How Real Estate Investors Can Reduce Taxes Without Hurting Their Next Deal

Aaron Zimmerman (00:00)
At most you’re able to deduct 25,000 if you’re not a real estate professional. 25,000 times whatever your tax rate is. Let’s say it’s 22%. Or let’s just say you’re saving about $5,000. To me, that’s not worth it to, potentially not get into your next home. So kind of keeping the bigger picture in mind, I think is just important overall in terms of what you can do. and even just thinking at the front end, like what house or what work does this house need, and like how much do I need to put in like this year, next year.

two years four like four years from now, things like that I would try and think about as well.

Dylan Silver (02:01)
Hey folks, welcome back to the show. Today we’re joined by Aaron Zimmerman, the founder of Brick House CPAs in Chicago, specializing in tax prep and advisory for real estate investors. Aaron, thanks for taking the time here today.

Aaron Zimmerman (02:17)
Thank you for having me.

Dylan Silver (02:18)
What types of deals are coming across your desk these days?

Aaron Zimmerman (02:21)
Yeah, right now I’m in a more passive stage of life and everything. So a lot of the deals that are kind of coming my way are a lot of people doing fix and flip or the BRRRR method and a lot of people I’m actually lending my capital to them at a at a fixed interest rate for six to twelve months. So those are most of the deals that are coming my way at this point in time.

Dylan Silver (02:40)
I was talking to you in the green room about the mentality that I think unfortunately a lot of investors find themselves in, which is, looking at this big tax bill that they have and realizing that maybe next year or right now they need to start thinking about tax strategy. So I I can imagine that for folks in your space it’s a lot of times maybe cleaning up messes. Is that an inaccurate statement?

Aaron Zimmerman (03:02)
I would say so. Yeah. There’s a lot of times where it’s just like in order to even do planning, you need to make sure that the book what I tell people is you need to make sure the bookkeeping is right so we can have an appropriate conversation. If we’re trying to do tax planning, let’s figure out where you’re actually at because if you tell me you’re making two hundred thousand in income and you’re actually making fifty thousand or even a loss, we’re having two totally different conversations. So it’s important

for us to have a good starting point to then do some planning. And a lot of times that might not be the case, especially in the first year and everything.

Dylan Silver (03:35)
I mean, when we talk about bookkeeping, sometimes I think, investors think, Bookkeeping, what is that? why do I need that? And until you have the tax strategy conversation or the tax preparation conversation, and until you run into maybe some challenging tax circumstances, you may not see the necessity for bookkeeping from your lens as someone who deals with folks in these situations,

On a base level, what do good books look like for a tax advisor?

Aaron Zimmerman (04:01)
Yeah, so good books. I’d say if we wanna kinda divide it into two things, let’s say flipping and then the like rentals. So flipping, it’s just making sure that all the costs related to the flip are properly included in, the profit and loss statement, assuming you sell it in the same year. just basically just a good tracking of all the costs is if I had to boil a commonality between the two.

and then on the rentals just making sure the income and then all the expenses tie. And on the rental side, what you’ll often miss or sometimes miss is accurate amounts for mortgage interest, taxes, insurance, and then repairs and capex. because there’s some room there’s some wiggle room on repairs versus capex, but it requires a little bit more questions and conversation.

Dylan Silver (04:45)
one of the things that I I see folks getting wrong is they think, well, it’s sometime halfway through the year I can go back and do my books and it’s not gonna be that much work. I mean I haven’t necessarily had the most complicated books. Little did they know that they’re about to engage in like forensic bookkeeping for however long that they haven’t done this and now they’re sitting back thinking, My goodness, my books are way more complicated than I realized.

Aaron Zimmerman (05:09)
Yep, totally. Yeah, I would I would on that I would probably recommend like for each like activity, like if you’re flipping, I’d have like one bank account for flipping, and then like one credit card. Like and likewise with the rental side of things, if it’s all in the like the same LLC, just keep one bank account, one credit card, just to kind of keep things simple. Cause what I see a lot of times is, I have my personal card.

And then I have another personal card. Now I have like two personal cards where I’m putting through expenses and I have my bank account where my W-2 comes through and it’s like I’m you you’re mixing up a lot of different things and it makes it very hard to keep track of things. So

Dylan Silver (05:46)
That that’s a great point. And having gone through this myself and hired a bookkeeper and I was in one of those people thinking, Do I really need this? And then I said, My goodness, this is complicated. It really goes to show I don’t think there is too early of a time to get started having good books, even if you’re not making, tens of thousands of dollars, a couple thousand dollars I think is enough to have bookkeeping going. Am I wrong there?

Aaron Zimmerman (06:10)
Yeah, I mean I would probably if you’re if you’re making if you’re not making that much money, I would I would try and DIY it. There’s a lot of free tools and resources available and everything. And I think there’s a lot that you can do. But once you get up and into probably or once you get up past a few properties, or, if you’re a service provider making a substantial amount of income, then I’d probably consider, potentially outsourcing the bookkeeping because what I

What I try to highlight is there’s an opportunity cost to you doing the bookkeeping if you don’t like doing it. If you like doing it, do it. But if you don’t, then it’s good to outsource it because if you’re a realtor, let’s say you can make that money back in one deal and sometimes even less than one deal.

Dylan Silver (06:48)
And then there’s also the ease of getting advice from someone like yourself when you have good books and also when you’re looking for funding and loans and a mortgage, etc. It makes all this easier. Even if you’re looking to rent a place, having good books is helpful. I do want to pivot here though, Aaron. in addition to advisory, you’re also an investor in

yourself, which came first for you? The CPA hat or the real estate investor

Aaron Zimmerman (07:15)
so I became a CPA in 2018, and then I became an investor in 2019. So technically the CPA by about by about a year.

Dylan Silver (07:24)
Okay. Did you always know that you were going to do both in tandem?

Aaron Zimmerman (08:16)
I knew that I was gonna be a CPA, but I didn’t know that I was gonna invest in real estate. I kind of saw one of my friends do it. He had a bad experience and I was like, it can’t get much worse than that. So I’m just gonna give it a go. If it doesn’t work, it doesn’t work. But fortunately I’m glad that I bought that property. especially I’m in the Chicago market, so prices are expensive here and to come up with a big down payment like twenty five percent is obviously pretty challenging.

So fortunate to use one of those owner occupied strategies with the FHA loan with three and a half percent down. I actually put it in a little bit more because there’s some restrictions there, but it wasn’t that much more than that.

Dylan Silver (08:51)
when we look at different ways where folks are investing in Chicago, do you see a lot of people doing like what you mentioned, a house hack if you will, or are most folks, mom and pop investors looking for, single family home opportunities?

Aaron Zimmerman (09:07)
Yeah, I’d say it’s a combination. A lot of the people, I’m 31, so a lot of people my age or younger to get into the real estate market to come up with that 25% down payment is going to be pretty, I don’t want to say unlikely, but there’s not that many people that can do it. So I think it’s I have a lot of clients that have started with house hacking and it’s been a great start for them. and then once you, once you have a few under your belt and everything, then you can kind of explore or I’ve seen

People explore like other opportunities where they’re buying, six units or things like that. but that’s usually a little bit later on their investor lifecycle because it does require, quite a bit of upfront capital to do that on those commercial buildings. I would say single families, not so much. it would have to be a bigger single family in Chicago, but perhaps the suburbs a little bit more.

Dylan Silver (09:54)
wanna get granular asking you about what it’s like in a house hack situation. So it was a fourplex if I’m not mistaken and correct me if I’m wrong there, but I understand that people always talk about the pros of house hacking. Are there any cons of house hacking?

Aaron Zimmerman (10:08)
yes, there are cons. I would say I mean the big so it depends. for mine it was separate living spaces, which was great. That said, I did live in a basement. so I would say that would that’s a con. If you don’t like living below grade, that would be one con. managing tenants, it would be another if you don’t like doing that. But with real estate, you’re going to have to learn how to do it. So with house hacking, it’s the lowest risk way to do it.

I had a good experience with two of the three residents. And then unfortunately with the third one, that was not such a good experience because I bought like right before COVID. Then that family’s income dropped significantly and it was very hard to get people out in Chicago during that COVID time. and they were somewhat communicative, but not very helpful. And keenly they were not the best of residents. They would smoke inside the unit.

They would create other disturbances in the property and bring kind of some unsavory people over. so that would be a con if and I was that would probably be the biggest con is if you pick the wrong resident to live there, that is going to impact your experience significantly.

Dylan Silver (11:10)
Yeah, and you’re not only the investor, you’re also their neighbor, right? So you’re living next to the these folks. So people sometimes understate that com that side of these deals. did you have to go through the court process in order to get that resolved?

Aaron Zimmerman (11:25)
I did. it basically the timeline was I bought in December twenty nineteen. they stopped paying probably February or March of twenty twenty we applied for some grants through the state, but that didn’t cover, a hundred percent of what they owed at that time. So we got money in I think twenty one, twenty two, and then

like they stopped paying in twenty two as well. So by the time it was they by the time it was like twenty two, I think I filed for an eviction maybe July of twenty two. It took until it took a March twenty three to get to get them out of the property and everything. Yeah.

Dylan Silver (12:02)
And

a lawyer is involved doing this all yourself.

Aaron Zimmerman (12:04)
no, yeah, in Chicago or Illinois I would definitely recommend attorneys, so I did use attorneys for that one.

Dylan Silver (12:10)
So yeah, it sounds like, this was a years long process. And I’ve heard that from multiple folks who are involved in the Chicago area. I mean, what can folks do to properly, screen tenants but also make sure that their properties aren’t sitting vacant for long? ‘Cause it is kind of a double edged sword, right?

Aaron Zimmerman (12:26)
Totally. Yeah, I would probably say on the inherited residents, you wanna you wanna get an understanding of like who they are. I would probably vet them a little bit harder now knowing what I know now. especially if you plan to kind of keep those residents and everything. one thing you could probably do is like a Freedom of Information Act request with the city or town and see if there’s been any like police reports or disturbances or things like that.

and then just, maybe seeing what was used to verify income in the past, just to kind of get comfortable with to get comfortable with those people. So yeah, definitely, a big risk. You ideally don’t want to have vacancy, and especially one that you can control. and then, when once you pick new residents, you want to, really do as much due diligence as possible on them and try to make the right choice there because evictions can be expensive and all that.

Dylan Silver (13:12)
It’s tough to say, right? putting you on the spot here a little bit. But I mean, if folks are looking at, they’re in Chicago, they’ve got a fourplex, they’re living in one of the units, they can swing the payments on the other units, but for how long, maybe they’re not comfortable doing it for a year. How long would you let a unit sit vacant until you find the good tenants?

Aaron Zimmerman (13:33)
I mean, it’s tough, right? Because you have to evaluate like time of year too. So like in Chicago and probably most northern markets, October through I’d say February is gonna be pretty slow. So I would probably try and drop rents accordingly and then find and then get the lease to end sometime in May, June, July, where you can then rent it up at peak rates. So I’d probably be willing to let it go maybe like two or three months, but I’m

I’m still not gonna pick, a bad resident to live there if it’s not the right fit. I would just try and drop rents or offer concessions at that point. and then try to try to have better odds in May, June, July if it doesn’t work out for the next one.

Dylan Silver (14:14)
You mentioned concessions, and I understand this is not happening to this degree in Chicago, but where I’m licensed as a realtor in Texas, these commercial grade properties are offering tremendous concessions. I’ve seen a month rent free. I’ve seen two months rent free or prorated. I’ve seen that plus a five hundred dollar, Amazon gift card. So people are borderline nearly being paid to move into these properties. and so you think, well, could that type of thing

happen in Chicago, I don’t think that would ever happen in Chicago.

Aaron Zimmerman (15:27)
I find that hard to believe. I think during COVID that was maybe a thing, but in Chicago there’s a lot of supply constraints and especially in the most desirable areas of the city to the point where there’s even like bidding wars. Like one of my clients he said that he listed like a unit for forty three hundred in rent. It literally got bid up to five thousand dollars. And then and then the second or the for the second year they signed like a two hundred or at least for fifty two hundred bucks. So

I’d say quite the opposite in Chicago, just given the dynamics here of not building as much.

Dylan Silver (15:57)
Wanna pivot back to the tax advisory. For folks who are looking for a good real estate tax advisor, real estate CPA, I’ve gotten this feedback from investors and folks like yourself, real estate CPAs, is you have to find someone who’s not just some someone that that’s close to you or that maybe you trust, but also that really has the real estate experience.

For myself and our audience who are maybe unclear why there could be a difference in, someone who’s a tax advisor versus someone who’s got that specific real estate savvy, what is the difference there?

Aaron Zimmerman (16:31)
I’d say a real estate advisor or someone that does tax prep in real estate is going to know a lot more than just like the general CPA. There’s a lot of things like bonus depreciation, 1031 exchanges, opportunity zones, things like that where the general CPA may have some knowledge on it, but they’re not gonna be like an expert on it. So there’s just a lot of nuance within the real estate sector. not to say that other

sectors don’t have the complexity, but it’s I think important to kind of find that person overall to have that background. A general CPA could, very well miss things. And even on that like the house hack is an example, getting like the rental percentage and the personal percentage correct with the rental being deductible, personal not being deductible is just one that kind of comes to mind that I even just saw yesterday.

Dylan Silver (17:16)
when folks are going through this for both investors and sing folks looking for their homestead alike, yeah. The things that I I’ve seen as a realtor and I’ve experienced it looking through my investor lens as well, is you can run into a situation where you may have deducted too much on your taxes and you need to prove your income and now you’re having to finance a homestead based off of bank statement loans instead of your tax return.

So, as someone who’s an investor yourself, but also when you’re looking at your role as an advisor, when should folks maybe pay more in taxes versus take more deductions?

Aaron Zimmerman (17:52)
Yeah, that yeah, great question. I would say obviously depends on your, on your situation, but overall, should i if you’re kind of driving yourself to be at like a very big loss, like for instance, like rentals, if you’re not a real estate professional, you can take up to twenty five thousand dollars of losses. Let’s say you’re making, let’s say a hundred thousand dollars and you could take up to twenty five thousand of losses if you want, it might not make sense to take

those losses. So this is where like the repairs versus capex conversation can come into play. A lot of times I see investors doing these big or some like remodels. Like there’s times where you can make some of that remodel cost or repair or supplies with certain items, or you could put that all in capex. It might make sense to put it in capex in that situation. because realistically like what you don’t want to happen is

At most you’re able to deduct 25,000 if you’re not a real estate professional. 25,000 times whatever your tax rate is. Let’s say it’s 22%. Or let’s just say you’re saving about $5,000. To me, that’s not worth it to, potentially not get into your next home. So kind of keeping the bigger picture in mind, I think is just important overall in terms of what you can do. and even just thinking at the front end, like what house or what work does this house need, and like how much do I need to put in like this year, next year.

two years four like four years from now, things like that I would I would try and think about as well.

Dylan Silver (19:07)
I wanna ask you something that’s certainly a hot topic here lately with everybody, AI as it relates to real estate and real estate investing. But I’m sure there’s a lot of people who think, I don’t need a bookkeeper, I don’t need a you tax advisor. I’ve got, my AI tool can help me with advisory. Are some of these tools, a sufficient, I don’t want to say replacement, but

But something where if someone doesn’t necessarily have the budget yet for a bookkeeper, a tax advisor, can they rely on, AI generated tax advice?

Aaron Zimmerman (19:38)
I probably would not at this point. it could certainly give like, ideas and everything, but I wouldn’t look to the tax like I wouldn’t look for them to cite or like AI to cite like tax co like tax code sections that you can actually rely on because if you do get audited, you’re gonna be in a situation where you’re where it’s like who like basically you need to defend yeah, like who did this like in like if you’re signing off on the return, you’re saying, Hey, I’m like

this is true and accurate to the best of my knowledge and everything. so I probably wouldn’t at this point in time, but I think it can give some ideas and everything. The issue is like knowing, one, knowing the right questions to ask, and then two, knowing if AI is right or wrong. And for the lay person that doesn’t know tax, I think that would be a little bit challenging. Cause like even on my end, like there’s just even like researching, it’s like, okay, like

based upon what I know, this like looks right in everything based upon like my years of experience. So it’s just important to know like if it seems too good to be true, like maybe you look into it basically. Look into it further.

Dylan Silver (20:39)
on that note, when we talk about what happens in the case of an audit, my understanding is, CPAs and enrolled agents, they can both and will represent you before the IRS and explain your return. And so on that note, there is a level of peace of mind, if nothing else. If folks are looking at this and saying, Well, I I’m not necessarily gonna get this huge deduction based on this, but you do want that.

that peace of mind. At the same point in time, the counter argument to that is, well, I if I’m not making, millions and millions of dollars, what are the chances of an audit? From your eyes, what are the realistic chances of an audit for, mom and pop real estate investors?

Aaron Zimmerman (21:23)
Yeah. So I mean, I think population wise, I think it’s under one percent overall for who gets audited. So in theory, that’s a relatively low chance. It’s just if you’re doing some of taking some more aggressive positions or taking positions that have a large write-off against your income, the IRS will see, okay, I made you made five hundred thousand dollars and now you’re taking three hundred thousand off of your income. Like, why is that basically? in that case, that may lead

that may be a bigger red flag and things like that. so realistically low, but with some of the real estate strategies, I would say it may be it may be a little bit higher, but I don’t exactly have that data to prove that out, basically.

Dylan Silver (22:04)
Want to talk about something that we see a lot, talking with single family investors, talking with folks getting into small, multifamily, or commercial properties. And this is what’s next for me? What’s next for my investment strategy? do I start buying bigger properties? Do I buy a land? Do I do ground up construction? My understanding is that there’s also a huge tax strategy play that goes into this. If folks are looking for

their next new venture. Is there anything that has been, particularly a appealing from a tax strategy perspective these days?

Aaron Zimmerman (22:38)
Yeah, I would probably short I’d say I’d probably say especially with a hundred percent bonus depreciation being back, a lot of people will have found short term rentals to be quite popular. because if you are if you’re able to rent out the property for seven days or less, a hundred hours or materially participate, there’s a few main tests, a hundred hours more than anybody else’s time, five hundred hours or substantially all the activity.

And not use it too much for personal use and don’t have a property manager, basically. there’s a way where you could potentially write off losses on the on the short term rental against your active income, which is pretty popular. So for higher income earners, let’s say making, five or let’s say, let’s say they’re making six hundred thousand dollars and they buy a short term rental and they’re able to take, let’s say, two or three hundred thousand of loss against active income, most of the time they do that.

via a cost segregation study, it just breaks the building down into its component pieces to say, hey, some of it’s five year property like appliances, seven year property like furniture and fixtures, 15 year property like land improvements. And then the rest is 39 year property, which is like commercial property, assuming it’s short term rental. so those things kind of combined, like I just had a client where they put a significant amount of work into the property and they were able to

they were able to reduce their tax bill pretty significantly from that. The only the only downside to the strategy is you may be locking yourself into the property because to pay the money back on the depreciation recapture could be pretty significant. So that would be the one caveat there. And the other caveat that I see people is that people are buying for tax benefits, not because it’s a good deal. If you want to make sure it’s a good deal not

if you want to make sure it’s a good deal first and then the tax benefits are I’d say secondary, which I know son a c kinda sounds counterintuitive coming from someone in tax, but I think that’s an important distinction. Like you don’t want to pay a hundred percent of the cost and get like a thirty percent rebate or coupon, let’s say, like you’re still out the seventy percent. So

Dylan Silver (24:32)
you may have touched on this, but with the short term, is it is it then easier to get that real estate professional status than it is with the long term?

Aaron Zimmerman (24:41)
so short term rental is kind of like different. It it’s basically like real estate professional status, but it like it’s just for short term rentals, but it accomplishes the same objective, moving income that would be passive income into like a non passive bucket to then offset against your active income. So it accomplishes the same objective, just REPS is usually more long-term rentals, and then short term rentals are more or the short term rental strategy is more short term rentals.

Dylan Silver (25:06)
being that I’m a Texas realtor and we’ve had lots of folks in the Sun Belt as a whole on our show here, we’ve seen a lot of people realize that it’s tough to fix and flip in certain markets, in the Sun Belt in particular, because you’re competing, and this is just n the math is if there’s a fix and flip that you can buy for, 175 and there’s a new build that’s two hundred, that’s roughly the same size.

Or there’s a new build that’s maybe substantially smaller, but it’s brand new, builder warranty lower rates and more cost effective, people are gonna go new build. Are there specific tax strategies when it relates to new build that are not applicable in the short term scenario that you laid out there?

Aaron Zimmerman (25:49)
like you’re talking about like you’re talking if someone is to build it and then like rent it out or build and then

Dylan Silver (25:54)
That’s good question. I hadn’t even thought about that. But we can take the build and rent out scenario.

Aaron Zimmerman (25:59)
I mean with the build-and-rent scenario, I mean, the it depend I’d probably say it depends on what the use would be. but I mean, if you’re adding in like a substantial amount of like land improvements and things like that, you may be able to control the amount of additional depreciation that you’re able to get because you’re a you’re the one, doing the work. So like if you’re adding a driveway or landscaping or

a sidewalk that would all be eligible for bonus depreciation. The question then would be, are you able to like, would it make sense to like utilize that this year, this year and then do a cost segregation study on that? because if it’s a long term rental, you may not be able to take advantage of the losses. whereas if it’s a short term rental, you may have a better chance of doing it. So that’s I I’d say requires a little bit more conversation with the individual investor. But yeah, those are kind of my thoughts on that.

Dylan Silver (26:48)
year to year, do does this whole strategy change, drastically year to year? Are there big changes that folks should be aware of or that they’re not aware of that do happen?

Aaron Zimmerman (27:01)
Yeah, I mean on the short term rental, the biggest change was just the a hundred percent bonus depreciation, but I’d say that’s more real estate overall, like the real estate sector overall. With the short term rental, it hasn’t really changed. The only thing that does change is the amount of court cases that happen, which gives us a little bit more data points to s or data points and insights in as to what the courts would think, because sometimes within the tax code things aren’t very clear, which is why people go to court to say, Hey, I think it’s this way, the court says it’s this way, like

what, ultimately the court decides, and everything on that. So it gives some insights. So I’d say that would be kind of be the biggest difference is just seeing some of those court cases be handled or the court cases be handled there.

Dylan Silver (27:41)
we are coming up on time here, Aaron. Any new projects or activities that you’re working on? Also anything you’d like to mention directly to our audience.

Aaron Zimmerman (27:49)
Yeah, in terms of new projects, mainly just growing my CPA business for tax prep and advisory for real estate investors, and then also just doing note investing. so those have all been good. for those that want to get a hold of me, I have a website, brickhousecpas.com. you can get a bunch of free resources on there. There’s my short-term rental template, real estate professional.

spreadsheet and then also my templates for rental properties. And then if you’re a realtor or fix and flipper, I have some templates on there for you as well. and also too, if you wanted to book a call with me, you can book a call on the website as well. so those would be those would kind of be the best ways to reach me in addition to LinkedIn. You can just find me Aaron Zimmerman on LinkedIn.

Dylan Silver (28:29)
Aaron, thank you so much for your time today. Thanks for joining us.