Maximizing Tax Savings for Real Estate Investors | Max Drew Strategies

Max Drew CPA (00:00)
Now a lot of people don’t realize that an LLC is actually in the eyes of the law. It’s a legal entity that limits the liability, limited liability corporation. But in reality, it’s not a real person.

So this is something in the eyes of the law they call a legal fiction. know, fiction means not true, but legally it is true. So interestingly enough, the states have left the, federal government has left all that imaginary world, the legal world to the states to make up their own legal fiction, their own delusions that we live in.

Scott Bursey (02:14)
Welcome back to the real estate pros podcast, the show dedicated to giving you the edge.

in a competitive market. I’m your host, Scott Bursey. Today, we’re pivoting our focus from the deal to the dollars as we sit down with a financial expert, Max Drew from Magnum Drew , CPA, PC. Max, thanks for being on the show.

Max Drew CPA (02:34)
Scott, thanks for having me. It’s a pleasure. This is my first live podcast, so I’m excited.

Scott Bursey (02:41)
⁓ I’m equally as excited. So for our listeners who may not be familiar with your journey, please tell us how’d your career begin and what’s your focus now?

Max Drew CPA (02:50)
Well, that’s a great question. Well, my career began with some wise words by my father. My father was actually a real estate investor and he made a lot of money in Northern California developing little small, what we call motels, little things off the side. Now, believe it or not, my dad was born in 1920. If you can believe that, or actually it might have been 19, yeah, it’s 1920, that’s right. So he’d be 106 if he was alive today.

Well, years ago I was over in China as an English teacher and ⁓ I knew I had to come back to the United States to get my ⁓ formal education with upper college and things like that. So I asked him, said, dad, you know, what would be a good business focus that I can do? And he said to me, he said, well, the people I ever know who helped me out a damn was the CPAs.

So I thought to myself, well, I do like helping people. Maybe I’ll become a CPA. So then I came to Chico State and got my education. And I was really excited about that. But I actually ended up working as a tax collector first. So I worked for the Tax ⁓ Office of California, the Board of Equalization as a business tax compliance person. And then about a decade ago, a little bit over a decade ago,

I went through, I did the CPA exams, I had all the education, the internships, everything that requires, and I became a CPA with my own firm, Magdom CPA.

Scott Bursey (04:24)
That is awesome and I’m sure your dad would be very proud of where your career is at this juncture.

Max Drew CPA (04:30)
Thanks. Yeah, yeah, I wish he was here to see it.

Scott Bursey (04:34)
But he was there when you needed him the most. that’s what matters. Max, let’s start with the foundation of ⁓ the structure here. And this question’s been on my mind since we booked you. Max, for a new real estate investor, what is the most significant tax advantage or pitfall, let’s say, associated with choosing between a simple LLC and an S-corp?

Max Drew CPA (04:39)
That’s right.

That’s a good question. Now a lot of times people come to me and they say, hey, I’ve got an LLC. How much do you charge to do my tax return and what can we do? Now a lot of people don’t realize that an LLC is actually in the eyes of the law. It’s a legal entity that limits the liability, limited liability corporation. But in reality, it’s not a real person.

So this is something in the eyes of the law they call a legal fiction. know, fiction means not true, but legally it is true. So interestingly enough, the states have left the, federal government has left all that imaginary world, the legal world to the states to make up their own legal fiction, their own delusions that we live in.

Well, why is this important? Because they can impact us.

on our pocketbook, our bank accounts. And interesting world that we live in nowadays, it’s so much of a mind world where we don’t actually touch the money and dollar bills, it’s all credits and all these legal fictions that are actually with the government. So the LLC itself does not have any tax filing status, they actually make tax elections. And there are four different ways an LLC could be taxed.

One is as a disregarded entity where you just file a schedule C as if you were a sole proprietor in your tax return. Another one could be a partnership, usually if there’s more than one owner. Another way could be as a C corporation, and another one could be as S corporation. So those are tax selections for an LLC as the flexibility to choose which way it’s going to be taxed. So an LLC is a good way to start your business.

because it gives you the opportunity to choose different tax selections with what makes sense with your tax return. But if you actually start as a corporation, and then you have to choose either S corporation or C corporation, which are very different tax structures. So it is very common that once a real estate professional, especially a realtor, if they start making more than about 30, $40,000 in profit a year,

they can actually significantly decrease some of their taxes by becoming incorporated as an LLC and choosing an S-corp election. One of the main savings they get is in their taxable payroll, their employment taxes, which is about 15 % of your income. Now imagine you’re already paying 32 % income to the federal government.

And if you have the privilege of living in California, you’ve got about another 8 % you’re paying to state of California. Pretty soon you’re at 40%. And of course, you might feel guilty not paying enough money to the government because America is a wonderful country and we want to pay as much as we can to the government to make sure we’re strong and healthy. So we pay another 15 % for employment taxes.

So once you get to about that 55 % tax bracket and you’re making sure that you’re giving the government at least half of the additional dollars that you’re making, you might say, well, you know what, maybe enough’s enough. How can I lower that? So when you talk to your CPA, we’ll be looking at different deductions that we can take. And one thing we can do is we can usually eliminate about half of that 15 % on the employment taxes. You can get that down to about 7.5 % by categorizing some of your income

is subject to payroll. And then another thing is we can usually find additional deductions, maybe up to about 20 % that you might be overlooking to bring that tax rate down. So just so you don’t feel bad, know, maybe we can bring down from 55 % to 35 or 40%. So you still feel good like you’re doing your fair share because I know you feel guilty if you paid like zero tax. But you know, for some people that want to pay zero tax,

There might be a way to do that. We’ll talk about that later. But I mean, you for those bizarre people who don’t love paying taxes, we can talk about those different strategies later.

Scott Bursey (09:55)
Max, that was broken down sensationally. Now, I gotta ask you this, how should investors align their entity structure with their long-term wealth goals?

Max Drew CPA (10:05)
Well, depending on what your goals are, entity structure, usually if you have significant assets, like say you’re not just a realtor selling houses, but you actually have multiple real estate properties, each one is recommended to have its own LLC.

And that’s because if somebody got hurt or, you know, slip and fall, I don’t know how bad it is in Kansas city, but here in Sacramento or California, they really Sue happy. And, they can actually Sue you for all everything you own. And unless you have like separate LLCs, then all those properties could be under one LLC. But if that’s the, all of your wealth.

that whole one LLC can be exposed and all your properties can be exposed. If you don’t have an LLC, it even gets better because they can sue you for everything you own. And if that’s not enough, they can also sue you for everything you will earn in the future, just in case somebody got a broken leg or whatever. And in California, they really love to award people lawsuits because they see the rich people as being somewhat evil.

anybody who’s poor as being like a wonderful person who should deserve everything for free. So, you know, we’re pretty compassionate that way, but in a more conservative state, I don’t know if it’s quite as bad, but here in California, we’re really watching our backs.

Scott Bursey (11:38)
That’s a critical distinction and thank you for elaborating on that and breaking that down sensationally. Max, when advising clients with substantial real estate portfolios, which advanced tax deferral strategy are you finding provides the greatest legitimate leverage in today’s high-rate environment?

Max Drew CPA (12:31)
Well, right now it’s absolutely fantastic. It’s something I specialize in and that is doing cost segregation for your real estate. Now you want to go with the person who’s a seasoned expert, a CPA, but there two different ways that this can come about. Now I’ve come about it one way where people were being severely taken advantage by people and another way, which is just normal people investing in property.

The first story I have, is kind of interesting, you know, some people get kind of, you know, the elderly people, they get a lot of time on their hands. And a lot of people who are older actually have most of the wealth in the United States. And sometimes people who are trying to do deals, they find somebody and they keep calling them, calling them, calling them, talking to them, talking to them, talking to them. And they’re trying to sell something and they might have a lot of time because they might be selling something that has a good

commission, say you sold a million dollar product to somebody at five percent commission, that’s like $50,000. Realtors might be kind of familiar with something like that, But one of the things happened happened to one of my clients. He had a million dollars in his retirement and somebody convinced him, hey, you know, you really should buy this restaurant. It’s one of these popular brands of restaurants.

So something that had a star and a logo, you know, there’s several of those different ones that you can speculate. But anyway, said, you know, this restaurant, they’re not going to go out of business. They’ve been in business forever. Sell this, buy this building, and they’re going to have a lease on it. You’re going to be guaranteed monthly payments. Won’t that be awesome? So the person thought, OK, so they took a million dollars out in leverage alone and a million dollars out of their retirement.

But what’s the problem with taking a million dollars out of your retirement in one year? The problem is you very high tax rate, California, 9.3 % federal 37 % 45 % tax rate. So the guy had enough money to buy a building. So he thought, but he didn’t have enough money to even be able to pay the $450,000 tax bill. Well, what we were able to do with a $2 million property

the restaurant property example, we went through and did a cost segregation. The government allows us to segregate the systems of the building and to take, if you manage the building yourself, you can actually take an active deduction against your tax return and offset some of that active income. Normally it’s only $25,000 that you can take, but if you actively manage, you can take up to the entire loss.

And we were able to help this person save hundreds of thousands of dollars in taxes, mainly because the building was leveraged and because the tax liability. But in that particular case, it was the difference between somebody being able to retire. And eventually that person was kind of older. They did go into like assisted living and stuff, but if they had been hit with that entire tax bill, they wouldn’t even been afforded the care that they needed for them in there.

their wife. So it is important for us to go out there and educate people and sometimes give them these cautionary tales because, you know, we want to help people, not hurt people. And we want to win, win. And unfortunately, as a CPA, CPA stands for certified public accountant. And my duty is first to the public to protect the public and second to my client, unlike a lawyer or a salesman or attorney. So we have a high standard.

of a fiduciary built in there. So talking to your CPA before you make any moves, usually they’re set more in the mindset of wanting to protect you and make sure you have a good financial outcome. Now in that particular one, the client actually, unfortunately told me after the fact that they purchased the Starbucks and, ⁓ you know, I was left to pick up the pieces. We were lucky because it was in one of the years where they did allow

this cost segregation and bonus depreciation. This is things that have only been allowed since Donald Trump’s presidency. If it had been in a different year, a different time, that person might have been stuck with the $450,000 tax bill. Good news is it’s currently available to people. The average person, if you’re buying a $500,000 property,

In California, we might be able to save you up to $60,000 in taxes, which a lot of people that can be one or two years of their taxes if they’re kind of a, you know, average type of real estate investor. So we do have some good news about how that can pay for your down payment. And does it get any better? Well, supposing with that extra $60,000 in savings, that less tax that you’re to pay at the end of the year, you use that

$30,000 to $60,000 to fully fund your retirement. You could also get another additional 40 % on that. Pretty soon that $60 deferral becomes, you know, maybe $70,000, $80,000 in your pocket at the end of the year. As opposed to doing the normal depreciation where you could get it, but it does take up to 27 and a half years to get your tax deduction with the depreciation.

And somebody once said a dollar today is worth more than a dollar tomorrow. Now, I always like to use what I call candy bar economics. When I was a kid, one of our biggest wins could be buying a candy bar at the corner store for just 15 cents. Nowadays, more than 20 years later, that same candy bar costs about $3. That’s inflation.

We were losing purchasing power where that same amount of money is only going to be worth 1 20th of what it was then. So even though we could hypothetically take that deduction later, the money today is going to have much more purchasing power than it will 27 and a half years later. So as your CPA, I’m not just talking about tax rates. I’m talking about building wealth, growing wealth, and overall increasing your financial power.

Scott Bursey (19:24)
That’s an amazing breakdown Max. Now let’s discuss the short-term rental sector for a bit.

What is often overlooked when it comes to requirements, when you’re looking, people are looking to meet for a real estate professional that qualify their short-term rental income as perhaps a true operating business for tax purposes, you know, allowing them to unlock valuable deductions that, that passive investors cannot access.

Max Drew CPA (19:54)
Okay, well, you know, I did want to address something special in this particular thing that I don’t know if other people are ⁓ doing, but I think it would be important for your podcast and maybe something to make this one stand out a little bit more. I’m recently talking to first time home buyers are people that are buying new homes, right? And they might be buying a home for themselves for a family member or whatnot. Well, what about

classifying this property before you move in, know, once you’ve got everything in there, you know, it’s just like before you move all your personal bed, personal furniture and stuff in, what if you turn it into a short-term rental for a short period of time, actively manage it like Airbnb, maybe three, four months, and you get that big deduction, you know, that $60,000, that 12 % of purchase price, whatever it is.

and then afterwards you move in. people might say, well, doesn’t that reduce the basis? Won’t I have to pay that back when I sell? Maybe not, because there two things that could happen. One is if you’re married, you get $500,000 of increase tax free. It might take a long time for that $500,000 house to increase by $500,000, and then you only pay the additional. But remember,

By the 20 years it takes for that house to become that much more expensive, that dollar that you have to pay back later in the future is only going to be worth maybe 1 20th of what it is now. So that’s actually when I usually tell people the five-year rule. If you’re going to hold onto it for at least five years, you might want to do a class segregation even if you have to pay it back. If it’s going to be less than five years, we can just see if it makes sense for you.

You could be on a much lower tax bracket five years later, so that might make sense. But if your tax bracket is the same, it’s kind of about a wash, is the way I usually say, by the time you pay for everything it takes to do that. The next situation could be, you could be determining if ⁓ you do move in, you know, after having as a rental for half a year and you take all that depreciation. ⁓ Sometimes people are deciding, you know,

which house they want to sell. Do they want to sell the house that’s almost fully depreciated and not fully they’re buying a new house? Sometimes it might make more sense for them to consider more advanced strategies which we can get into. But you know, doing 1031 exchanges, different things like that. But that might be getting a little bit more advanced than what we’re talking about here today. So I don’t know if I answered that question. Okay, I feel like I’m starting to get off into the weeds here.

Scott Bursey (22:32)
You did very, very well. that’s excellent advice. Cost segregation. Excellent. Max, I believe our listeners would love to know the qualified business income deduction is a massive benefit. What is the single biggest mistake real estate investors make when calculating or attempting to maximize their QBI deduction?

Max Drew CPA (22:52)
Oh, that’s a good question. Well, you know, it does matter how much money you’re making. So, but normally that does kind of flow through as long as you’re actively in the real estate business. I don’t know if as a passive person, if it would qualify. So we do want to make sure that you are actively managing the business. Now, a lot of times people get confused whether they can qualify for

that the losses that ⁓ a cost segregation will make are the qualified business income, so are the deduction. So sometimes it takes less to make it an active business than you think. Right now it could be a minimum of like a hundred hours that you spend on the property. One of the main things is that you spend more of your time than anyone else. So

and then it can become active whether you’re a licensed relator or not. really talking in advance with your CPA about what your plan is for the year. And what we like to do is what’s called a tax projection. So we can get all your information, everything about the case, tell us everything that you’re going to do, everything you expect to happen for your business. As a normal tax client, I will give them two tax projections during the year.

and we’ll have a chance to do everything in advance to see what their returns can look like six months or a year before they have their taxes. But if you’re thinking about trying something new and you want to know the outcome in advance, talk to your CPA in advance. We can send an hour researching the laws, trying the different things, manipulating the software, finding the outcome in advance, and it’s well worth it to have that tax projection, as we call it. So,

I don’t know if I exactly had the right answer you’re looking for, but I hope that helps and gives people a chance to work with their CPA to do those tax projections and see what can change based on how they classify their income.

Scott Bursey (24:50)
absolutely. Proper communication is the golden nugget I’m getting out of that. Consult your CPA. Don’t be scared to ⁓ book those appointments and have that hour long discussion and plan some strategy. That was excellent. Max, focusing on the capital side. However, the recent changes or continued scrutiny around opportunity zones and their reporting requirements impacted their viability as a long-term investment vehicle.

Max Drew CPA (25:18)
Well, I have to tell you the truth is I haven’t done much work in opportunity zones. So even though I’ve lived in opportunity zones and I worked in opportunity zones, when it comes to real estate or investors investing in those opportunity zones, not too many of my clients have done that. So that’s an area that I’m not totally familiar with. Usually that doesn’t mean that we couldn’t look at that area.

But that might be something that would go into a couple hours of research and working with us. Each one’s going to be different because the opportunity tax credits tend to be governed by the county and the city, or sometimes it could be federal. But typically they’re going to have their own requirements and their own different things. So that’s a very ⁓ significant thing, just where you have to do a case by case basis and find out the total qualifications for that. But I appreciate the question. Sorry I couldn’t give you like the ace answer.

Scott Bursey (26:12)
Well thank you for being candid with that. And Max, if you could give every real estate professional just one piece of immediate tax and financial preparation advice for the coming year, something they should implement today, what would that be?

Max Drew CPA (26:27)
I would say let clients know and for yourself, think about how the tax benefits might benefit you and don’t be afraid to explore it. Whether you implement it or not, you’re in the driver’s seat, which I always tell people, I’m your co-pilot, but a good CPA should be your co-pilot along the way. At the end of the day, the buck stops with you, but

You know, we might be responsible for giving you the right coordinates. And if, you know, if you’ve got a good roadmap, you’ll usually be a lot happier with where you end up at the end of the day.

Scott Bursey (27:03)
Absolutely. Now that’s golden advice. And Max, we love fostering connections here at Real Estate Pros. For the listeners who want to follow your journey or collaborate with you, what’s the best way for them to reach you?

Max Drew CPA (27:16)
Well, feel free to reach out to me directly. I can give you my direct email.

it’s [email protected] And I also have a weekly YouTube channel where I’m just starting to put out some blogs and Facebook. ⁓ So I’ll ⁓ provide that.

to you Scott and maybe you put that in the show notes for our listeners. that sound?

Scott Bursey (27:43)
That is awesome and thank you for joining us today, Max. This has been a valuable conversation full of insights. Thank you so much.

Max Drew CPA (27:53)
You’re welcome sir, and I had a great time. Thank you for being such a great host.

Scott Bursey (27:57)
Very well welcome and we would welcome you back at any time. And for our listeners, we appreciate you. If you got value from today’s episode, please subscribe. We have more conversations coming up with operators just like Max. Until next time, keep your standards high and your vision clear. We’ll see you in the next episode, everyone.