JF1685: Section 199 Cap A Deduction, Save Money On Taxes #SkillSetSunday with Chris Hesse
Chris is a principal in the National Tax Office of CliftonLarsenAllen, and is here today to tell us about a new deduction that can save real estate investors thousands of dollars in taxes. Also known as the pass-through deduction, Chris will give us the details on the the deduction and we’ll have a better understanding of if we can take advantage of the deduction. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!
Best Ever Tweet:
“If you don’t have employees you can also look to another factor on the amount of depreciable property that you have in your rental” – Chris Hesse
Chris Hesse Real Estate Background:
- Principal in the National Tax Office of CliftonLarsonAllen
- Authority on the recently enacted tax reform, the SEC 199A deduction
- Based in Richland, Washington
- Say hi to him at www.claconnect.com
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Joe Fairless: Best Ever listeners, how are you doing? Welcome to the best real estate investing advice ever show. I’m Joe Fairless, and this is the world’s longest-running daily real estate investing podcast. We only talk about the best advice ever, we don’t get into any of that fluffy stuff.
First off, I hope you’re having a best ever weekend. Because today is Sunday, we’ve got a special segment for you called Skillset Sunday. By the end of this conversation you will have acquired or honed a skill that will help you with your real estate endeavors. Today we’re gonna be talking about taxes; don’t go away, it’s gonna be helpful for you, it’s going to be interesting. We’re gonna talk about taxes, and specifically we’re gonna be talking about Section 199 Cap A Deduction. With us today, Chris Hesse to talk through that. How are you doing, Chris?
Chris Hesse: I’m doing well, Joe. How are you doing?
Joe Fairless: I am doing well as well, and looking forward to our conversation. Chris is a principal in the National Tax Office of CliftonLarsonAllen, which happens to be our accounting firm for Ashcroft Capital. He’s also an authority on the recently enacted tax reform, Section 199 Cap A Deduction. Based in Richland, Washington. With that being said, Chris, first do you wanna give the Best Ever listeners a little bit more about your background? Then we’ll go right into the deduction.
Chris Hesse: Sure, Joe. As Joe said, I’m a principal in the National Tax Office. That means I get to answer income tax questions from people throughout the country, from all out of all of our offices of the firm. When they get to a particular hang-up on an issue, a new tax law, it’s my responsibility to find out what’s going on with this new tax law and how our clients can benefit from that. Then we distribute that information and continue answering questions throughout the country, and also we train other CPA on new tax laws as well.
Joe Fairless: Oh, that’s an interesting role. That’s gotta keep you on your toes, and keeps your mind fresh too, I imagine, because you’re always learning new stuff and seeing how it can be applied towards your customers.
Chris Hesse: Well, absolutely, it does keep us on our toes, because you’re in front of 100, 200, 400 CPAs, and they’re all sharp people as well. They’re there to absorb whatever I have to tell them, and hopefully I’m telling them the right things. Then I suppose the other thing that pushes my buttons on that is taking their questions and on the spot hopefully being able to answer them with a cogent and precise answer. Everyone likes their CPA to be precise.
Joe Fairless: Yes, yes, and I think that goes hand in hand, CPA and precise. Those words tend to be next to each other. So with Section 199 Cap A Deduction, why are we talking about this?
Chris Hesse: Yeah, yeah. Other terms for that is the pass-through deduction, people may have heard about that, or 20% qualified business income deduction… It goes by a few different names. Like any other new tax law, I suppose it takes a little while to settle on what we might call that, or everyone might call that in the future… But it’s a 20% tax deduction that people may claim if you’re a sole proprietor, or a partner in a partnership, or a shareholder in an S corporation, where this income is reported on your individual income tax return.
You get a 20% tax deduction — I call it a phantom deduction, because it doesn’t actually require you to pay out an expense. Usually, you have to pay somebody something in order to get a tax deduction; but you get this one just because it is qualified business income. That was the effect, Joe, of reducing the effective tax rate that a person has on their business income.
Joe Fairless: So how do you qualify?
Chris Hesse: The easy answer is I’m in a trader business, I’m an independent contractor, I may or may not have employees – I’m generating income, of course, from that business. You have to have business to have this deduction… And it’s much more complex than that, but also in the real estate, that’s your show here, the real estate – if the real estate rises to the level of a trader business… And this is the sticky thing with regard to the income tax law, because it’s not clear that every rental real estate qualifies as a trader business, rises to the level of being in a trader business. You may ask, “Well, why not?”
Joe Fairless: Right.
Chris Hesse: Well, the IRS, backed up by the courts – the courts say “You have to be pursuing a profit…”, yeah, we all wanna pursue a profit, “…and you have to be doing this with regularity and continuity.” This is just from my viewpoint, the person who owns their own property and is responsible for maintenance, cleaning… If it’s commercial property, you have the building that you’re maintaining, parking lot that you’re maintaining, sweeping, snow removal… Maybe no removal down in your area, but snow removal up here… That’s doing things with regularity and continuity. And because you’re doing it for a profit, that should rise to the level of a trader business. You might ask, “Well, what doesn’t then?”
Joe Fairless: Right.
Chris Hesse: Well, a triple-net lease… There’s a lot of concern on triple-net lease, where the tenant is responsible for everything; all I get is a monthly check–
Joe Fairless: But you have to get that check from your mailbox and deposit it on a regular basis.
Chris Hesse: [laughs] You have to make that effort to go out to the mailbox…
Joe Fairless: You have to sign the back of the check.
Chris Hesse: But not in today’s environment. We can have that automatically deposited, wired to me. [laughter]
Joe Fairless: So the takeaway here is if you have triple-net, make sure they mail you a check, versus do ACH. That way you can qualify.
Chris Hesse: Yeah, I think it’s gonna be a little bit more cumbersome than that.
Joe Fairless: I imagine most accountants are aware of this, [unintelligible [00:07:50].00] you don’t know what most accountants are or aren’t aware of; I’m gonna put on my attorney hat… You have no idea what most of the accountants are aware of, but I imagine this is fairly well-known… So should a real estate investor who wants to take advantage of this do anything special in terms of speaking to their CPAs, or preparing something in advance for the tax preparation, to make sure that they’re gonna be able to receive this?
Chris Hesse: There are some nuances on this, and this is where our position in instructing other CPAs gives some enlightenment as well, because we find in providing these seminars we get a feel for just how much knowledge there is out there in the participants… And I can tell you that there are participants and instructors. There are other instructors out there.
We’ve heard about instructors who say “Well, no rental activity qualifies.” Then there are other instructors that will say “Every rental activity qualifies.” And neither one of those is a correct statement. It’s coming from me, but neither one of those is a correct statement. We do have to make these evaluations of intent to make a profit, performing this, where the landlord, or the landlord’s employees, or the landlord’s agents are doing something with regularity and continuity.
In the extreme – let’s just take a ground lease underneath a skyscraper in Downtown L.A. It’s a 99-year lease. The landlord just gets a check. There’s nothing for the landlord to do. Very doubtful if that qualifies. But again, I can just tell you that there is a wide range of spectrum. This is a brand new law, and just like any other brand new law, sometimes it takes ten years before we know all of the nuances, because somebody has to litigate against the IRS as to their particular position, and the court needs to rule…
Joe Fairless: I’m calling not it for that litigation. I don’t wanna be a front runner.
Chris Hesse: You don’t wanna be that person?
Joe Fairless: No, I don’t wanna be that person.
Chris Hesse: You don’t wanna be the test case for it?
Joe Fairless: [laughs] Sorry, go ahead.
Chris Hesse: No, but you get the idea… With new legislation, we need to bring up the tax preparers, the CPAs, get everyone familiar with what it is that’s going on with this new tax provision, because there’s no body of law that gives this a guidepost as to what to follow. All we have is the raw language of the statute, and as of last Friday, the IRS issued final regulations that give us some information on this.
Joe Fairless: Anything else that we should talk about that we haven’t talked about, as it relates to the pass-through deduction?
Chris Hesse: Sure. There’s more nuances in that. I said that you get this deduction of 20% if your rental rises to the level of a trader business, but there’s more to it than that, in that of course there are limitations. As your income goes up, you have to meet a couple more tests. The higher-income people – you can ask me later as to what higher-income means – their deduction is limited to a factor on the amount of wages expense that they pay. Do you have employees? And if you don’t have employees, or you don’t have enough employees, then you can also look to another factor on the amount of depreciable property that you have in your rental.
Joe Fairless: Got it. And how can the Best Ever listeners learn more about either this, or your company? …if they want to either have a discussion with you or just learn more about CliftonLarsonAllen.
Chris Hesse: They can look at our website, at claconnect.com, and find an office near them, or there’s a wealth of information on the website that has all manner of tax information that’s available for free… And — well, the value of it is indicated by its cost; if a person wants to learn the nuances because their ownership and their generation of a considerable amount of net rental income or business income, perhaps they should visit with a professional and find out just “How I can restructure my particular ownership, or what might I do in order to enhance this tax deduction for me.”
Joe Fairless: Chris, thank you so much for being on the show, talking about Section 199 Cap A Deduction, or the pass-through deduction, as it’s known in other circles… And just educating us on this being a thing, number one, if a Best Ever listener has not heard of it, and then also some of the nuances that are involved with it, to be aware of it. Thanks again for being on the show. I hope you have a best ever day, and we’ll talk to you soon.
Chris Hesse: Great. Thank you, Joe, for asking me to join with you today.