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Year-End Tax Tips and How to Owe Even Less in 2023

The BiggerPockets Money Podcast
30 min read
Year-End Tax Tips and How to Owe Even Less in 2023

If you talk about how to avoid taxes, most people will think you’re doing something fishy in the eyes of the IRS. Very few know you can use the tax code to massively lower your year-end burden, all while making an ordinary income. Real estate investors have been doing this for years, using so-called “tax cheat codes” like depreciation and cost segregation studies to write off massive paper losses on their taxes. But how do they do it, and if you’re an investor, can you do the same?

Natalie Kolodij, IRS Enrolled Agent, works exclusively with real estate investors to lower their taxes as much as legally possible. She knows the tricks of the trade that allow investors to not only pay less at the end of the year but grow their businesses more efficiently so financial freedom comes even faster! Natalie is also an active real estate investor and part of the FIRE movement, so if there’s one person who knows the right tax moves to make, it’s her!

Natalie gives us a masterclass on how investors can lower their 2022 taxes as the year comes to an end, how to set yourself up for a successful 2023, and the massive real estate tax write-offs you should be utilizing. She also touches on how much CPAs and tax preparers can cost, when to start strategizing your taxes, backdoor Roths, and how to legally pay your children tax-free income so they get a boost on their financial future.

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Listen to the Podcast Here

Read the Transcript Here

Mindy:
Hello, hello, hello, and welcome to the BiggerPockets Money Podcast where I interview tax expert Natalie Kolodij and talk about taxes and planning for 2023.

Natalie:
Looking into 2023, so looking for the upcoming year, this is when you should be talking to your professional about if it makes sense to change your entity for the upcoming year. Maybe you’re doing flipping or wholesaling and an S corporation might make sense. Maybe you have children and you want to have your kids help in the business and you want to put them on payroll. This is an awesome strategy, and we hear about it a lot, but no one walks you through the steps of what you have to do. And you do have to set them up as an employee. You do have to set up to file those payroll reports. You do have to find tasks they can do and actually pay them for them.

Mindy:
I am Mindy Jensen, and I am here to make financial independence less scary, less just for somebody else, to introduce you to every money story, because I truly believe financial freedom is attainable for everyone, no matter when or where you’re starting. Whether you want to retire early and travel the world, go on to make big time investments in assets like real estate, start your own business, or simply make your tax preparations for next year easier, we will help you reach your financial goals and get money out of the way so you can launch yourself toward your dreams.
Now, we have spoken with Natalie on several episodes in the past, episode 112 and bonus episode 118 and a half. Before I bring in Natalie, let’s take a quick break. And we’re back. Natalie is an IRS enrolled agent, which is kind of like a super tax nerd. She has been working exclusively with real estate investors for almost a decade. As an active real estate investor and FIRE enthusiast, she understands the need to pay as little tax as legally possible while simultaneously ensuring you qualify for the financing that you need to grow. Her hobbies include posting sassy responses to incorrect tax answers on Facebook and making pottery and traveling. Natalie, welcome back to the BiggerPockets Money Podcast. It’s so nice to see you. I’m so excited to talk to you today.

Natalie:
Hello, Mindy. Thank you so much for having me. I am always excited to talk about taxes.

Mindy:
I actually know an extraordinary number of people who can say that. But in real life, not everybody is super excited to talk about taxes. I, however, am, and I think that everybody listening is also very, very excited to talk about taxes. Before we jump into 2023, let’s do a quick review of 2022. What are some year end tax tips for people to keep in mind as they’re getting ready for next year?

Natalie:
Yeah. I would say something to keep in mind is that at this point we’re at the end of the year, so you’re really kind of limited on what you can do now. But a few things that you should look over and start preparing for are start organizing now. We just got through Thanksgiving. People aren’t thinking about tax time yet, but you should be. So start gathering the receipts, putting everything into a spreadsheet, getting organized now to save the headache in April. And then be mindful of what you can do for the end of the year. There are some things you can do there. Talk to your CPA, look at your business numbers. See if you do need a new vehicle before year end, or see if there is more you can put into a retirement account or any of these year end planning activities you can do to lower your income.
Another good thing to look at before year end is things that relate to your personal expenses. So looking at your charitable contributions and being mindful of your primary home insurance and taxes. If you pay those out of pocket, not through escrow, the timing on all of those things, it might make more sense to time it so you’re making two payments in one year, if you have the option, some flexibility there so that you can get above that mark for itemized deductions. Or before making a big year end charitable donation, instead of doing 10,000 this year, it might benefit you to do 20,000 all next year instead and combine them. So sit down with your tax professional now and see if any of those year end sort of shifts of payments impact you or if you’re in a place to, like I said, add some other expenses through a car or a contribution or any big business purchases you might have left for the end of year.

Mindy:
Natalie is too nice to say this, but I am going to remind you that year end is December 31st. However, your tax pro doesn’t have any time to talk to you at 4:30 on December 31st if that’s when you’re first making the call. And you don’t have a lot of time to do any of this stuff at 4:30 PM on December 31st. So that you have an opportunity to speak with your tax pro and they have an opportunity to get back to you.
Also, she said, “Start organizing now.” That means now, not, “Oh, next week,” which gets puts back to the next week and the next week and the next week. Your tax pro will absolutely love you when you come up to them on February 1st with all of your ducks in a row and you say, “Here are all of my things. I would appreciate it if you could do my taxes this year,” as opposed to you rolling up on April 14th with all of your receipts stuffed into a shoebox and say, “Hey, could you do this for me by tomorrow?” I know the answer. Let me look in my crystal ball. “No.” That is the answer of every single tax pro. And if they say, “Yes,” they’re not a good tax pro.

Natalie:
Yeah, that’s a big part of it. If someone’s just got that free time at the busiest time of year, ask yourself why. So your good professional’s going to need some heads-up. You’re going to need to get in a queue to work with them.

Mindy:
Let’s talk about getting in the queue to work with them, getting a new tax professional, getting a CPA. When should a taxpayer or an investor start thinking about getting a CPA? When is too soon? And when is like, “Ooh, should have done that a while ago”?

Natalie:
Yeah. There’s no right or wrong answer to this, and this comes up a lot. It’s based on your personal situation, because, like you say, personal finance is personal. So if your plan is you just want a couple of rental properties, you’re probably never going to do anything too complicated, or you’re just investing through your retirement accounts at work, if it’s pretty simple, you may or may not need a professional, or just using the person your family uses or something like that might be perfect.
But if you are one of those people who is like, “I want to be retired in the next two years. I’m planning to buy so many properties. I want to set up a solo 401(k) and a Roth for my kids and do all these complicated things,” you should probably bring someone on board sooner. It’s just a balance between having the strategy and then the cost, and so there’s that tipping point. But if you’re really hitting the ground running and you’re going all in, it’s like anything else with your business where paying for that expertise early on can really help get you there sooner. But don’t jump the gun if you’re not overly complicated yet. There’s a lot that you can learn on your own, and work with just a general tax practitioner.

Mindy:
Okay. I don’t know if you’ve heard this, but in the news lately, there has been this concept of quiet quitting or outright quitting and there’s a shortage everywhere and nobody wants to work. Has this hit the CPA and tax professionals as much as everybody else?

Natalie:
Yes, in a huge way. And it’s funny because when I was in college, they were telling us that 70% of current CPAs were going to retire in 10 years. And at the time we were like, “Oh, great. Job security.” Well, now here we are. We’re at that point. We’re 10 years in and it’s happening. Especially with COVID the last few years, the CARES Act, all of the stimulus checks, the PPP loans added so much work and so much new tax law that a lot of people who were in the end of their career there or close to retiring were just like, “Heck this, I’m out,” and they sold their firms, they retired, they got out of tax. So there’s a big shortage right now in tax. So I’m getting a lot of people who are getting kind of shuffled around. The person they’ve worked with for 20 years might be retiring. They’re trying to find someone new. And so this is especially a year to start looking early because there is a huge shortage of professionals right now.

Mindy:
This sounds like we’re going to circle back to that get prepared, get your stuff in line, get all your ducks in a row, because if your tax preparer is out of business and you don’t find out until April 14th, you are going to be in a pinch. And I would hope that your tax preparer has sent a note out saying, “Hey, I’ve retired. You’re going to need to find a new tax preparer,” or even better, “Hey, I’ve retired, go reach out to Natalie,” but if they do that with their whole business and you’re already totally booked, you’re not going to be able to take on their whole new business. So start looking. When is too soon to start looking? I’ve already decided that I need a tax preparer or I’ve been using one and they retired. Should I start looking now? Should I start reaching out to tax pros now?

Natalie:
Yeah. What it comes down to is just don’t reach out during tax time for someone new. If your taxes are done for the year and it’s February and you’ve done yours, that is not the time to start interviewing people. They’re busy doing taxes. So anytime after April 15th, like over the summer is a really good time to talk to several professionals, or now at year end is kind of a good time. But don’t wait until they’re in the thick of tax season to try to switch because a lot of people are going to be booked at that point and not taking on any more clients for that year. It’s like trying to get into preschool. We’re going to end up with these seven year wait lists, the same as everything else. But you have to plan the summer for the upcoming tax years, when I would say would be the best time to start talking to people and setting up those consultations and interviewing some people.

Mindy:
Okay. So I find myself in a rather unique position, being very cost conscious. Some people would pronounce that cheap. Some people would pronounce it frugal. And also knowing that there’s this shortage and the law of supply and demand means that there’s a high demand, so it’s going to cost more. How much does a tax preparer cost? It feels like I want to get… I mean, who doesn’t, right? … I want to get the most for my money while paying the least for it. But how much does it cost to have your taxes done?
I mean, I know that getting a plain old tax return is going to be way different and much less expensive than a more complicated… I have a very complicated, not very complicated, but I have a solo 401(k), I have an LLC, I have investments within the LLC, I have multiple streams of income, I have all these things, and I pay more than my daughter will, who just has W-2s and that’s it. I mean, frankly, we’re probably going to do TurboTax on her because she has nothing. She has no deduction. She’s not even going to end up paying taxes because she’s going to make $1,000 this year.

Natalie:
Yeah. It’s like asking, “What does a hamburger cost?” You can get one for 99 cents at McDonald’s, or you can go to a Michelin 5 star restaurant and get one that’s probably $500. There’s across the gamut. So what I typically tell people is, so NATP, the National Association of Tax Preparers, puts out an annual survey with the average fees, and that takes into account everywhere in the country, so really affordable places, really high cost places. So it gives you a good starting point. So cheaper isn’t always better, because if you’re working with someone who is charging $400 for a corporate return when the industry averages 1,000, there’s a why. How are they able to do that? Right? Why?
Or if you are looking to work with someone who is going to work more on the strategy side with you, that’s going to cost a lot more too. And those are two very different things. This comes up a lot in the Facebook groups. People say, “What do you pay? What do you pay?” And someone, “Oh, I pay this, I pay that.” But if the person paying more has a professional who works with them throughout the year and is saving them $40,000 on average from tax planning, is it worth it that they pay twice as much as the person who’s not getting that planning and not saving that $40,000?
So there’s no cookie cutter answer. Just be leery if someone’s much cheaper than even the standard, and look at people’s backgrounds and find what is the biggest priority for you. And if paying more to save more is worth it to you, or if it’s real simple and there’s not a lot of strategy to be applied, maybe you only have a W-2, then probably fall somewhere in the middle of the pack. But look at the credentials, look at the price point and what makes sense for you, and look at a few options and see what shoe fits best.

Mindy:
Okay. I’m going to jump in here and say I know a lot of different tax preparers, and some of them focus on small business, which means they know the ins and outs of small business tax law. How thick is the tax book this year? It’s like a billion pages long or something like that. No tax preparer, outside of Sheldon Cooper, maybe, will know everything in the tax book. They just won’t. And you can’t be everything to everyone. So you specialize. And Natalie knows real estate tax stuff. Is it real estate tax law or real estate taxes? What’s the right way for me to phrase that?

Natalie:
Either way. It’s internal revenue code. It’s just tax laws.

Mindy:
Okay.

Natalie:
But, yeah, every good professional should be focused down at this point because there is so much inclusive in the tax code, it’s impossible to be an expert in all of it.

Mindy:
Yeah. So if you have real estate holdings, you need somebody who knows the real estate tax laws. If you don’t have real estate holdings, then going to somebody who focuses on real estate tax law might not be your best choice. So what is causing you to go to a tax professional? If you have a W-2 and no fancy anythings and you could get by with doing TurboTax, maybe that’s your best choice. But if you have an LLC and a bunch of random weird stuff, then you need somebody who specializes in the things that you have. So make sure that you’re covered. Otherwise, you could be giving up large deductions, large advantages that your tax pro simply isn’t aware of because the tax code is a billion pages long. I’m not kidding. It’s a billion pages. Quote me. Okay. Let’s look forward to 2023. What are some great tips you can give an investor who is planning for his taxes?

Natalie:
Absolutely. His or her taxes, their taxes. So at this point of year, forward looking planning. So when you asked about talking about this, I said, “Oh gosh, what we always hear at the end of the year is, ‘Year end tax tips. Year end tax tips,'” but it’s really, the boat has sailed at this point. This is the time where you should be looking forward, because when you’re trying to do things retroactively, you’re going to lose out on a lot of opportunities. So at this point, looking into 2023, so looking for the upcoming year, this is when you should be talking to your professional about if it makes sense to change your entity for the upcoming year. Maybe you’re doing flipping or wholesaling and an S corporation might make sense.
Maybe you have children and you want to have your kids help in the business and you want to put them on payroll. This is an awesome strategy and we hear about it a lot, but no one walks you through the steps of what you have to do. And you do have to set them up as an employee. You do have to set up to file those payroll reports. You do have to find tasks they can do and actually pay them for them. So, that’s much easier to do at the beginning of the year and just have it set up correctly for the whole year.
Same as switching to an S corp. We always hear, “S corps save you money. You need to take a salary. You need to have an accountable plan in place to reimburse you for personal use of your car and stuff.” This is the time of year to really set up all of those things. And be properly structured from the start so it’s done correctly the whole year, instead of it being November and being like, “Oh crap, I didn’t do any of that. Now what do I do? I’ve got to file this form. I got to file that form. Is it late? Am I going to pay a penalty? Can we do this backwards for five months?” Do it at this point to get set up for the upcoming year.

Mindy:
That’s awesome. So I should reach out to my tax pro and say, “I would like a review of what’s going on for next year so that I can properly plan for next year”?

Natalie:
Yep, absolutely.

Mindy:
Let’s talk about minimizing tax liabilities. I want to pay as little tax as I legally can. I want to pay all the tax that I am obligated to pay. I do believe that I’m thankful for the roads, I’m thankful for the police, I’m thankful for the fire department, I want to pay all the tax I have to, but I do better with my money than Uncle Sam does. So let’s minimize those tax liabilities.

Natalie:
Absolutely. So there’s an infinite number of tax strategies, and this is another thing to be mindful of, because I think what happens is a lot of people hear one of these podcasts and they go to their accountant and they say, “I want to do this, this, this, this, this, this and this.” But maybe only three of those things apply to you. So the big ones that I think apply to a lot of people that are definitely worth bringing up with your accountant and seeing if they work for you, a few of those, my biggest thing I’m hung up on right now, I think a lot of us are, anyone in real estate, all we’re hearing about is cost segregations, cost seg, cost seg, cost seg.
And for those who don’t know what that is, basically, when you own a house, you get to write it off, the value of the property as it wears off in theory, across 27 years. That’s just the IRS life of it. A cost seg says, “Well, you didn’t really buy just a house. That house has stuff, right? It has floors and windows and other pieces of it.” We can use an expert to break out the cost of those and you can write them off quicker. One of those quicker ways is anything where that smaller piece, like the flooring’s life, anything with a life of less than 20 years, qualifies for bonus depreciation where the IRS just said, “Oh, if you want to, you can actually just write it all off the first year. Just go ahead and take that one.”
So 2022 is the last year for 100% bonus, meaning if an asset has less than 20 year life, you can write off 100% of its cost year one. Next year it’s going to drop to 80% and it’s going to keep dropping down over the next several years. So if you have a property where a cost segregation would make sense, you’ll want to do that before you file your 2022 taxes if that makes sense for you. So that’s a big one, and that’s why we keep hearing about it as we’re about to lose that 100% amount.

Mindy:
Oh, okay. So let’s say that again. If a cost segregation was on your Christmas list, you want to do that before you file your taxes, so in theory before April 15th. But if you get an extension, then you have until that extension deadline to do your cost segregation and get the 100%.

Natalie:
Yep, yep. And there was just a BiggerPockets Podcast episode on this. So, that’s a great starting point. Go listen to that podcast episode, I think it came out last week, to learn more about cost seg. But the things to be mindful of is the rental has to be in service by the end of 2022. So even though you don’t have to do the cost seg till you file, that rental has to qualify to be on your 2022 tax return. So it has to be in service, meaning ready and available for rent by the end of the year. So if you are about to close on a property, push the gas on that, get it wrapped up, listed ready for rent by year end, and then it gives you that four months or potentially out till October if you file an extension to do the cost seg. But that’s why it’s being brought up so heavily right now is that next year that benefit drops by 20%.

Mindy:
All right. That is BiggerPockets Real Estate episode 689 that came out last week, like you said, Natalie. That is an awesome tip. The in service by end of 2022 means that you really don’t have much time to get that going. But if you can get it rented, boy, that’s a really great tip. Again, that’s episode 689, Landlord Tax Loopholes That’ll Help You Pay ZERO Taxes in 2022. Awesome. Okay. What are some other ways to minimize your tax liabilities?

Natalie:
Yeah. This is something that I think anyone who has children should look into and that is employing your kids. This is such a great benefit, and everyone who has kids should be doing this and doing it the correct way. So the reason this is a huge benefit and how we can use this is if you or if anyone makes less than the amount of the standard deduction, which is just under 13,000, if you’re single, for the upcoming year, if you earn less than that, you are not obligated to pay tax because it’s going to be zeroed out by that, so there’s no tax on that. So what this means is that your kids can work in your business and you can pay them. And as long as it’s under that amount, what we’re doing is basically taking almost $13,000 from your 27 adult level, 35% higher tax bracket and moving it to zero. But that money stays in your household.
So instead of you needing to earn more money to then take your after tax money to buy your kids school supplies and clothes or the toys they want, the video games, the et cetera, you can have them work for you. And it does have to be a reasonable amount of salary. So you have to pay them the same you would pay someone else. They actually have to do the work. It does have to be W-2, not 1099. Triggering self-employment tax ruins the strategy. But then, yeah, you can have them work in your business. There’s all kinds of stuff they could do. It has to be age appropriate work and paid a reasonable amount for it. But then you are shifting that money down to literally tax-free. You’re getting a write-off for it. They’re not paying tax on it.
And on top of that, again, hitting just that $13,000 mark can be a little bit hard when they’re little. For a five-year-old to earn $13,000, they have important toddler stuff to do, so they’re probably not going to be able to work that much. But especially when you have teenagers, you can make teenagers do all kinds of stuff. Teenagers are probably better at running your email and social than you are. So let them go crazy with that. And once you are at that $13,000 mark, if your child has earned income, they can have a Roth IRA and they can fund a Roth IRA. So if from the time your child is 10, you’re putting that extra $6,000 a year into a Roth IRA, the average Roth balance for an 18 to 24-year-old is less than $5,000, but by the time your kid turns 18, there’ll be over $50,000 in their Roth IRA.
And that’s huge. The time value of money, that’s such a big advantage. So this is such a great strategy for that compounded reason of reducing your taxable income now, shifting it to zero income in your kids’ tax rate and then also setting them up to have this pre-funded retirement account. It’s just a fantastic strategy that everyone should look into. And again for the upcoming year, because, again, you got to set up that payroll, set up the tasks, set them up as an employee. So this is a great time to really talk to your accountant about getting that going for this upcoming year.

Mindy:
Ooh, that is a good point. And I have already been thinking about having my 15-year-old do my email and my social media because, like you said, she’s way better at it than I am.

Natalie:
Yep.

Mindy:
She’s ruthless too. Delete, delete, delete, delete. I’m like, “Oh, well, I’ll respond later.” She’s like, “No, you won’t.”

Natalie:
So when I don’t hear from you, that’s what’s happening. It’s just teenagers, just running amok.

Mindy:
I won’t let her into my texts. You can just text me. Okay. Let’s switch gears and talk about errors, because I’m sure that your tax returns are perfect, but I know not all of the tax returns that come across your desk from past years that other people have done are.

Natalie:
Yeah.

Mindy:
What are some of the biggest errors that you’re seeing?

Natalie:
Yeah. There’s a few things that we see over and over again, especially with real estate, but recently, based on what I’m hearing from other professionals and seeing wrong, there’s a few key things that I think a lot of… I hate to say standard tax professionals, but those who aren’t specialized in real estate tend to miss or don’t really understand what you’re doing. And there’s a few key things there. The big one is short-term rentals. There’s a lot of misunderstanding on this, on when it’s still a rental, if it can be non-passive, if you pay self-employment tax on it.
And so just a key overview of what to look for and how to know if you should get a second opinion is if you have a short-term rental where the average stay is seven days or less and you materially participate, and there’s seven different ways for that, but basically if you’re involved in the day-to-day management of it. But if that’s all you’re doing, if there’s no substantial services, it should not be on your Schedule C of your tax return. Schedule C is for business income and you pay self-employment tax on that. It’s an extra 15 and a half percent tax.
So if you have a standard Airbnb where you clean in between guests, you provide furniture and bedding, but you’re not offering meals every day, you’re not coming in and cleaning every day, you’re not having the sheets washed and the beds made every day, if it’s only services in between guests that you’re cleaning the apartment, then it probably doesn’t meet the qualifications to be on Schedule C and pay that extra tax. And a lot of tax professionals I think haven’t figured out the nuance to that yet. So a lot of people, I think, are paying that self-employment tax unnecessarily.
So one thing to check is if you have a short-term rental, if you know you’re not running it like a hotel or a bed and breakfast, basically, like all those extra daily services, if you see that listed on Schedule C on your tax return, I would recommend getting just a second opinion, having another accountant look at it, preferably one who’s more specialized in real estate. Because if that was the last few years, you also might be able to amend that and receive a refund if it was incorrectly reported.

Mindy:
Ooh. How far back can you go and do an amendment?

Natalie:
So you can go back three years is where you can get a refund for errors.

Mindy:
Oh, okay. Ooh, that’s good to know. What are some other errors that you’re seeing?

Natalie:
The other errors typically tie into depreciation, which is, like I said, that amount you get to write off in this. You hear about this so much with real estate because when you hear people say, “Oh, my rentals have a loss,” we’re not all just buying really bad properties, don’t do that, it’s what we call a phantom loss or a paper loss. So what depreciation is, you didn’t actually have to write a check this year to get to write off this portion of the building value. It’s just something you’re getting to write off for tax purposes versus if you have to put a new roof on, you had to pay that $15,000. That was cash out of pocket. But depreciation, there is no cash out of pocket. So that’s how you’ll have these rentals where, at the end of the year, you have cash in the bank, but then on your taxes you might show a loss. So it’s huge in real estate and it’s one of your best benefits. So you want to make sure it’s correct.
So errors we see with this a lot and the easy ones to look for are not backing out land value. So when you depreciate a house, you only get to write off the portion of the building. Land isn’t wearing out. It’s just here. We just exist on it. We’re on a floating rock. It’s just going to be here forever. So we don’t get to write off the land. So if on your depreciation schedule on your tax return, and you can find this, it’s either called a depreciation schedule or an asset schedule, it’s typically a horizontal sheet so it’s easier to spot, it’s sideways from everything else, if the amount being depreciated, the amount listed as the building, if that is literally the total you paid, then they might not have backed out that land portion that’s not allowed to be written off. So just double check that. If it’s a condo, there might not be land value because it’s all combined, but just that’s kind of a red flag.
The other thing we see missed a lot is if you’ve done a big renovation on a property. A small part of me dies inside every time I just see one line item that just says like, “Renovations: $150,000.” Because, again, there’s a good chance that part of that were things that have a shorter life. So instead of this $150,000 being written off across this 27 years, if you bought appliances, those could have been written off all in the first year. If you put in new flooring, that likely could have been written off in the first year. Any land improvements, so like new fences, landscaping, sidewalks, potentially all first year. So if you see a big, big amount written off across 27 years without any parts of the renovation broken out, there is a huge missed savings opportunity there. So those are the big things that are worth going back and looking at to see if you’re easily missing money or it can easily be corrected.

Mindy:
Ooh, that’s a really good tip. What about backdoor Roths? Something we talk about on this show is the backdoor Roth. It sounds complicated, and I think it is complicated. And I think that anytime something is simple, people will make mistakes, but when it’s complicated there’s just that many more opportunities to make mistakes.

Natalie:
Yeah. So with the backdoor Roth, in case someone hasn’t heard about what that is before, to contribute to a Roth, which is the type of retirement account where you’re not taxed on the earnings later, instead you’re taxed on the way in, so it lets it grow tax-free, but there’s an income cap. So if you earn over a certain amount, you can’t contribute directly to a Roth. So this backdoor Roth, you basically contribute to a traditional as a non-deductible contribution, and then you roll it into a Roth. You just reclassify it over to a Roth. So it’s kind of another step in the middle. But I’ve seen a lot of people who are doing their own tax returns who, on the reporting, are missing this or missing part of it. And even with tax professionals, if it’s not a tax professional who’s really knowledgeable, this backdoor Roth strategy tends to be big in the FIRE community and big in those who are more investment focused.
A lot of accountants just aren’t familiar with it and don’t know what you’re doing necessarily. So if they only get a 1099-R… Because when you do the backdoor Roth, you should have two forms each year. The 5498 shows that contribution into the non-deductible contribution into your IRA. Then the 1099-R is what shows that reclassification into a Roth. So if they just have a 10-99, they might just think you took out money from an IRA this year. They don’t know that there was another step to it. So it’s one of those things where you just want to make sure you’re communicating to your tax professional that that’s what you did to make sure it’s on there correctly and that they are knowing to ask for both forms. It’s just something easily missed, I think, because not everyone knows their client is doing it. So make sure they know that that’s what happened for the year.

Mindy:
I think the phrase backdoor Roth implies that you’re doing some sort of sneaky thing. And this is legal to do. We’re not suggesting something that’s illegal. It’s just a different way. You can’t legally contribute the normal way to a Roth IRA. So now you’re legally contributing, but it has to be through a couple of steps. So, yeah, don’t hide this from your tax professional that you’re doing this because you’re not doing anything wrong, even though it’s called a backdoor Roth. I think it kind of implies some hidden or, “Ooh, don’t tell anybody,” you’re sneaking in the back door, but it’s legal to do this. You just have to do it in different ways.

Natalie:
Yep, absolutely.

Mindy:
Okay. Let’s go back to that cost segregation because that is something that I’ve… It’s hard to sit here and work for BiggerPockets for seven years and say I thought cost segregation was just for large multifamily properties. And the way that you phrased it made it sound like you could do this on single family homes.

Natalie:
Yeah. So it kind of used to be. So cost segregations used to have only one way of doing them, where a engineer basically would come in and analyze the property and break apart those costs. So it was really cost prohibitive because it would cost several thousand dollars to have it done. So we did use to only see it on large multifamily or commercial buildings. But now there’s a few different ways of doing them, and I think it’s become more commonplace, so the pricing has become a little more obtainable. So you can still do a full-fledged cost segregation. I think they tend to range around $2,000. But there’s also a streamlined way that uses software and a database to assign values, and those tend to be under $1,000. So it’s much more obtainable on single family houses now.
And whether it’s worth it or not, there’s a few things to look at. One, and because again, we hear this a lot, people, like I said, right now especially, are going crazy for cost segs, telling everyone to do a cost seg, but step one is figure out if doing a cost seg will actually benefit you. So with rentals we can’t always use the losses they create. If your income is over 150,000, passive losses can be limited, meaning you might not be able to deduct a loss this year. You could use it down the road, it doesn’t go away, but it might not help you this year. So be aware of that and talk to your professional first before doing one. Because if you do a cost seg and create a $100,000 loss, but then your tax position keeps you from deducting it, well, that might not have been what you were really hoping to accomplish.
If you’re a real estate professional, they can always help you, if you have other passive income where you need to offset it. So this is also a great strategy if you are selling a rental this year. If you have two rentals and you’re going to sell one and have $100,000 worth of gain, maybe you don’t want to do a 1031 exchange. Maybe you just want to sell it. And if you do a cost seg on your other rental and can generate $100,000 of loss, those two can net out to zero. So it can be an awesome tool in several different ways. And this is why it’s really important to talk to your tax professional and sit down and look at your real estate and your investing and all of your business plans for the next couple of years. Because if you know you’re going to sell a rental next year, they might say, “Hang on. Let’s do this cost seg next year,” and time it out where it’s going to zero out your gain, or there might be these big picture moving parts to look at.

Mindy:
Okay. We just talked about going backwards, and you can go three years back to get a refund on an error. How far forward can you push a loss that you can’t take this year?

Natalie:
So they carry on forever. They never expire. So the passive losses just roll forward until your situation changes where you can use it. So if you then have passive income in the future, passive losses and passive income are in the same bucket, you’ll always be able to use that. If in the future your income drops down, maybe you take a year off to travel and you have no earned income, or very little, now you’re below that $150,000 mark, now you’re in the threshold where you can use some of that loss.
Or if you have, like I said, a rental, a sale of a rental creates technically that same type of passive income where it’s in the same bucket again. So it doesn’t ever go away. And so it’s important to note that even if you can’t use a loss this year, there’s likely a way you’ll be able to use it in the future or create a plan for using it. And it’s just important to do that, not just let them exist willy-nilly. Have a plan for the loss before you spend the money on the cost seg to create it. But there can be more than one way to get benefit from doing a cost segregation.

Mindy:
Okay. Now let me put on my tax amateur hat. And cost seg, this is the last year to do 100%.

Natalie:
Mm-hmm.

Mindy:
Can I do a cost seg, but I make too much money to take advantage of that, does my 100% go forward because I did it in 2022? Or is it a use it or lose it year?

Natalie:
No, it would still carry forward. So the difference would be if, say, the qualifying amount a cost seg could break out was $100,000, we’ll ignore other income expenses just for simplicity, but this year you would have $100,000 loss, and even if you couldn’t use it against your W-2 income this year, it would roll to next year. And then say next year you sell a rental and have that gain, that whole 100,000 will be available to offset it versus if you waited till next year, knowing next year you could use the loss but doing a cost seg in ’23 on your 2023 taxes, only 80% of the $100,000 would be that year one write-off. So you would lose a $20,000 differential by waiting till next year. So it might make sense to do it now, even if you can’t use it now, if you know have a plan for it for the future.

Mindy:
And how do I find a cost segregator?

Natalie:
A cost segregator, like an alligator. Yeah. So I think the starting point where I send most people is to talk to Yonah Weiss. He’s been on a bunch of BiggerPockets stuff, and he’s awesome. I would start off by chatting with him and seeing if this is a good fit for you.

Mindy:
Okay. Yeah. He is the only one that I know that does cost seg, but I’m sure there are other people who do. Wow, this was a lot of information thrown at us. Can I give you an opportunity to say, “No rentals in S corps”?

Natalie:
Yes, absolutely. When you are planning your new entities for the upcoming year, please do not put your rentals in S corps for a plethora of reasons. There might be a weird situation where it’s helpful, but as a general rule, please don’t. It’s not saving you any money, and it’s creating tax negatives.

Mindy:
Yes. Natalie has a T-shirt that says, “Do not put your rentals in S corps,” and it makes me laugh every single time. Yeah. If your CPA, if your tax professional wants you to put your rentals in an S corp, ask them why.

Natalie:
Yep.

Mindy:
And if they don’t have a really, really, really good answer, if they can’t rattle on forever like Natalie, they’re not the right tax pro for you and your rental properties. All right. Natalie, this was super fun if you like talking about taxes, which I do. So thank you very much for your time. Where can people find you and find out more about you?

Natalie:
Yeah, absolutely. So on all social media, I’m just at re_tax_strategist, and the best website to find me is also retaxstrategist.com.

Mindy:
Well, we will include all of those in our show notes today, and I really appreciate your time. You are the best. You’re my favorite tax pro.

Natalie:
Thank you. Thanks for having me.

Mindy:
And enrolled agent, super nerd, super tax nerd. Yay. All right. Well, thank you so much, and we will talk to you soon. From this episode of the BiggerPockets Money Podcast, she’s Natalie Kolodij and I am Mindy Jensen, saying, see you later, tax segregator.

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In This Episode We Cover

  • Year-end tax tips to lower your 2022 taxes as much as possible
  • When to hire a CPA or tax preparer (and how much they’ll cost you)
  • 2023 tax deductions for real estate investors and what you should take advantage of NOW
  • How to get your children investing early with tax-free income from your business
  • The biggest tax mistakes that investors make and why you may be overpaying in taxes
  • Cost segregation studies, bonus depreciation, and how to cancel out the capital gains of a home sale
  • And So Much More!

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.