WS1908 Who Can Actually Deduct Real Estate Losses? | Kelsey Head

In today's episode of the Real Estate Syndication Show, we had the pleasure of speaking with Kelsey Head, a seasoned tax expert and partner at Head Tiler LLP. Kelsey brought her 19 years of tax experience to the table, providing invaluable insights into the tax nuances of passive investments, particularly in real estate syndication.

Key Takeaways:

• Passive Loss Limitations: Kelsey clarified a common misconception among new investors regarding passive losses. The IRS allows the collection of passive income without concern, but passive losses can only be deducted against passive income, not active income like wages from a job.
• Depreciation and Passive Investments: Many investors are enticed by the promise of significant depreciation in the first year of investment. However, Kelsey pointed out that unless you have other passive income, these losses don't provide an immediate tax benefit. They are not lost but carried forward to offset future gains from the sale of the property.
• Active Participation Requirements: To be considered active in an investment, one would need to contribute at least 500 hours of work to a single activity. For limited partners in a syndication deal, achieving this level of involvement is highly unlikely.
• Offsetting Gains with Carried Forward Losses: When a property is sold, and a gain is realized, the passive losses that have been carried forward can be used to offset this gain, reducing the potential tax burden.
• Investment Timing and Strategy: Kelsey suggested that investors might need to be more strategic with their investment timing, especially with the phase-down of bonus depreciation from 100% in 2022 to 80% in 2023 and further reducing in subsequent years.

This episode shed light on the intricacies of passive investment taxation, emphasizing the importance of understanding the IRS rules and planning accordingly. Kelsey's expertise highlighted the need for investors to manage their expectations regarding immediate tax benefits and to consider their long-term investment strategy for optimizing tax advantages.

Remember to like, subscribe, and share the Real Estate Syndication Show with friends who could benefit from these insights into real estate investing and taxation.

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Transcript

Whitney Sewell: What the IRS says is, you know, nice try. If you have a passive investment, you can always pick up passive income. They're never, you know, worried about that. But you cannot take a passive loss unless you have passive income to offset it.

Kelsey Head: This is your daily real estate syndication show. I'm your host, Whitney Sewell. Today, our guest is Kelsey Head. She's a partner at Head Tiler LLP, which she founded in 2020 during COVID after leaving a large firm. But this is her 19th year in tax. I think she said to be approximately 18, 19 years of experience in tax as a CPA. She is going to dive into a series here with us. I hope you'll listen to each segment because we're going to dive into different questions that I get asked as an operator from our limited partners often. And so you're going to hear a number of things that I know you've had questions about. Kelsey, welcome. I'm honored to get this time with you to interview you and really go through some tax questions. I know I get asked all the time, and often I have to say, hey, I am not the one to be asking that question of. And so I have to look for, obviously, people like yourself, right, that are team members of ours, that we partner with, trusted experts like you that have those skill sets. And in your case, it's tax, which we seem to, most of us need help in that world of tax. So happy to get to chat with you today. Welcome. Thank you. Appreciate you having me. Kelsey, who can actually deduct these real estate losses, right? I think there's confusion there often. Who can use those? Who can't?

Whitney Sewell: That is probably one of the number one questions I get a lot of times. It's new investors. It's their first real estate investment. And this doesn't only pertain to real estate, but it's anything that is passive. So I give you $50,000 of my money. And then essentially, other than checking in to make sure it's going okay and getting my distributions every year. I don't do anything right I, I invest my money for you to put it to work. Then we sell a property and I get, you know, some percentage of that sale, and hopefully that's a gain and we move on. So by nature I'm passive in that investment. So what the IRS says is, you know, nice try. If you have a passive investment, you can always pick up passive income. They're never, you know, worried about that. But you cannot take a passive loss unless you have passive income to offset it. And so what I, what I find the most often is that someone goes out and they read these offerings or they read you know blogs or wherever they get their news source. And they, they see invest 50,000 and get 35,000 of depreciation expense in year one, you're going to get this big loss and save all these taxes. And that's where everyone stops reading. And what, what really happens is, assuming that's in a bubble, and you just have that one K one, I don't have 10 other investments that I'm not active in that loss. doesn't go anywhere. It sits there, you get to keep it, it's yours, but you can't deduct it in the first year because you're not active. In order to be active, you'd have to have at least 500 hours in any one activity. Looking for investments doesn't count. So truly out there pounding the pavement, part of it, or more than anyone else. So in an LP deal, a normal real estate deal, that's just not gonna happen. However, all of that loss carries forward. And so when we were talking earlier of, you know, we had gain on a sale and so I got distributions of $100,000, but I have $100,000 gain so I normally have, you know, somewhere in the $30,000 tax range. Instead now because I was passive. I've got all these old losses if I hold the property, say, three years. Year one and two losses are hanging out there. They didn't help me, right? Nothing happened. But now in year three, I sell it and all those old losses collapse down and help me out against that gain. So if you had taken it in the past, then you'd be totally exposed on the game. But by not taking it, and it hangs there, then the two net come together. And that's where you get your benefit. So you you get it, but it doesn't, it's not going to offset your wages from your doctor's office, your wages from, you know, wherever you may work, that passive loss is just not not going to offset that. And I think there's just a lot of confusion around that particular little nuance that we get really excited about the depreciation losses, but don't stop to make sure it all fits into your particular situation.

Kelsey Head: Yeah, I know, especially early on, I remember being confused about that, especially the more investors I talked to as well, you know, and they have a W-2 and that's what they're hoping for. Right? That's what they're open for.

Whitney Sewell: Absolutely.

Kelsey Head: Yeah. Wouldn't we all, right? But it's the, you know, you have to remember, you have to have the passive investment or the passive income, right? To have the passive losses. But even the active piece, you mentioned to be considered active 500 hours, and that's pretty significant.

Whitney Sewell: Right, right, it's a lot and you know you can you can get there a lot easier if say you own a rental property so you, you know, buy a couple of duplexes, then it's a little easier to get to that active participation, and you maybe take some of those losses there. But they're going to find a way to take them away if they can like that's the way I always try to tell everyone and think about it is if it if it sounds too good or too easy. It probably is. And so just always keep in mind that, you know, if you're if you're putting up 50 grand. that you understand that there's there's kind of a deferred portion of that so you're you're going to get your investment back and you're going to get to take losses or offset that game but it might not be a you know right up front gratification on that on that tax savings.

Kelsey Head: Yeah, so if you are, and then maybe this is too specific, but if you're a W-2 employer, you're a doctor or whatever, it may be beneficial to own a duplex so you have some active hours. Is that in real estate?

Whitney Sewell: It helps a little bit, but it still won't get you there with your LP investments. It would just maybe get you some losses somewhere else. It might help you out, but these LP investments, For the most part, if you're a W-2 employee, you're just not going to get there. So it's more about where it comes into play is, say I'm in a year where I had my first LP investment, and now we're into that sale year. And I don't have enough losses to offset that gain. And I've got a bunch of ordinary income and sitting out there and I'm exposed. That's when you can time it and maybe go into another investment. And because you have passive income from a sale, now you might get to offset with some of those new losses. So you start into a pattern, if you're willing to do it, you start into a pattern of kind of chasing deals is what you end up with. To where if I know I've got a big exposure of tax in this year, well now's a good time to go invest in another property, get some of those losses to help offset. You're kind of pushing it down the road, As long as you're willing and able to put up the money, that's how you can kind of use those losses.

Kelsey Head: Wow. Any other tips or thoughts around that or the way people have done that or just any confusion around that from LPs?

Whitney Sewell: Right. I mean, I think the big thing now is the bang has gone down a little bit because bonus depreciation is phasing down. So up through 2022, we were taking 100% bonus doing cost segregation studies. It was easier getting a good 30% of every property as 100% bonus and deducting it. 2023 comes along, that's 80%. Now we've started 2024, we're down to 60. Now, you know, we're all patiently or impatiently waiting for something to happen. And that get changed again. But right now, we're at 60%. And so you're really gonna have to start to be careful, I think you're going to see people maybe being a little more deliberate about when they invest and how they invest. knowing that the dollars are a little smaller now. Again, it's all timing, right? You get it. It's just a matter of when.

Kelsey Head: Thank you for being with us again today. I hope that you have learned a lot from the show. Don't forget to like and subscribe. I hope you're telling your friends about the Real Estate Syndication Show and how they can also build wealth in real estate. You can also go to lifebridgecapital.com and start investing today.