously a wealth of knowledge, and I'm sure Dan might have some additional questions for you as well. So hope you guys appreciated all the information that was dropped here. Definitely reach out to Thomas if you're trying to figure out any of these confusing tax strategies or situations that come around owning a real estate investment business. Remember, people come on these shows because they want you to engage with them. So don't be shy. Shoot him a message. Check out his business, and we will all make a mutually beneficial sort of ecosystem here where you are learning, he's getting business, and people will still keep wanting to come on here because it's worth their time. So appreciate your joy, guys. We appreciate you guys all listening, and we'll talk to you next week.

Dan Austin: [42:38] Thanks, Thomas.

Thomas Castelli: [42:39] Bye. Thanks for having me.

Speaker 4: [42:40] Thanks. Thanks for listening to collecting keys. Drop us a five star review on iTunes and send us a screenshot to mike@collectingkeys.com for your chance to receive a free collecting keys t shirt.