Summary
In this interview I speak with Chris Grindy, the owner of Grindy Tax Service in San Jose, California. They discuss various tax topics, particularly as they relate to real estate. They talk about the tax advantages of owning property, the changes brought about by the Tax Cuts and Jobs Act, and the deductions and expenses that can be claimed for rental properties. Chris emphasizes the importance of finding a trustworthy tax professional and provides resources for finding an Enrolled Agent.
Transcript
Chris owns and operates Grindy Tax Service in San Jose, California. This is a family run business. They’ve actually been in business for just about 75 years now. That’s pretty incredible. They’re located very conveniently, right in the heart of San Jose. I was pleased to be able to go to the office, sit down with Chris, and have a good long chat about taxes, mostly as they relate to real estate. One of the big things about having a house are the different tax advantages that come with owning property. There’s a lot of things that you need to know if you really want to take the best advantage you possibly can of the tax code if you own real property.
And the thing is that it’s always changing, right? Like the tax cut and jobs act, which Trump passed along with the Republican Congress in 2017, which took effect in 2018, totally upended the calculus for owning real estate for many people in California. So we talked quite a bit about that and many other hot topics like tax, deferred exchanges, vacation rentals, depreciation, investment, property, all kinds of great stuff. We took a real deep dive into taxation issues just in general and around real estate in particular. I learned a ton, and I know you will too. So without further ado, please sit back, relax, and listen to what Chris Grindy has to say.
Hey Chris, how are you doing? I’m doing good. So thank you so much for having me over to your office today. I really appreciate it. Hey, I’m glad to have you here. What would you like to know? Well, I’d like to start my podcast by having the guest Tell me a little story. Do you have a little story you can share with us about who is Chris Brandy or some little nugget from your past that kind of give us a feeling for who you are and what you’re about? So I grew up right here in San Jose, this building, that’s our office now, has been here since I was born, and I used to run around here and cause all kinds of trouble. Went to high school at Lee High School, loved playing chess, loved driving my car, playing Dungeons and Dragons with friends, running cross country, just doing a bunch of stuff but didn’t really have a target, a goal in my life. Went down to the army recruiter’s office with my best friend. He went into the Army recruiter’s office. I went next door to the Navy recruiter and took the ASVAB test. Took the test. Oh, I took that in high school. Yeah, armed surfaces, vocational aptitude, battery test, and I didn’t remember what it was called.
I remember.
So I went in the Navy. They offered me a job in the nuclear power program.
They wanted me to do the same thing. Wow. Parallel lives here almost. I didn’t go to Lee High School though. Okay.
So I did that. I did that for 20 years. I actually went from the nuclear power program into physical security in the military. Learned how to be basically a police officer in the military. Thought about coming out of that and being part of fema because I knew about engineering, I knew about physical security. I knew how to develop all of that stuff. Didn’t go work for FEMA because I figured out that I’d be away from home more than I was away from home in the military. Had four kids by that point in time. I married somebody from that. I had actually met on the senior trip in high school, San Francisco River. Cruz. Met her when we were crossing underneath the golden gate.
So I still did engineering though, became a land surveyor. Did that for a couple years. But I had an opportunity while I was in the Navy to learn about taxes. The navy partners with the Internal Revenue Service to do what’s called vita, voluntary Income Tax Assistance. And it’s not just the Navy, it’s an I R SS program, but it was free training. Free training, and learned how to do taxes. So I learned how to do taxes, which is a family business. It’s been a family business since 1941. My father was in the Navy. My grandfather was in the Navy, so I’m a Jimmy Buffett son, son of a son of a sailor. When the housing market took a dive, I’m sure you remember that. I
Do remember that
I came and started working full-time here at the tax office. I’d already been doing taxes for a couple of years during the winter and doing survey work during the summer. Came full-time here to work at the office, and I’ve been doing taxes ever since. I became an enrolled agent, which is somebody who can represent taxpayers to the I R s with a power of attorney, whether I prepared your taxes or not, if you had a problem, if you got those i r s letters, I could work with the I r s on your behalf. So just to speak their language, play in their sandbox, use their rules to best represent you.
Wow, that’s pretty diverse background there. Before we talk about anything about tax, tell me about the navy. So this nuclear engineering thing where a nuclear engineering, were you on aircraft carriers? Submarines? What kind of
So aircraft carriers and I trained actually on a submarine prototype, which is a inactive submarine. But the nuclear power portion is really more about providing ship’s power. Whether a ship has boilers or nuclear reactors, it’s used to generate electricity, propel the ship through the water, make fresh water, and just provide that power to the ship. So engineering, I was a mechanic.
Pretty
Good mechanic. Or you could say I was a glorified plumber. So who
Made those reactors on the ships, do you remember?
So the ones that I worked on mostly were General Electric.
General Electric, because my uncle, he designed nuclear power plants for submarines and he worked for Westinghouse
And
So he had passed away, but he lived on the east coast. He would come and visit us every couple of years because they were sending him to somewhere around here, I guess Merri Island maybe. I don’t really know to, I don’t know, work on the reactors. He would hang him out for a week or two and then go back. He did that for several years, so that’s really cool. I had another client up in Ben Lomond and he worked on, he was on submarines for a good long time, like 15 years, something like that in the Navy. And he had many interesting experiences in the Navy. Have you been all over the world then? Have you?
I have just about circumnavigated the globe in the Navy. I’ve been across both across the equator and into the North Atlantic. The best place that I’d say I’d ever been to is Israel. Really. We spent a couple weeks in Israel. People were wonderful. I took tours, made it into Jerusalem, and also we didn’t get to go to Bethlehem. That’s because they were fighting and shooting. It was a war in the streets. The time in Bethlehem taped off every single citizen in Israel becomes part of the military. It’s mandatory enlistment. Two years for women. I think it’s three to five years for men. When a young military member goes home to visit their family, they take their M 16 or whatever rifle it is with them. If they’re still active duty, they’re always active duty. The tour guide that we had was a reservist officer. He was required to always wear his sidearm when he wasn’t in his home because if he was activated, he was activated immediately. So it’s a very different culture. I never felt as safe. I never felt that safe anywhere else in the world. And the people are wonderful. The people are very accepting and for people to be that accepting is, it was just a blessing being there and going and seeing all of the places went to where they had Sermon on the Mount, went to the Jordan River, huge catfish in the Jordan River, by the way. So yeah, it was a wonderful experience.
How was the hummus?
I did not have hummus, but I did have the roasted lamb that they
Shear off. Oh yes, right.
That
Was that exquisite probably. Wonderful,
Wonderful.
Yeah. My brother went to Israel in 1980 in the San Francisco Boys Forest. They did a tour and he had a tremendous time. He’s been back several times. He works at Intel and they have some fabs down there or whatever. So he’s been back several times. But as a kid growing up, I remember his favorite story was that they had a bodyguard wherever they went in Israel, and he said, our bodyguard slept with a gun under his pillow. And that must’ve been very exciting for a 10 or 11 year old kid to see that. But yeah, everyone’s armed in the teeth. They don’t have a problem with mass shootings in Israel really, even though everyone has a gun. It’s kind of a different culture, I guess, than we have here.
Definitely a different culture. We didn’t spend the night out. We took bus tours and then back to our ship
Because
Our ship was in port there, so we had our own place to stay the night.
Right. Well that’s good. So that’s awesome. I would love to go to Israel. I never have gone. A friend of mine is talking about going there for his 50th birthday, and that would be I guess next year. And I would love to be able to go to Israel. I hear it’s wonderful. My uncle’s been there, my brother’s been there several times. It sounds like an amazing, amazing place to visit and so much history. I mean, I’m kind of a history buff and I think I could just really have an amazing time in Israel. So you are an enrolled agent now. How long have enrolled agents been, I’m speaking about history. How long have enrolled agents been around? Is this like a new thing or has this been going on for a while?
Enrolled agents have been around since the Civil War. After the Civil War, there was a lot of turmoil with people wanting their stuff back that had been utilized. Their horses, their land, their people’s crops had been used to feed the troops. And the government wanted a central representative to be able to represent people to the government for compensation. And so everything was monetized. What was the value of the horse? What was the value of the crops? And so that way the government could compensate for what was used or return what was used, but also put values on it as the tax laws came into effect. Those same enrolled agents, they’re enrolled to represent to taxpayers, to the I R S. So to say that this is taxable. This is not taxable, how much tax is owed. Enrolled agents have always been a part of that system, but they’re the part of the system that is looking after the benefit of the taxpayer, not the government.
So you have a fiduciary relationship with your clients and you can act kind of as them as an attorney almost. But for taxes is that
That is correct. We get power of attorney. If somebody is being collected on by the Internal Revenue Service by any of the 50 states, we can directly represent that person and make agreements for that person, get information for that person, negotiate for that person in order to reach. It’s not a settlement. It’s in order for the person to become compliant. Compliance means that we know the rules that the i R S goes by, franchise tax, by board goes by, and those rules allow for people to pay their taxes, but they also allow them to live their life. If you can’t pay all of your taxes right away, you are still allowed to have a house. You’re still allowed to eat, you’re still allowed to travel, you’re still allowed to pay for medical. And so if you don’t have enough money for all of that, you are allowed to have a budget and then pay your taxes out of what’s left. And if that’s not enough to pay your entire tax liability, that’s okay, but as long as you still make payments that you agree on you in compliance. So being in compliance doesn’t necessarily mean you’re paying everything that has been calculated. That’s the goal. And you’re supposed to keep up, but it doesn’t always work out that way. Just
You’re square with the I R S. You’ve come into compliance. So why would someone go to an enrolled agent versus A C P A? Is there what’s
And C P A is a certified public accountant. CPAs trained to do audits of major corporation financials, CPAs. Some CPAs do specialize in tax enrolled agents, concentrate in tax, solely tax, including representation that we were talking about. Whereas A C P A may or may not. And even in the tax realm, there are some clients that I refer to, other enrolled agents, sometimes I refer them to attorneys depending on how much trouble they’re in because of their specialties. There are numerous different types of taxes. If we look at trust, tax returns, a trust. The very first seminar that I ever took for trusts, there was an attorney that gave the seminar and at the beginning of the seminar he said, how many people here prepare trust tax returns? Two thirds of the room put their hands up and he said, I could take 95% of you to court and sue you and win. And then he proceeded to tell us and demonstrate how many different ways a trust, one trust can be different from another trust legally in wording and everything else. Just so that we would understand that we have to be very careful in what we’re doing in preparing a trust. It’s just like a partnership agreement. If you have a partner and you have a partnership tax return, but you don’t have anything in writing, there’s nothing solid if it’s not in writing. I learned that in the military. If it’s not written down, it doesn’t mean anything.
Good point. Yeah, I’ve experienced that as well. Yeah. Everything in writing, and I’m glad you mentioned trusts because I am kind of in the process of setting up a trust for myself. We have a house and people who own houses should have a trust. Is that fair to say? Is that
Absolutely.
Why should you have a trust if you own a house?
So if you have assets, and we’ll talk more about assets, but if you have assets, if whether it’s a house, you have a car, you have stock, you should have a trust. The reason being is a trust helps move your assets to where they belong. A trust can also protect your assets if, do you have kids?
Yes.
How many? Two. Okay. Do your kids have kids?
No, they’re young. They are eight and 10.
Well, good. So if you want your kids to use your house after you pass away, you’d put that in your trust. If you want your kids to sell the house, you put that in the trust. If you want one kid to have the house and another kid to have all of your stock in I B M, you’d put that in your trust. A trust is better than a will a trust. If you have your things in a trust, now you have to put your house in the trust. Just having a trust does not mean the same thing as funding a trust. A funding a trust means you go down to the county assessor’s office and you say, okay, I’m transferring the title of my house to my trust, but the trust will designate what happens with your stuff, with your assets when you pass away, you’re married, you have a wife.
What happens if one of you passes away? Do the kids all of a sudden get the house or does the wife keep the house until she passes away? And it helps prevent probate, or excuse me, avoid probate. If you only have a will, that means that the court system has to approve what happens to your stuff. So your beneficiaries still have to go to court to say, this is what we’re doing with everything. And the judge still has to say, yes. Okay, that’s fine. Do that. If there’s other parties that start asking, well, wait a minute, what about us? I’m his brother. I helped buy that house, so therefore I get part of the house. Well, that could cause a lot more legal fees. So a trust helps of prevent that. And so that way a trust can just, you’ve got the trust, these things go to those people, Roger that, and it goes forth. So it is a much more substantial document.
And you also avoid the probate fees, right? So if I die and then a house isn’t in a trust, my wife and I die in a plane crash or whatever, and then our kids are not on the plane. So normally if we didn’t have a trust, they have to go through probate, and the probate fees could be 30,000, 40, 50 that, I mean, they’re substantial, right?
The probate fees can be dependent upon the size of your assets, the size of your estate,
And you avoid all those fees or almost all those fees if you have it in a trust. But now, do I have to file a tax return every year if I have a trust,
You do not file a tax return for the trust you are talking about. Some trusts do file a tax return every year a special needs trust, but your trust is simply the trust in the name of yourself and your wife. And as long as yourself and your wife are still filing your own tax returns, all of your income, all of your expenses is yours. Even if your stockbroker account or your rental property is in the name of the trust, all of that income and expenses flows through your tax return. It always has nothing special to do, but a trust will actually say, upon this person’s passing, or upon that person’s passing, this is the steps to take. Most trusts would say when Sebastian dies, because, well, you’re the guy and you’re probably going to die first
I’m sure of.
So when you die, your wife has the benefit of everything. Everything still goes on her tax return,
Right? There’s no must. There’s no fuss. It’s just like automatic. Nope. Not even questioned by anybody.
That’s correct.
Right?
Some trust, a little more complicated. If I was on my second marriage and my house that you helped me buy, thank you very much, up in Brookdale was owned by my first wife and myself. Maybe when I die, my first wife gets the house and it goes solely to her and I release that part of the house, or the house gets sold and my first wife gets half and my second wife gets half of the proceeds. So when you have mixed families, a trust can help guide the actions to take when certain events happen. So they’re even more important as your assets get larger as the families get mixed as they do.
Right. Okay. Now thank you so much for that. I appreciate that. I’m glad to hear I don’t have to file a tax return for my trust because when you said that tax return for the trust, I was like, oh, great, another piece of paperwork I have to worry about. So tell me about this enrolled agent thing a little bit more. How does one become an enrolled agent? Do you have to go
To school
Or class or what’s the certification process?
So the certification process to become an enrolled agent is a lot of education. We have to go through a 72 hour classes both on individual tax law, on estates and trusts, corporations, and on ethics, what finds the penalties the Internal Revenue Service can impose. And after going through this education, there is a three part exam that is administered for the I R S, not by the I R S anymore, but it’s for the I R S. That exam used to actually be a four-part exam, and you would go in at the beginning of the day and do two hours for every single part, but you would have to take all four parts on the same day, and they would only give it once every six months.
So if you didn’t pass them all, you’d have to come back in six months and try again. The exams in three parts, they kind of consolidated a little bit. You have to take the exams, you have to be able to pass all three sections of the exam within a two year period. Once you become an enrolled agent, education does not stop. You have to have education hours every single year, ethics hours, every single year. Currently this year I am up to 74 hours of continuing education, both in about 12 hours, eight hours worth of webinars, and the rest has been in person in
Classroom
Seminars, in classroom. Yeah.
So that next question is that things change a lot all the time. It seems like the tax rules change. Do they change every year? I mean, every year there’s new rules. I mean,
Every year something changes. I have clients often that say, well, it’s the same. Can’t you just use last year’s numbers? And even if everything you did was exactly the same, you would not have the same tax return because there’s always inflation adjustments that happen. There’s always presidents that change. Presidents bring in their tax reforms. We’re in the middle of a huge tax reform that changed 2017 versus 2018 drastically.
That’s one thing I would love to talk about is the tax cut and growth job act. What was it called?
Tax Cuts and Jobs
Act. Trump. That was passed in a very short period of time with very little discussion and then became law on January 1st, 2018. What are some of the biggest things that happened in that tax cut and jobs act that homeowners or would-be homeowners need to know about that maybe they weren’t aware of? Can you give me like three or four biggies?
So the T C J A as we love to T put
Everything T, there’s even an acronym for it. There
Is an acronym. There’s acronyms for everything, almost as many as there were in the military. So the tax cuts and Jobs Act drastically changed how tax returns flow for most of America. There are multiple parts of that, tax cuts and jobs acts. But we’re going to talk about homeowners a little bit and we’ll talk about homeowners. We’ll talk a little bit about people with kids too. Okay? Because how many kids you have now kind of changes how your tax return changed. Also itemized in your tax return, and I’m going to talk a little bit technical here. The first part of a tax return is income total up all your income. That’s your adjusted gross income. The second part of your tax return is deductions. Now in the first part, there are some adjustments to income, but I’m leaving those out deductions. His historically have been a deduction that has either been known as the standard or itemized deductions, and there’s also an exemption deduction. The first one I’m going to talk about is the exemption deduction. The exemption deduction historically has been X number of dollars per person in your household, yourself, your wife, your two kids.
You feel like the W two and they say, how many exemptions are you taking?
Exactly. That’s the same relationship. So there was a year, a couple years back where that exemption deduction was exactly $4,000 per person, which means you would take $16,000 for that exemption deduction
For a family of four
Off of your income, and you would not have to pay tax on that. Got it. Okay. So the exemption deduction still exists, but the amount for the exemption deduction for 2018 through 2025 is zero.
It’s very generous.
Okay, so now let’s talk about, this is backwards order, but now let’s talk about whether you take either standard or itemized deductions. Okay, so exemption and deductions. So the exemption deduction went to zero, but they took the standard deduction, which is basically the minimum that any person or tax return receives.
There was always a standard deduction, right? There’s
Always been a standard deduction. So the standard deduction when exemption amounts were $4,000 for one person was a little bit more than $6,000. Okay? So you would get $6,000 of standard deduction. You’d get $4,000 for your exemption, just you all by yourself, no wife and kids. We’re not going to confuse that just yet. So you’d get about 10,600 bucks just below 11,000. Now the standard deduction for a single person is $12,000. So you lost $4,000 in one spot, but you gained a little bit more than that in other spot. So the deductions didn’t go down, they moved, they shifted, however, and the same thing happened for a married couple. It used to be 11,000, now it’s 24,000. So you lost $8,000 worth of exemption deductions because it was two times 4,000, but you gained more than that on your standard deduction. So that deduction shifted. But when you start adding kids in there, which is another 4,000 and another 4,000, you lost $16,000 worth of exemption deductions because of four people in your household, but you didn’t gain $16,000 on your standard deduction.
The other thing, the next thing that changed, okay, so that’s the standard deduction. You can either take the standard deduction, which now for a married couple for yourself is 24,000, or you can take itemized deductions. Itemized deductions is where you say, how much did I pay in charity? How much did I pay in mortgage interest? How much did I pay in property tax? And then there’s a miscellaneous category at the bottom, and there’s medical at the top. We’re going to ignore miscellaneous and medical. Those are not the big ones. We’re going to talk about charity. If you give to charity the value of what you give to charity, whether cash or everything that’s deductible, never changed. Still the same. Your mortgage interest, your mortgage interest that you can claim if you already had a house still the same, your property tax and your state taxes that you pay that is now limited to $10,000. So if your property taxes were $15,000 and you paid $5,000 to California for state taxes, that’s $20,000. You lost half of that. So you used to be able to deduct $20,000 of your income and now you can only deduct $10,000 for that category. For that category, exactly.
So that was a big change. It’s not as drastic as it sounds though. It’s not as drastic as it sounds because the tax rates also changed for people in California who pay alternative minimum tax. Alternative minimum tax is a, it’s a second tax calculation that changes the different things that you can deduct. You uses different tax rates and comes up with a different answer, and if that answer is higher than the tax that you would pay using the normal calculation, the is added onto your tax. But the calculation for alternative minimum tax also changed. So there was a lot of people in California, especially in this area that were paying alternative minimum tax, which was an extra tax that no longer pay that extra tax. So their tax may have gone up in one place and come down in another. The end result or the end conclusion is you have to do the math. There’s absolutely no way for me to say that everybody’s taxes got better or everybody’s taxes got worse because it’s not true. There are some people whose taxes got better. There are some people whose taxes got worse, and there’s actually a large number of people whose taxes didn’t change very much at all. Just the way it was calculated shifted around.
So when they were passing, this thing I remember was the guy, Paul Ryan was like, you can do your taxes now on a postcard. I remember that. And you’re like, oh, great. But that’s not true because you really have to calculate it twice. You have to say, do I take the standard deduction or do I itemize? In order to answer that question, you have to run your taxes through as if you to itemize them all out and then figure out which one is better for you, standard or itemized.
Well, I have to say that they did make the tax return shorter. The tax return used to be on two pages. They took it and put it on one page. However, in order to do that, all of the things that I kind of skimmed over that I said, well, we have adjustments here and we have this kind of deduction there, and you have a business or you have a rental. All of those categories move moved from the regular tax form onto separate schedules. They created six new schedules or six new pages that may or may not be needed on your tax return in order to take what was on two pages and squish it down to one page. Right? So yes, it’s a postcard.
It’s a postcard. So when all this C C J A was going through the California Association of Realtors, they were all up in arms. They were saying, Hey, people are not going to be able to take as many deductions now as they were previously because of the cap on the state and local taxes, which in California Silicon Valley, very, very high, right? You might be paying $20,000 a year in property tax. You might be paying $15,000 a year in California. Tax mortgage interest might be another $20,000. Who knows? That might be 50 or 60,000, but now you can only take a $25,000 deduction as your standard. It’s capped, right? I’m conflating these things, but it’s capped. What have you seen now that you’ve been doing taxes now for 2018, right? So 2018, that deadline has now passed. All those taxes are filed. Have you seen that your same clients now, typical homeowner maybe in alma den or someplace, are they paying more tax? Are they paying less tax on average? What have you noticed?
So the interesting thing is, yes, the new homeowners are the ones that are hit the worst and they’re hit the worst because of the limit on home value that is. So you pay interest on your mortgage. Mortgage interest is deductible historically prior to this, and also for California, you can buy a house for a million dollars or up to a million dollars and deduct all of the interest you pay on that loan. So if you have a loan for a million dollars now for the Internal Revenue Service, if you purchased your house after January 1st, 2018, that amount is actually limited to $750,000. So you can only deduct the interest on a $750,000 loan. All of your loans combined for your main house. This doesn’t affect rentals. Rental property is still a business. You can deduct all of the mortgage interest that you have on that rental property.
So maybe you have some planning to do. Some people call me up and say, which loan do I pay off? And I look at their tax return, and a lot of ’em, the one I talked to just yesterday, who is looking at selling one of their three rentals and paying off their main home is doing the right thing. They’re going to pay off their main home because that interest does not benefit them as much as it used to the taxes. The interesting thing is those same people who were hurt by not being able to deduct state taxes and property taxes on their tax return, a lot of that was from state income taxes and that alternative minimum tax that I was talking about actually put those state taxes back into the calculation. So there were a lot of the median ones where their regular tax went up. Their A M T alternative minimum tax went down another acronym. So their tax liability, their total tax at the end was less. Not everybody though. There are definitely people who work and have high executive positions whose w twos, whose wages are coming in the high sixes, low seven figures, and there are people that did pay 20, $30,000 more in tax. Everything’s individual, everything’s, there is no dividing line for income purposes. The higher you go in income, but the more likely it is, you’re going to pay more tax, period.
So it’s been a lot of going back and forth. The one thing that did happen, which was very interesting, is because the tax reform said, Hey, everybody’s taxes are going to be lower. Those people who have jobs who just get their taxes taken out automatically, those federal taxes that were taken out automatically were taken out at a lower percentage. So there were people that had to pay at the end of the year, not because their taxes went up, but because their withholding went down, they had less tax, total tax withheld from their pay, not because of anything they did, but because the government changed the tax tables.
Right? Right. Yeah. A lot of people basically had lowered less money taken out and they owed more money at tax time and they were surprised by that. So is there anything like the savvy high income person can do to lower their taxes into this new TC tax cut and Jobs Act thing? Like for example, this whole thing business passed through income or whatever. I mean is that, you know what I’m talking about.
So there is another thing that is totally separate from the tax cuts and job tax, but California has come up with a new definition of employee versus contractor. It’s a lot more restrictive. It really closes the window on who can legally be a contractor. And so there were a lot of people going, well, I’m just going to start my own business, get my income that way, and take a whole bunch of deductions. That’s fine. If you have a legitimate business and you’re running it as a business, but if you are doing real estate and you’re in a real estate office and that’s what they do, you’re an employee. If I’m doing taxes and I’m, let’s say I’m just a tax preparer in this office and it’s not my company, it’s not our family business. I’m just a tax preparer, but that’s what the office does. Well, that means I’m an employee, not a contractor. I can’t just be a contractor because I feel like it and deduct things that are not ordinary and necessary business expenses. Doing real estate, you have ordinary and necessary expenses. You have to drive places to show houses, you have to pay for fees for transactions, you have to pay for your license, you have to pay for a whole bunch of stuff. That’s all still just as much a business expense as it always has been.
I’ve seen a lot of people try to manipulate the whole tax cuts and jobs act. Now we have this special business deduction, so I want to take advantage of that. It hasn’t worked out very well for many people unless they actually do run a business. If you run a business, take every expense you possibly can. Keep track of your income, keep track of your expenses, keep good records. That’s the biggest thing any business person can do, is make sure they have a good record keeping system that makes sense to them. Because ultimately, if somebody says, where did this expense come from? That person has to be able to produce the canceled check, the credit card statement, the receipt, whatever, and it has to be reasonable.
Right? Got it. Okay. So what about capital gains? Calculating capital gains, this is a big issue for a lot of people because when they sell their houses, they have gigantic capital gains. So you buy a house for 500 and you sell it for a million, but in the interim time period you’ve had some expenses, right? So you can deduct the commission and all that, or your cost of sale out of your capital gains. But what if I remodel my house or put on a new roof? Are those things that add to your tax basis to diminish your capital gains? But maintenance is not deductible, right? So what’s the dividing line between maintenance and capital improvement?
Maintenance and capital improvement? Okay, so the answer is capital gains. Whether you’re talking about a house or stock, an asset, you’re buying an asset at some point in time, you’re selling it at some other point in time, those are still treated the same. California, no special treatment, if it’s capital gains, it’s at the same tax rate that California taxes everything else at for federal purposes, if you’ve owned something more than a year when you sell it, if it’s a capital asset that the gain that you have to pay tax on, which is basically the difference between what you bought it for and what you sold it for. I bought a house for 500,000, I sell it for a million, which means I have $500,000 of capital gain.
If that $500,000 is taxed at a lower tax rate if I’ve held onto that house for more than a year. When you are talking specifically about a house, you have to differentiate between whether it’s a rental or a business investment or your main house. One nice thing that the i r s gives us and California conforms is they give us an allowance that of an amount that we don’t have to pay taxes on as long as we’ve lived in that house for at least two years, two out of the last five. So you buy your house for 500,000, you live in it for one year, 11 months and sell it. You’re going to pay tax on that 500,000. If you sell it for a million, wait another month and you and your wife have this house, you and your wife sell the house, you each get a $250,000 exclusion that you don’t have to pay tax on, which means the house that you bought for 500,000 and you sold for 1,000,003 years later, two years, one day later, you don’t have to pay any tax on that first $500,000 of gain if during the interim you did capital improvements.
A capital improvement is something that increases the value of your house that was not there before. If you had a fence going around your yard when you’ve moved in and the fence deteriorates over time and you replaced the fence, that’s not an improvement. That’s a repair. If you never had a fence to begin with and you put in a fence line, that’s an improvement. If you painted the house, that’s a repair
And a roof. A roof like you had a roof before. So a roof is not a capital improvement. That’s
Roof is not a capital
Improvement.
Now, if you move into a house and it’s been up in the Santa Cruz hills under the Redwoods, getting all kinds of moisture and you have to replace the roof right when you move in, then I would call that a capital improvement because the roof was destroyed when you walked in. It was part of what you
Needed to do, had no, had no value.
So my house within the year, I replaced water heater, I replaced the stove. They were just old when I moved in,
They had
Value. So I kept track of that.
But
There’s things that I’ve done since that is just because I wanted to
Painting and carpeting
That I’m not keeping track of.
Well, that’s very interesting. Chris. Are there i r s regulations about this or is this just the art of tax preparation, shall we say?
This is closer to the art of tax preparation. The Internal Revenue Service does not give clear definition on many different things. This is one of those areas, buy, build, or improve. That’s the terms they use for a loan buy, build or improve. Improve is something that increases the value of the house. It’s a capital improvement compared to basically what it was when you moved in. If you move in and the paint is just fine, the value may go down because the paint’s crap in 10 years and you repaint it. That didn’t really improve it based on the condition it was when you first bought it.
So let’s just say you move in, you have linoleum floors in your house and you live with oleum floors for five years, and then you decide to replace it with lovely hardwood floors. That’s a capital improvement. That’s not maintenance. Maybe there are holes in the floor before and now you have lovely Brazilian mahogany or whatever. That’s a capital improvement. That’s not, I say so. Right?
And a lot of people will say, I didn’t keep good records, and I tell that person, I said, go walk through your house. I have pictures from our house from before we bought it. I actually still have the listing pictures and I can go walk through my house and I can say, wait a minute, I did this, I did that, I did this, I did that. And those materials cost something. Or you had a contractor come in and tear out your kitchen, put in all new kitchen. That’s a capital improvement.
You
Do do a remodel if you tear down the entire house leaving one wall like I’ve seen done in Willow Glen and rebuild the house around it, that’s definitely a capital improvement.
Got it. So now, investment property. So investment property, let’s just say I am somebody, I said, you know what, I want to have just a rental house and now I’m going to have a rental house. Now what can you deduct on your rental house? You have depreciation, you can deduct depreciation, and you can deduct mortgage interest, right? Because that’s considered to be a business expense or how does that work if you’re not, you
Have to be
Actively managing it. As a property manager, I’m a little fuzzy on that part. I know I get to because I’m a full-time real estate professional,
But if
You’re a software engineer and you buy a rental house, what all can you deduct?
So a rental house is treated by the I R s like any other business, and the i r s has a phrase that they use, and that phrase is ordinary and necessary if the expense for your business rental house, any business that you’re running is an ordinary expense for that business and it’s necessary to do that business. It’s an expense against that business. Income rentals have a few more rules thrown in. That is yes, you get to take depreciation. Depreciation is where you take the value of the structure and claim that as an expense over 27 and a half years. Which means you buy a house for, let’s say we’re still talking to our $500,000 house, let’s say. Well, the land here, we’re here in California, so the land is worth 300,000 and the structure is worth 200,000. You take the 200,000 divided it by 27 and a half, and you get that much of an expense each year.
You still get to take your property tax, your mortgage interest, your insurance, your repairs, supplies if you’re running a bed and breakfast, and take all of those things that you spend on that house and claim that as an expense. Now, one thing, you don’t get to claim as an expense. You get a house in Palm Beach and it’s on a golf course, and because it’s on the golf course, you pay membership fees to that country club. As a overwhelming general rule, the Internal Revenue Service does not allow country club fees, even though they’re required by the country club to be taken against your rental.
Alright, so
Now, but let’s just say let’s, you’re making 200 grand a year and you’re buying this house and then you are making, you’re renting the house out for five grand a month, 60 grand a year in income. And against that, you can deduct not the principal payments, but the mortgage interest and you can deduct the depreciation and any other expenses that you may incur. But if those expenses, those deductions exceed the rental amount, you can’t then take that deduction against your own personal salary. So you can only deduct as much income as you’re getting. Is that
You
Can’t transfer that across
If you were making $200,000 a year. That is a correct statement. Okay? There is a line, and it’s different depending on your filing status. So I’m not even going to give a number, but there is a line, actually, it’s a range where above a certain point, if you have negative income from your rental property or properties, if you have three rental properties and you have a positive 5,000, a positive 5,000 and a negative 15,000, the two positive five thousands would net against a negative 15,000, and your net would be a negative 5,000. Okay? So that negative 5,000, if you are receiving $200,000 of income on your W two, that negative 5,000, you would not be able to claim on your tax return that year. It would still be part of your tax return, and it would be what’s called a loss carryover, which means for 2018, that negative 5,000, that $5,000 loss would go forward into 2019. And then if the net income from all three rentals ended up being $5,000, you could use that negative 5,000 from the prior year to offset the current years positive. If you had positive 4,000 in 2019, you had a negative 5,000 from 2018, you offset the positive 4,000 and you still have another thousand dollars lost to carry forward. Conversely, if your income is low enough, you can take up to a $25,000 loss against your ordinary income from rental real estate.
Interesting. So let’s just say I’ve owned a rental property and I’ve been depreciating it for 10 years. So for every 10 years I’m taking seven and a half thousand dollars deduction because of depreciation after 10 years, that’s 75 grand. How does that affect my taxes when I go to sell the property? I mean, I have to pay that back or how does that work?
So you’ve been claiming depreciation, you claimed 7,000 over 10 years. So you have $70,000 worth of depreciation claimed if you paid, let’s go real simple. Let’s say you paid a hundred thousand dollars for the piece of property, okay? Madera, somewhere out in the Central Valley, okay? Right? So you bought it for a hundred thousand dollars and you’ve depreciated $70,000 of that. So now you’ve expensed all but $30,000 of what you bought it for. You go to sell it and you sell it for $200,000. You take the 200,000 and then you subtract the 30,000 of what’s left. You bought it for a hundred, you depreciated or you expensed 70,000 of that $30,000 of that purchase prices left. Subtract that from the 200,000. Now you have $170,000 worth of profit to pay tax on. If in the same instance you still had a $5,000 loss carryover, that would also go against your profit. So now it’s instead of 130,000, excuse me, 170,000, now you’re down to 165,000. So when you sell that piece of property, if you have not been able to claim your losses, if there’s anything left in that carryover bucket in the year that you sell that piece of property, you get to take the losses against your profits. So it’s not something that you totally lose.
Okay? Yeah, this is very complicated. I think I need to talk to the tax guy about this, but
One last
Question here and that is, let’s just say you are buying a ocean view condo down by the beach, and you’re going to use it as a vacation rental, but you’re going to use it sometimes yourself. Now, is that a property held for investment purposes or is that your second home?
Alright, I’m going to give you the tax preparer answer for that.
Okay.
It depends. Talk to your tax preparer. As long as you spend less than 14 days using the property for yourself, then it is still treated like a regular rental property. Income and expenses. If you use it for more than 14 days personal use, then it becomes a math calculation and you don’t get all of the expenses. You still have to claim all the income, but you don’t get all of a full portion on the expenses. I’m going to talk about a couple of special things here. Number one, you have a main house. Your main house is in Santa Clara, your main house is in Santa Clara. And guess what happens? Super Bowl comes to Santa Clara,
Right?
Okay. And you have absolutely no desire to be anywhere near Santa Clara during the Super Bowl. So you’re like, I’m
Out.
I’m going to go down to
Mexico,
Southern California, I’m going to go to Pismo Beach, I’m going somewhere else. I’m going to come to Santa Cruz. We love you in Santa Cruz. And so you decide you’re going to rent out your house for a week while you’re gone because there’s so many people coming to Santa Clara that you can rent your house out for 10 grand for the week because people want need a place to hang out. During the Super Bowl, you just made 10 grand you don’t have to pay taxes on.
Really? Wow.
You can rent out your main home for up to 14 days during a year, and that income does not count anywhere.
Interesting.
Strange, completely weird rule.
Wow. So if I go on a European vacation for two weeks, I can rent my house out for two weeks and that’s just free money.
Free money.
So everyone should do that. Everyone go to vacation for two weeks out of the year, check
Your homeowner’s insurance and see how much it’s going to cost to have other people staying in your house. First, check with your tax preparer, your tax professional before you start messing with anything like that and going here. I heard this on a podcast,
Right? So Chris, I got to confess, I talk about this stuff fairly frequently, but a lot of this just went over my head. Now, what I’m coming away with really is that I really don’t have any hope. I don’t think as an ordinary mere mortal to really understand hardly any of this. And I think that I have a guy, but a lot of people don’t have guys, you’re a guy who does this. How do people get ahold of you? It sounds like you’ve got it going on. You know what the score is. How do people get ahold of you if they need someone to help them with all this?
My recommendation. So my recommendation is find somebody close to you,
Physically close
Physically, somebody whose office you can walk into, somebody you can relate to, somebody you can trust because it’s a large part of your life.
It’s going to be intimate relationship you’re having with these people.
So there are several organizations. There is the California Society of Enrolled Agents, cs.org. Dot org, California Society of Enrolled Agents. There is also National Association of Enrolled agents n a.org. Both of these organizations, both of these websites have a tool on them, known as Find and ea, find an Enrolled Agent. And you can use that tool by zip code by last name because of a referral. You can go on Yelp, you can go on. I’ve been found by my website just because of a Google listing. I’ve been found by the Nextdoor app.
Yes,
I’ve, I get my clients 90 some odd percent by word of mouth referrals. And that’s because in the business that I’m in, in this business, if my clients trust me, they’re going to come back next year if they need me. Some of ’em don’t need me. Sometimes I tell people that come in the door, listen, your stuff is simple or your son’s stuff is simple. Have ’em go to the I r S website, have ’em go to the Franchise tax board website because if your income is low enough, you can use a volunteer income tax assistance VITA Center, or you can use the free e-file systems that both of them have on their websites. But when you have something that you need help with, find somebody that you can trust. And the best way to find somebody you can trust is ask other people who they use. That’s how I get 90 some odd percent of my clients. It’s word of mouth. My location’s wonderful.
Right on the corner. It’s easy to find. So on the web though, you are GR d, what is it?
Gr d tax.com.
That’s very simple.
It is very simple. G R I N D Y T A x.com.
Are there other people to talk to here in the office besides you? If somebody wanted walking down the street and they said, Hey, help me my taxes, will they talk to you or are there other people here who can help them?
Most of the time they don’t get to talk to me. I have over 300 clients myself. I have special projects that I’m working on to try to help people come into compliance. We have six tax preparers here at the office. Wow.
Wow.
We have four of our tax preparers are enrolled agents. Two of our tax preparers are California Registered tax Preparers also means they’re registered in California. They’ve taken a 60 hour class. They take continuing education at all as well. Excuse me. And one of those two. She’s very, very happy. Sticking with California, registered doing California tax returns for the clients she has. The other one is simply a younger, a newer tax preparer. He’s excellent at listening and he’s working on his enrolled agent. But like I said, it takes a little bit of time. It’ll take some experience to become an enrolled agent, have to pass all three tests to become an enrolled agent. So we’ve got him busy. But Joe is who I filter almost all of my new clients through. He’s here year round and he is a wonderful filter for people that I don’t have to talk to because I need to be able to allocate my time well enough to where the special projects I was talking about. I can get those done. Sure.
Well, with 300 clients, I mean, that’s a tremendous amount of work. So your address here is, what’s your address?
2, 2, 4 7 Camden Avenue.
2 4 7 Camden Avenue. Very essentially located easy parking. And so if anybody’s driving by Ken and Avenue, take a look for a granny tax surface. It’s on the corner. And if you need any help with your taxes, just stop on in. Ring a bell. And there’s good people here.
Yeah, check our website first. Give us a
Call
During tax season. We’re here a lot, but we’re seeing clients. We take appointments, we schedule all of our stuff via appointments. When it’s not tax season, we reduce our hours so my people can get a break. Actually, the worst time to talk to me is right after the April 15th deadline. And that’s because right after the April 15th deadline, my brain is done and I don’t have anything left. Honestly, most of my staff take about a one week vacation right after that April 15th deadline because they need the rest. But we try to call people back as soon as possible. We try to email people back. I’m a little bit of old school guy. I’d rather talk to you on the phone than bounce emails back and forth, right?
Yes.
My daughter who is up front and Joe, they email voicemail, talk to ’em on the phone, their brains go a million miles minute. I have a tendency to work through a problem one piece at a time, slightly meticulous, slightly. O C D I was the guy in math classes who would really upset the person who studied all week because I only studied for one day and got a better score.
Right, because you played all that. Dungeons and Dragons, they’ve come out with studies now showing that people who play dungeons and dragons are much better. Everybody else, if you’re,
I’m pretty sure that some of the people that I went to school with have produced several of the games that people play now or have played before because this is where we’re at. It’s the area that we’re at. We’ve got Netflix down the street, eBay in the other direction, and you’re
In the heart of it. You’re in the thick.
We’re in the heart of it, but it’s also given us a lot of exposure. One of my tax preparers, the tax class that he went to, the tax class that I went to in the military and then I went military, then I went h r block. But those tax classes was when I was still attached to the military. I wasn’t living in the Bay Area, I was living in the Central Valleys, so was the other tax preparer. And the people that taught us said, you’ll never see this. You’ll never see that. You’ll never see this. And I could instruct them on so many different things about stock, about corporations, about trusts that they said I would never see that I’m getting asked questions about every single day by both clients and other tax preparers because there are some things that just have a huge amount of exposure to, because we’re here, right? Because you’re here. Alright. Well Chris, I know you’re very busy. I really want to thank you so much for all your time. I really appreciate it. I learned a ton and I’m sure that my listeners have as well. Thank you very much for coming. Alright, we’ll catch on the flip side. Alright, bye.
All right. That wraps up episode number 48 of the Beta Bay podcast. That sure was a whole ton of information. I think you might want to listen to this episode again a couple of times because there are so many nuggets that Chris dropped about taxation there that my head is still spinning. I know I’m going to go back and listen to it as well because there’s all kinds of stuff that I learned, so I hope you enjoyed it. Listen, as always, the Bay to Bay Podcast is sponsored by the sold book.com. That’s right. Go to the sold book.com to order your free copy of my book, get It Sold. It’s all about how you can quickly and easily sell your home for the very highest price possible and have a good time doing it. Now, this is a real book. You can go onto amazon.com and buy it.
It’s 13 bucks on amazon.com has got some great reviews, but if you were to go and go to the sold book.com, you can get it sent to you for free and check it out if you use the coupon code free ship at checkout, that’s F R E E S H I P. Use the coupon code free ship at checkout. I’ll even ship it to you for free. Now, what kind of a great deal is that? It’s awesome. Go ahead, get the book. It’s fun. It’s easy. It’s a quick read. It’s only 110 pages and I wrote every word myself. Alright, that is it for this episode of the Be To Pay podcast. I hope you’ve been enjoyed listening, and I’ll have another episode up again before too long.
