Discussing the possibilities and future at the intersection of healthcare and commercial real estate
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On today’s episode of the Providers, Properties, and Performance podcast, I wanted to give you a more detailed glimpse into specific strategies and examples for physician owned properties. I invited CPA Thomas Castelli to discuss this topic, and we dive into tax strategies for real estate ownership, helping you understand your options for your property ownership hold period. Listen in as we discuss appreciation, depreciation, and using leverage as a tax strategy.
[02:29] Thomas’s background and path to real estate tax strategies
As a child, Thomas was encouraged by his parents to pursue accounting. He began his college career studying accounting, and realized he would need to start investing if he wanted to achieve his life goals. He began to read Rich Dad Poor Dad books and then stumbled onto real estate information. After graduating college, he continued to educate himself on the real estate space, attended an event where he learned about real estate syndication, and completely fell in love with the strategy. He had started work at a Top 10 accounting firm, but soon realized auditing wasn’t the life he wanted to pursue. As he explored alternative options, he met his current business partner, Brandon, who founded the firm for which Thomas now works. He has been on the path of real estate tax strategies ever since.
[05:55] How to understand the difference between passive and nonpassive activities
Understanding the difference between passive and nonpassive activities can be crucial in the world of real estate investing. Underneath the Tax Reform Act of 1986, passive activities include all rental activities. If there’s a business in which you aren’t actively involved, it’s termed ‘materially participating.’ If you’re simply the money partner, then it’s considered passive. All rental real estates are passive by default. Businesses in which you are actively involved are nonpassive, including W-2 jobs. This is important to understand because losses from passive rental activities cannot offset the nonpassive income, unless you’re a real estate professional or use short term rentals.
[07:01] The benefits of owning a building
First, it’s important to note that neither Thomas or I are attorneys, and you should always consult with your attorney on matters such as these. When you own a medical practice and you buy an associated building, your attorneys are likely going to strongly advise you not to put the building in the same LLC as your medical practice for liability reasons. The challenge that this presents is that it often results in a rental activity, which is passive. You then have a building with depreciation and you can’t use those losses against the income from your medical practice.
An election under Section 1.469-4 allows you to group your rental activity with your operating business, which includes your medical practice, as long as each owner is the same in each entity. This will allow you to take the losses from your rental property against the income from your medical practice. This is a relatively common strategy that people use and it’s one of the big benefits of owning the building versus leasing.
[09:54} A closer look at depreciation
When you buy an office building, it’s going to be depreciated for just over 39 years. Over that period, your property depreciates year after year. Since your building will likely house items of all different class lives, like office equipment, a cost segregation would be completed. A five, seven, and 15 year property would help you recover your costs much more quickly. There’s also something called bonus depreciation, which allows you to completely depreciate property with a class life of 20 years all in the first year of property ownership. Usually somewhere between 20-30% of a property’s value can be allocated in the five, seven, and 15 year property. This allows you to significantly increase that depreciation expense. In the end, the best thing about depreciation is that it’s noncash.
[13:02] Strategies for using leverage as a tax strategy
If you’re in a growing or stable market, your property is going to be increasing in value over time. You can also increase the value of your property by making renovations to force the value to rise. As you pay down the property loan, you’re increasing your equity. One of the best things about real estate is that it’s an asset that’s very easy to collateralize, so you can go to the bank and take a loan against your property and use it to buy or fund other investments like an expansion to your medical practice or another building. You’re able to tap into the equity of your property and take loans out pretty easily.
[14:49] Tax deductible interest
Interest is tax deductible if used for business purposes. Interest tracing rules specify that interest on the debt is categorized however the debt proceeds are used. For example, buying a luxury car and using it for personal purposes would not be tax deductible, but if the interest is used to expand your medical practice or to pay expenses for said practice, then it would be deductible.
[17:10] Ways to reduce tax liability
Have you ever completed a sale leaseback and then felt unsure of what to do with the proceeds because you don’t want to end up with a huge tax bill? There are ways you can reduce your tax liability, depending on your specific goals and whether you want to continue to manage or exit real estate.
A 1031 exchange would involve selling a property. You can defer the capital gains tax and depreciation recapture tax by buying another property. Typically in this scenario you would have to roll over the entire sales proceeds and replace mortgages on the property.
Another way to reduce tax liability would be to purchase another property and use a cost segregation study to generate bonus depreciation from the original property. You can use the losses from the new property to offset the gain on the sale of the old property.
With a 721 exchange, you’re able to put real estate into a partnership and collect nontaxable interest on the partnership. If you have a piece of highly appreciated real estate, you could contribute it to the partnership. This is typically used with partnerships that roll into a REIT.
[23:48] The importance of having an attorney
If you’re going to become a bank or a buyer, it is crucial that you have an attorney to help you. When it comes to legal documents, hire an attorney and have it done correctly the first time through. Thomas shares that he has seen a lot of entity structures go through the painful process of trying to fix something after having used a cookie-cutter website in their attempt to cut corners financially. If not done the right way, documents could be rendered not legally binding and end up costing you more in the end.
[24:55] Thomas’s first job
Thomas started his first job as a cashier while he was in high school. He considers his time at BDO as an audit associate as first real job.
[25:13] What Thomas would be doing for a living if he wasn’t a CPA
If Thomas wasn’t working as a CPA for real estate investors, he would likely either be a real estate agent with a brokerage or be involved with something tech related.
[25:31] What Thomas is currently reading or listening to for news, information, or inspiration
For news, Thomas has a subscription to Bloomberg, which he really enjoys. For inspiration he listens to Alex and Leila Hormozi’s podcast.
[26:09] What Thomas does for healthy self-care
Thomas is heavily interested in fitness and is at the gym around six days a week. His self-care includes working out and being intentional about what he eats and puts into his body.
[26:35] Thomas’s thoughts on whether leaders are born or trained
Thomas believes that some people have a natural inclination toward leadership, but that overall leadership is a trained skill.
Thank you for tuning into the Providers, Properties, & Performance podcast!