134 I Am An Accredited Investor, Is Pass-Through Depreciation Possible?
In today’s episode of Passive Wealth Show, Bill Fairman and Jonathan David of Carolina Capital Management will answer the “ Ugly Question” of the day:
” I Am An Accredited Investor, Is Pass-Through Depreciation Possible? “
0:01 – Teaser – “ As an investor, have you ever wondered if you could take advantage of tax deductions?”
0:42 – Introduction
1:43 – Breaking News
14:45 – Today’s “Ugly Question” – I Am An Accredited Investor, Is Pass-Through Depreciation Possible?
Carolina Capital is a hard money lender serving the needs of the “Real Estate Investor” and the “Small Builder” borrower who is striving to build wealth and generate income for themselves and their families. We offer “hard money rehab loans” and “Ground-up Construction Loans” for investors only in NC, SC, GA, VA, and TN (some areas of FL, as well).
As part of our business practices, we also serve as consultants for investors guiding them to network with other investors and educating them in locating and structuring transactions. Rarely, if ever, will you find a hard money lender willing to invest in your success like Carolina Capital Management.
Bill Fairman (00:00):
Hi, it’s Bill Fairman and Jonathan Davis. Wendy is not going to be joining us today.
Jonathan Davis (00:08):
Yeah. Contain your sadness.
Bill Fairman (00:08):
Well, there’s nothing wrong0. She’ll be fine. As an investor possibly in a fund, have you ever wondered if you could take advantage of some of the tax deductions and things that most property owners can take advantage of?
Jonathan Davis (00:28):
Things in details coming up.
Bill Fairman (00:31):
Yeah. Right after this. I’m sorry. We meant to say stuff in details.
Jonathan Davis (00:44):
Instead of things.
Bill Fairman (00:47):
Welcome to the Passive Wealth Show. Once again, I am Bill Fairman. This is Jonathan Davis. We are Carolina Capital Management. We are lenders in the Southeast. We make loans to real estate investors. So if you’re a borrower interested in borrowing money, go to our website, CarolinaHardMoney.com click on the apply now tab. If you’re an investor looking for passive returns, then click on the accredited investor tab. Don’t forget to share like, subscribe, hit the bell. Also, we do have a comment section for questions if you have any. It’s either on the right hand side of your screen or below, depending on the platform you’re viewing us from. But in a question, if we have an answer, we’ll answer it. If we don’t, we’ll tell you we’ll get back with you or find someone who does.
Jonathan Davis (01:40):
We’ll conveniently skip over and not see it.
Bill Fairman (01:43):
We have some interesting real estate news locally that we’d like to discuss. So let’s get to the breaking news. Okay. And we’re back. All right. So I’m going to cover really quickly the employment numbers that we’ve been covering every week since the pandemic. So last week’s numbers that were initial claims of 683,000 was the lowest since COVID.
Jonathan Davis (02:29):
Which is great, which you know, couples with, you know, Friday’s job reports will be the highest that’s been, what? 8 months, 9 months?
Bill Fairman (02:35):
So if you go back this week, a year ago, initial jobless claims were over 6 million and this week it was 719,000. So it’s drifted up a little bit from last week, but still, if you want to compare the two it’s the economy has come back
Bill Fairman (03:04):
And you can couple with, I mean, you know, hospitality is starting to add more jobs because they’re allowed to being opened up more with more vaccine. If people are taking vaccines and stuff like that,
Bill Fairman (03:15):
Speaking of vaccines, I’ve been waiting for the Johnson and Johnson shot because I only want to do those.
Jonathan Davis (03:20):
Well they’re back, order now.
Bill Fairman (03:21):
And now they had a problem with their manufacturing and they took 20 million doses off the market. So apparently my wait is going to be a little bit longer. Fortunately, I still have antibodies. So I get time. If you guys are wondering why and I just posted this on our, Facebook page, the Carolina Capital Management Facebook page about 30 minutes ago, it was a great article by a Roofstock. And I’m looking to really see where the market is, especially in the Charlotte area, since that’s where we’re based. And I was wondering about inventory. Well, from the Charlotte observer, we have equates to 18 days supply of existing homes.
Jonathan Davis (04:12):
So that’s pretty low.
Bill Fairman (04:12):
18 days. They posted a picture in there of a line of 25 people waiting to get into an open house on this past Sunday. The median sales price in Charlotte has gone up 11.7% from last year.
Jonathan Davis (04:38):
It’s a lot of appreciation in that.
Bill Fairman (04:42):
Man. So these are the type of markets that if you make a bunch of mistakes, the market is going to reward you anyway.
Jonathan Davis (04:53):
Oh yeah. I have a project that, you know, I’ve made several mistakes on and luckily we’re in this market. I can make those mistakes.
Bill Fairman (05:03):
Yeah. If you’re going to do this and you’re kind of new and you’re going to earn while you learn, you’re definitely going to be on the earning side more than I’m paying to learn, because it’s hard to go wrong in this market. Just because the, again, 18 days supply
Jonathan Davis (05:22):
18 days supply, 11 days appreciation
Bill Fairman (05:26):
A stable market is six months, not 18 days
Jonathan Davis (05:29):
Bill Fairman (05:31):
And that’s just unbelievable. Now, speaking of mistakes that you made, and I’m not going to talk about the mistakes, I’m just going to talk about the area you made them in.
Jonathan Davis (05:41):
Bill Fairman (05:41):
No, the house short.
Jonathan Davis (05:44):
Oh yeah, the area.
Bill Fairman (05:44):
Concorde, which is a real, don’t know it was a suburb of Charlotte.
Jonathan Davis (05:49):
That’s where the Charlotte Speedway.
Bill Fairman (05:51):
The Charlotte motor Speedway and their drag strip. And they have completed a major part of the interstate going North. And so that whole Northern corridor has really opened up. And so Concord, city of Concord has got the 20th fastest growing economy in the country right now.
Jonathan Davis (06:19):
I knew that. I knew that was going to happen. And that’s why I bought that house in Concord.
Bill Fairman (06:23):
Yes. I’m sure
Bill Fairman (06:26):
But if you get a chance, like I said, I posted that article on our Facebook page, it’s Carolina Capital Management Facebook page, it goes into a lot of detail on why Charlotte is a great market for investors, as well as people that are moving here. People are already moving here prior to COVID and even more people are moving here because you can work remotely. Charlotte has a great diversity in employment. Charlotte is the second largest financial, , hub.
Jonathan Davis (07:03):
Bill Fairman (07:03):
Hub behind, you know, New York city. But we also have really good high tech jobs as well as distribution. And I said this before Charlotte is within one day’s truck drive of nearly 50% of the US population.
Jonathan Davis (07:17):
The entire Eastern seaboard.
Bill Fairman (07:19):
Logistics is, and that’s part of the reason why Concord is getting so popular. They have a lot of warehouses going up.
Jonathan Davis (07:30):
Oh yeah. There’s a lot more land out that way.
Bill Fairman (07:31):
Yeah, that’s right. And we have a very good North South East, West interstate system here too.
Jonathan Davis (07:42):
Yep. 77 85.
Bill Fairman (07:44):
So what are you seeing from some of our customers trying to find inventory?
Jonathan Davis (07:50):
They’re trying to find inventory. You know, I think right now I have more, I’m seeing more an uptick in new construction, which, you know, naturally, when you don’t have inventory to take down. I mean the off market, I guess deals, I think everyone thinks that they’re down. I don’t think that they’re down, I think targeting them has to change. And there’s some really good guys in Collective Genius who have talked about that. And what’s one of their names?
Bill Fairman (08:33):
Well, actually, Michael Molton is right here in town.
Jonathan Davis (08:38):
Oh yeah. Mike Molton. Well, he’s in Kannapolis
Bill Fairman (08:41):
I don’t think he’s up in Kannapolis. Anyway, he’s in the Northern part of the town
Jonathan Davis (08:50):
He was getting spectrum.
Bill Fairman (08:51):
Jonathan Davis (08:51):
Yeah. He’s in Kannapolis.
Bill Fairman (08:52):
He’s in Kannapolis?
Jonathan Davis (08:52):
Yeah. He’s in Kannapolis.
Bill Fairman (08:52):
And we were talking about this because his house was so far off the road that he had to pay gobs of money just to get them to put cable down to his house and he decided, instead of them do it, he would just do it himself and then they would connect him.
Bill Fairman (09:12):
But now he’s got high speed internet.
Jonathan Davis (09:16):
It all works out.
Bill Fairman (09:17):
And a TV.
Jonathan Davis (09:18):
So, you know, new construction is on the rise even with the higher. So it costs more to get into a lot. A lot of prices have searched and it costs more to build. So cause you know, not just, I mean, we all talk about lumber, but everything across the board, I mean, even the handles, cabinet handles and drawer handles, like the package of handles, you used to buy for $19 is now $24.
Bill Fairman (09:48):
Yes. It’s commodities. And we’re running into an issue where there is real inflation and I’m going to cover that soon. While I say that, well, I’m on the subject. If you’re investing, you have to keep an eye on inflation. And if you’re not investing in real estate, I don’t see any way that you’re going to keep up with real inflation. You’re going to get appreciation
Jonathan Davis (10:20):
What you mean by real inflation is not just the fed reported monetary inflation. You’re talking about inflation of everything like the cost to live
Bill Fairman (10:28):
Yeah. They take out food and energy right off the top. They don’t even count back.
Jonathan Davis (10:36):
But we all know that food prices go up. So do resources
Bill Fairman (10:41):
Their reasoning behind it is because it’s too volatile. Well, you still should include it. Over time, those things will. If it is volatile, that’s fine. But over time, you still get those numbers. They don’t want to include it because they don’t want to raise the social security checks.
Jonathan Davis (11:01):
Bill Fairman (11:04):
That said, there is a school of thought that because our monetary system is still a little strained.
Jonathan Davis (11:16):
Bill Fairman (11:17):
Well now, they’re not, if they aren’t lending money, like they should be,
Jonathan Davis (11:26):
Bill Fairman (11:27):
Because you have regulations on the big banks are still going to have reserve requirements that they have to maintain while they’re easing up on them a little bit. The more restrictions that the banks have, the less money that they can lend and so the thought is that, inflation will stay kinda in, I don’t believe it.
Jonathan Davis (11:54):
I want to pin it off inflation because you brought up banks and like, it’s a sore subject for me. We were talking just the other day about that fund that blew up over, was it over the weekend?
Bill Fairman (12:07):[Inaudible]
Jonathan Davis (12:08):
And they were levered. What’d you say they were leveraged?
Bill Fairman (12:11):
Five to one.
Jonathan Davis (12:12):
Five to one. So every dollar that they had, they had $5 lent to them.
Bill Fairman (12:17):
Yes. By the way, they still haven’t, none of the big banks that gave them that leverage and still come out to see how much they could lose. It’s taking them this long. They still haven’t calculated.
Jonathan Davis (12:32):
Well, why would they do that? Because they just had to close out Q1. They don’t want that to affect their Q1 numbers. You know, like everyone starts sailing,
Bill Fairman (12:40):
Well, part of that is they probably don’t know yet because they haven’t sold off all the asset
Jonathan Davis (12:44):
It can be another piece of it. There are estimations. But I guess what, so this guy, didn’t you say the fund, wasn’t he a convicted through the SEC of.
Bill Fairman (12:56):
Jonathan Davis (12:57):
Insider trading, which is a felony, right?
Bill Fairman (13:00):
As far as I know.
Jonathan Davis (13:01):
As far as, you know, it’s a felony, so we have a felon getting five to one leverage on his fund. So the part that
Bill Fairman (13:10):
Martha Stewart went to prison for insider trading, actually, no, she didn’t. She was questioned about insider trading and then she lied to the FBI about not trading insider information.
Jonathan Davis (13:27):
Gotcha. Well, just because Martha Stewart does, it doesn’t mean you should. But what bothers me is, so this was several months back, you know, more into the COVID pandemic, where it was more fresh. I tried to get one of my properties refinanced with a local bank and so there was a tenant in there, cash flowing almost a 1.5 debt service coverage ratio. I had actually more cash with that bank than the loan amount that I requested. So I was giving them a first lien on a property with a tenant who was paying and also had, I couldn’t get that loan. I couldn’t get it but a convicted felon of insider trading can get billions of dollars in leverage with our banks who get belt out when they make bad choices.
Bill Fairman (14:24):
That’s because you’re not a well-known fund manager who knows people on the inside.
Jonathan Davis (14:31):
I’m kind of well known. We have like 20 followers.
Bill Fairman (14:36):
At least 25. So that concludes our news of the day. Let’s get over and talk about our Ugly Question.
Jonathan Davis (14:48):
Bill Fairman (14:57):
Well, frankly, today’s question isn’t really that ugly. It is a question from an investor. If I’m an accredited investor, is pass through depreciation possible? That all depends on whether the fund has a depreciation in it or not.
Jonathan Davis (15:15):
Or even if it’s a fund. I mean, I guess it could be, it could be an LLC partnership that’s passing through.
Bill Fairman (15:22):
We’re all going to start off with this same attorney answer. It depends. It depends on how the fund is structured, but in most cases, private placement funds are owned. They’re LLCs that are owned by the investors.
Jonathan Davis (15:44):
Bill Fairman (15:45):
So if the LLC is buying a property and if you’re in the real estate side of things and essentially you’re buying property for the income, and then, and again, there’s different types of funds. Some funds are going to buy existing cash flowing properties that don’t need improvements.
Jonathan Davis (16:08):
Some are going to build
Bill Fairman (16:09):
And then some are going to do development, and then some are going to do a value add. So when you’re in a development and when you’re in value, add, there is going to be a lot of depreciation. Of course, we were talking about the accelerated. What’s that called?
Jonathan Davis (16:24):
Cost segregation is a way for funds or even individuals to accelerate the appreciation of a property by having a study done saying like, Hey, this needs to be replaced every five years, or this needs to be replaced every 10 years. And not the app. What is it like, 35 years is what they normally do it at?
Bill Fairman (16:50):
All that said, yes, you can participate in the depreciation. Here’s a caveat though, if you’re in a fund and you’re, this is the only money you’re getting from the fund. If you’re only participating in one fund that you’re getting depreciation on, it’s not going to offset the income you make actively. So let’s say you mean actively outside of the fund or actively. So if you’re, let’s just say you’re a dentist and you have a practice and you’re getting taxed on your active income, the passive depreciation that you’re getting on your passive investment isn’t going to offset any of that.
Jonathan Davis (17:42):
Those are two separate buckets.
Bill Fairman (17:44):
And so what I’m saying is that if you have, say, for example, you have money in our fund, which is income and growth, but it is got no depreciation, there are no tax benefits to being in a fund, it’s just strictly income. It’s still passive income. You could use the depreciation from the property owning fund, who all set the, gain or the tax on the income from our fund. But if at some point you’re in one of those funds where let’s say it’s a syndication, you have one property in there. And you’re getting this depreciation along the way. It’s not offsetting anything other than income that you would be receiving from the property as it’s being developed
Jonathan Davis (18:40):
After the IRS sees active income and passive income, same thing as appreciation as two separate items.
Bill Fairman (18:46):
Now, again, I’m not a tax expert and I don’t claim to be.
Jonathan Davis (18:50):
Nor am I.
Bill Fairman (18:50):
Talk to your CPA. There may be a way to use some of the depreciation to offset some of your capital gain, which it looks like with the current administration. There’s going to be a lot of capital gains going on.
Jonathan Davis (19:03):
Yeah. You know, one strategy might be, you know, not on the appreciation side, but on the active side, if you want to offset active income, you just need to pass the test of being an active real estate investor for the IRS. Talk to your CPA about what that is. And it allows you to offset active income with income through the properties. Because now you’re an active real estate investor. And now that income gets to be, or that depreciation or losses get to offset the active income.
Bill Fairman (19:41):
I don’t want to bring this up, cause this is for another show, but the way that the new administration is thinking about taxing, I started thinking about this too, especially with the inflation, you’re gonna try to avoid a capital gain whenever possible. So I’m thinking a lot of the funds may be rethinking their strategy of selling when a project is complete and refinancing it, cashing out and then holding it for income. Because if you’re an investor in a syndication and itself, that’s all capital gains to the investor. If you cash out and it’s, you refinance it, you cash them out, then that’s a cash out refinance and that’s not taxable.
Jonathan Davis (20:38):
Yeah. And isn’t, I don’t know the answer to this, the new administration, aren’t they, against 10 31 exchanges?
Bill Fairman (20:48):
They’re against anything that they can’t get money from.
Jonathan Davis (20:51):
So 10 31 exchanges would be in that bucket. So, you know, then you can’t shelter those capital gains through a 10 31 exchange into a new property. So the strategy that you just said is probably about the only way you could shelter anything
Bill Fairman (21:06):
But I can tell you this, no matter what they do, there will be loopholes that somebody will figure out and what really is a shame is that they try to complicate things so much. The easiest thing to do is be there, just keep the tax rates to the way they are, and then just don’t allow deductions. Just everybody pays whatever percentage. And that’s it. They raised so much money.
Jonathan Davis (21:31):
Come on now.
Bill Fairman (21:32):
I’m just saying.
Jonathan Davis (21:33):
Everybody likes their deductions.
Bill Fairman (21:34):
Well, of course they do, but wouldn’t you rather just pay a lower rate,
Jonathan Davis (21:38):
Pay a lower rate and have no deductions or pay a higher rate and have deductions. I don’t know.
Bill Fairman (21:46):
You still have expenses. They’re not deductions. They’re just expenses that don’t count in profit. So those are still not taxable the expenses.
Jonathan Davis (21:58):
Yeah. Hmm. Interesting. I will talk to my CPA about that.
Bill Fairman (22:03):
No, you need to talk to your Congressman because your CPA can just advise you, they don’t make the law. They make a policy.
Jonathan Davis (22:12):
But they find the best ways to work around the law.
Bill Fairman (22:15):
Well, that’s true. Yeah, but they do have a good lobby and.
Jonathan Davis (22:19):
Toward with the law, not around it. I’m sorry.
Bill Fairman (22:19):
That’s why there’s not a flat tax is because the CPA lobby. Financial services lobby.
Jonathan Davis (22:28):
Bill Fairman (22:28):
Alright. I hope that answered your question. One of the ways you can offset taxes and fight inflation is to be in a fund that allows you to compound your returns over time. Because if you’re just getting your standard return, whatever it is, whatever fund you’re in, that’s going to be at a certain level, but if you’re allowed and you’re in a position to grow versus you need the money right away. My suggestion is to always compound it and let it grow because now you’re definitely going to beat inflation if you’re compounding your returns overtime
Jonathan Davis (23:03):
Yeah. I mean, what, like, what if someone created a Roth IRA, started a self-directed Roth IRA, started loading money into it, took that money and invested into a, I don’t know, a fund like ours and allows you to compound interest. So now you’ve already paid the tax on the front and you’re compounding interest. That’s a pretty sweet deal, isn’t it?
Bill Fairman (23:29):
Yeah. You can do the same thing with a life insurance policy that you can borrow against it. And the money that’s inside of the life insurance policy is non-taxable, but the money that you make in the fund would be taxable, but it’s a way to offset at least half of your return and tax wise. All right. We’re getting down here to the bottom of the hour. I don’t want to forget, Wednesday with Wendy. Wendy gives people 30 minutes of her time talking about anything real estate. There’s the link. Our next show is with Javier Hinojo. He is a real estate investor in the Raleigh Durham area, and he’s got quite a story to tell. So don’t forget about our next show. We also are participating in the Quest Expo that is coming up at the end of April. I think we have a link there as well. There’s a code where you can get 50% off, I think, for tickets. Thanks again for joining us. This is the Passive Wealth Show. I am Bill Fairman and that is Jonathan Davis. We are Carolina Capital Management. We are a lender in the Southeast. If you’re a borrower or interested in borrowing money, CarolinaHardMoney.com click on the apply now tab. And if you’re an investor looking for passive returns, click on the accredited investor tab. Again, don’t forget to subscribe, share, like hit the bell. We’ll see you on the next show. It starts momentarily. See you later.