All Forum Posts by: Jim Kennedy

@Stephen Sawrie, maybe I didnt phrase it properly. Tom holds his 30 rentals and buys and flips 2 others during the year, so he gets his steady rental loss from his core 30. He needs to prove the hours test for the rentals. And we group them all into one. The hours count towards the rentals becuase thats the loss you want to deduct. Theres no sense tracking the hours on the flips because there's no loss there that he's chasing. The hours must match the activity.

Jim Kennedy

@Stephen Sawrie

I know, and I'm about to share, a LOT about this and how it is good for you. I have more than a dozen years of experience with real estate professionals under Internal Revenue Code section 469.  I spent time working at the Internal Revenue Service first as a tax examiner, then in the Criminal Investigation Division, where I learned to read and understand the tax code. Also, I am a CPA whose firm prepares hundreds of tax returns for real estate investors annually including real estate professionals. I myself am the investor/owner/operator along with my wife of residential and commercial properties in NJ and until recently, Texas, two. Anyway, here is where the benefits of being a real estate professional outweigh the risks and the labor involved:.

Before I give an example of where these rules really help, I wanted to review the rules of what you stated. You are correct in that you must work more than 750 hours a year, which is about 15 hours a week, but in addition you must spend more than 50% of your time performing real estate. For example, I had a client who worked 20 hours a week loading and unloading trucks at FedEx, and she managed eight properties full-time. She got audited, and we used her log to document that she spent more than 1092 hours a year, which is 21 hours a week for 52 weeks to year. I instructed her, like all clients in this category, to book the entire years worth of time, which ended up being closer to about 1600 hrs. She did it, but she wasn't happy about all the work until she learned why: the auditor studied the log and began to challenge some of the line items, and began to hack away at the hours to try to get it below 750. The auditor failed. She identified about 160 hours that she wanted to disqualify, but we were so way over 750. I could've spent hours arguing that they were all bona fide, but rather than run the bill up, I said, "okay, go ahead." When the auditor did that, my client was still well over the amount required.

So here is an example of where the code section 469 regulations work to the taxpayers advantage: my client, "Tom"  is a full-time real estate investor. By taking advantage of the loopholes that I taught him about cost segregation and component appreciation, every year his 30 or so rental properties generate a $48,000 loss. Because he is a full-time real estate investor, is not passive, this is how he feeds his family, so the risk of gain or loss is recognized in the current year. Yes, I enter a$48,000 loss for him and I'm comfortable with it. Why? I'm glad you asked. Here's why:

There is about $60,000 of depreciation in that $40,000 loss. Remember, depreciation is a paper expense – you don't really write a check for it. So as an IRS auditor, I wonder where the money comes from to pay the bills (follow the cash, follow the cash, follow the cash). If you take that $48,000 loss, and add back to $60,000, you are at positive $12,000, or $1000 per month. It passes the smell test with flying colors.

This is just background, though. Here's the payoff. Tom slips two houses a year and makes 70 or $80,000 of taxable gain. When you take that $80,000 of gain, and offset it with the $48,000 of deductible rental losses, it leaves him with $22,000 of taxable income. His itemized deductions and his dependency exemptions for his wife and daughter and up zeroing out his tax liability completely.

Think about that for a minute: this guy makes $80,000 of cash profit for two flips and pays no income tax on it whatsoever. Not a bad lifestyle!

What if he gets audited? I know he's a target, so I showed him how to keep an investors log to document his time spent, and he books his time, day by day, property by property, 15 min. by 15 min. I suggested he buys some tax deductible speech recognition software, and as he makes his notes thru the course of the day, he later dictates them into a gigantic word document, when he gets home and at the end of the year he sends it to me along with his tax information that he e-mails up. He lives in Florida, and I am located in southern New Jersey. 

And, for the record, to further tighten down the documentation and decrease his risk of negative audit outcomes, he uses a list that I provided him of 64 things that are personal property upon which we celebrate the depreciation. Each one of these things is fully substantiated by a private letter ruling, a revenue ruling, regulation section, or a court case.

Is it a lot of work for him? He hates recordkeeping, but keeps his log religiously because he knows it will save income tax on $70-80,000 every year. This will be his 11th year of filing like this with me, and there's been no audits by the IRS by correspondence or by personal visit. being prepared ahead of time? It's just one of the things that I hammer away with all the time, not just in real estate or tax planning but in all phases of my life: the 5P's of the Marines teach us "prior planning prevents poor performance"

I have other clients who are real estate professionals, and the more properties you have, the bigger the loss you can legitimately generate.Hope that helps.

Jim Kennedy

My 2 cents: I am a CPA and have been using QB for over 20 years. We use the QB class system, and manage a dozen properties very nicely. It doesn't have the features or PM software extras such as rent rolls and lease expiration dates, but it works well to summarize information for the tax return and for reconciling cash.

When I worked at the IRS, I was taught to follow the cash. If the cash ties in to the bank statement then it doesn't matter if you call it legal expense or professional fee.

Jim Kennedy 

Yes! Your accountant didn't tell you that either? Hmmmmmm.

Jim Kennedy

@Steve Babiak - Your considerations are correct and there are more, but as I wrote, I was only going for the 10,000 foot overall big picture.

Jim Kennedy

@Kimberly H.

Yes there is a new due date. I filed an extension for some of my clients who asked.

My comment here is about the The Protecting Americans from Tax Hikes (PATH) Act of 2015. At a recent continuing ed seminar I learned that the if P.A.T.H. applies Except Those In Congress, P.A.T.H.becomes P.A.T.H.E.T.I.C.

Jim Kennedy

@Pandu Chimata - Okay, then so much for my bright idea!

Jim Kennedy, CPA

@Timothy Metra

Staring a business for a legit purpose? Now there's a concept worth looking into. 

Before everybody gets hyped about writing off their lease, lets review how to write off your vehicle expense. There are two ways to write off auto expenses: what is the actual method and the other one is the mileage method, and the basic concept will pretty much match whatever you thought when you read those words.

before I dig in, this is not tax advice. Do not rely on it because I do not know the unique facts and circumstances to your particular tax return. While all tax returns are the same, all taxes are different. They are the same in that we all use the same forms and schedules, and they're all different because the two of us have the same facts and circumstances. There are a few other points of the tax code that I don't have the time to get into. This commentary is basically a view from 10,000 feet, okay? Good. Let's do it:

In the mileage method, you track your miles in a logbook, day by day, or you use an app like mild bug or something else. (there are other ways to but again were working from 10,000 feet here) The problem with the apps is many of them are free, but only for the first six months. Anyway, you take your total business miles that you track and you multiply them by the applicable rate, which Congress changes every year to adjust for inflation. For example, in 2015 the rate was 57.5 cents per mile. Gas prices came down and for 2016, the rate is 54 1/2 cents or so. So, if you drove, say 10,000 miles for business that you had documented in your log or app, it would be that many miles times the applicable rate, and you would have a deduction of about just under $5500.

The actual expense method, you track all the actual expenses of the car. Hey Jim, does that include tolls? No. It only includes what happens inside the car. Tolls are separate. I'm talking about gas, oil, tires, battery, wiper fluid, etc. etc. So you track all your receipts, and total them up. Then you can take an allocable portion, and the allocable portion is a percentage. The percentage is the number of business miles traveled by the total number of miles. If you drove 10,000 miles, and 7000 were business, and 70% of all your actual expenses would be deductible. That you would depreciate the car or truck also. That he would do the same thing with the lease payment.

So either way you are supposed to track your miles. Yes there is a 90 day rule what you can develop a representation of three months and then annualize it, but the IRS can always challenge that. They cannot challenge a logbook as far as total miles.

Unless you are leasing a Cadillac Escalade  and paying $3600 a month for the lease, and almost every single situation I've seen as a CPA filing tax returns the mileage method is more beneficial. It also involves less work and less tracking. I don't just save my clients money, I also try to help them save time to.

There is one more little loophole that makes the mileage method more attractive. In the first year that you place your vehicle in service, if you elect the mileage method, you can that flip-flop back and forth to whichever is more advantageous for you. For example if you do that, and then in a future year you have to replace the entire transmission and spend a ton of money. If this board bandits for you to take the actual expense percentage, you can!

Jim Kennedy, CPA

Something is not right in this. I cant put my finger on it. I emailed an IRS Liaison I know to get his take on it. Ill report back.

Jim Kennedy, CPA

@Timothy Metra I worked in the Criminal Investigation Division of the IRS. I now own a CPA firm (a business) and my wife and I run a huy-and-hold business. Notice that we run both fo these businesses with the intent of making a profit (more on that in a few more sentences) The fact is you can TRY and deduct ANYTHING you want, but if you cant substantiate it in an audit, you will be in big trouble. I would never sign a return with this kind of aggressive borderline fraud. One of the biggest factors at the IRS  is whats known as "taxpayer intent" Open a business and show no gross revenue? Taxpayer intent is not to have a profit. It is to misrepresent the purpose of the business. Here are my comments on the items you listed:

• 1.If he is suggesting what I think, then this can be done. If he is saying to claim that many dependency exemptions on your W4, its ok. It just tells the withholding tables how many mouths you are feeding, and tax is withheld accordingly. More mouths: less withholding. All it does is result in the lowest amount of Fed w/h check after check. That means you get more net pay up front, but you may end up paying serious amounts come filing time, along with underpayment penalties and interest.
• 2.That’s a fraud. Theres no intent to generate business income. A business by IRS standards is not a hobby if it has a for profit motive, does advertising, has necessary expenses and shows income or attempts at making income. If you say it’s a business and you know its not, that’s fraud – “a willfull misrepresentation”. And then you sign the affidavit that everything is true and correct as far as you know and its not: That’s perjury, and against the IRS, a government entity: that’s a felony offense.
• 3.Need to have a documented mileage log to sunstantiate it under audit. Plus if its used in the sham business, see previous comment.
• 4.This is the result of #1 – see above. 

The IRS assigns a rating to your return called a DIF score which is used in determining what returns will get selected for score. What this guy is suggesting would blow the DIF score thru the roof.

There are other CPA's on BP besides me. Even though I seem to have more buy and hold and IRS experience then others here, I seriously believe that none of the CPA's or tax preparers on this very page would pull any kind of stunts like the podcaster suggests, and all their work is of honest intent to pay the lowest legal amount of tax. Even if BP members don't come to me, I would rather see them go to another legitimate candidate than to do this kind of risky stuff.

Jim Kennedy, CPA