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Hit 7 figures but losing 5 figures to taxes? Earn a 6-figure income but feel financial chaos? Welcome to the show helping you Simplify Your Numbers.
Most business owners in the $1M–$10M range feel like "passive payers"—surprised by a massive bill every April and wondering why their hard work isn't reflected in their bank account. Host Fabrice Metan, a veteran CFO and tax strategist, cuts through the noise of complex financial data to provide straightforward, actionable insights for the "7-6-5" entrepreneur.
This podcast is the bridge between traditional bookkeeping and high-level advisory. We move you away from a reactive "compliance mindset" and into a proactive strategy where your business becomes your greatest wealth-building tool.
Stop being a passenger in your own financials. It’s time to simplify your numbers, maximize your profit, and hold onto more of what you earn.
Subscribe to join the 7-6-5 community and start your transformation today.
Ep03
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[00:00:00]
Tax Bill Shock
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Fabrice Metan: One of my clients had the kind of year every entrepreneur dreams about.
After some very difficult years in business, things finally clicked. Revenue was up, profits were strong. But when we ran the numbers for taxes, he was devastated. The IRS wanted $21,000, but a few weeks later, that $21,000 tax bill turned into a $4,000 tax refund In this episode.
Seven Tax Strategies
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Fabrice Metan: I'd like to tell you a little bit more about how real estate made that possible and share seven real estate strategies that can dramatically reduce your tax bill.
Fabrice Metan: [00:01:00] Real estate. Real estate. Real estate. Everyone wants to invest in real estate and you wonder why most wealthy investors and business owners see real estate as one of their most favorite asset class to invest in. And so I wanted to share those seven ways that I believe are.
Very strategic and can help considerably reduce your tax bill.
Depreciation Basics
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Fabrice Metan: And we start with number one, which is something called depreciation. Now [00:02:00] depreciation, to put it simply, is a paper expense that you get to take on your tax return, even though you did not have to spend that expense dollar for dollar in cash.
So to better explain that. The IRS essentially gives you, when it comes to real estate, gives you about 27 and a half years to depreciate a residential rental property and 39 years for a commercial property. And just to give you some numbers, if the property is, say $275,000 over 27 and a half, you get to expense about $10,000 of that value every single year for the next 27 years.
And so even though you did not necessarily spend that $10,000, you do get to take that as a tax write off. And so if I, you know, to give you an example, let's assume that that property rents for about $24,000 for the whole [00:03:00] year. And that your expenses attached to that property, the amount of money that you actually had to spend towards that investment was say about 12,000.
Well, let's call it $15,000. For during that year, you can now take $10,000 in depreciation and reduce the remaining $9,000 in profit to a negative $1,000 net loss just because you used the depreciation on the property. And so that is something that is extremely important to consider when investing in real estate.
And of course that is the first step. That makes you understand why investing in real estate can be very beneficial to your tax bill.
Cost Segregation Boost
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Fabrice Metan: Now as we talk about depreciation, the next item on the list would be cost segregation. Now, why would a cost segregation be something important here? A cost segregation study identifies components of the property that can depreciate faster.[00:04:00]
So in other words, your property is expected to depreciate over 27 and a half years, but there's about 20 to 30% of that value that is attributed to items like appliances, flooring, lighting some of those items that can actually depreciate on a shorter life, on a shorter schedule. And so by identifying all of those components, we're able to actually accelerate the depreciation on those specific items and apply what's called bonus depreciation to now take a hundred percent of those items as a tax write-off in the first year in the year that the property was actually placed in service.
And so in the case of the client that I was discussing in my opener, you're looking at a situation where the client owed $21,000, but also had three new properties that were placed in [00:05:00] service during that year. When taking straight line depreciation on those properties, he was going to have that high of a tax bill, but by.
Performing a cost segregation, we were able to identify close to a hundred thousand dollars in actual expense that it could take against its ordinary income and considerably reduce the amount that he earned that year. That is how the $20,021,000 tax bill turned into a $4,000 refund.
And so if you ever wonder why, I think a few years ago there was a debate regarding the amount of taxes that the president actually paid, which I think was about $750. Luke no further than real estate and cost segregation.
Passive Loss Rules
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Fabrice Metan: Now, as you take advantage of depreciation and cost segregation, you could find yourself in a situation where you might have a huge net loss [00:06:00] that you actually cannot take against your ordinary income.
The reason why is because real estate is considered a passive investment. In other words, the losses from your real estate being passive losses can only be taken against passive income by default. However, if your income is below a hundred thousand dollars threshold, you can take up to $25,000 of those losses against your income.
That amount phases out between a hundred to $150,000 in income. Once you hit a hundred, $150,000, there's what's called passive loss limitations. That essentially stops you from taking any of those losses against your ordinary income, and so now your losses are trapped and carry forward to the next year until you actually have passive income to claim those losses against.[00:07:00]
Or until it's time to sell the property, at what point you can actually unlock those losses.
Real Estate Pro Status
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Fabrice Metan: And so what needs to happen in a situation like that is for you to qualify for something called real estate professional status. Essentially with real estate professional status, it allows for your passive losses to turn into active losses, which now can offset your business income.
Your W2, your consulting income, essentially your ordinary income can now be reduced a hundred percent by those passive losses simply because you are a real estate professional. But to qualify for that. Someone in the household must spend 750 hours per year in real estate activities and spend more time in real estate than any other profession.
But there's something extremely important that I said here, someone in the household. [00:08:00] In other words, if you are the primary taxpayer and your spouse is stay at home, you guessed. She can qualify as the real estate professional. That's why we have a lot of doctors, dentists who make very high earned income, right?
Could be W2, could be in their own businesses that would typically have a stay at home spouse who handles and manages all of the real estate that they invest in so they can qualify for real estate professional status and actually take those losses against their very high ordinary income.
But another strategy that can allow you to turn some so-called passive losses into active losses. If you cannot qualify for a real estate professional, let's say that you and your wife are actually high earners, W2 income, we have a few clients like that.
Short Term Rental Loophole
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Fabrice Metan: Another strategy would be to actually invest in short term rentals, Airbnb, VRBO, [00:09:00] essentially.
Something that, you know, they even coined the Airbnb tax strategy. So normally your rentals are going to be considered passive, but when it comes to a short term rental, as long as the stay averages less than seven days, the activity may not be treated as a passive rental.
As a traditional rental, right? Which means the losses can now become active. Of course that depends on your amount of involvement in the business. No one can spend more time into your short term real estate portfolio than you. There's a certain amount of hours that you have to be able to show and justify, and of course, the average stay.
That automatically turns that passive investment into more of an active participation business, in which case those ordinary losses will now be able to be used to offset your [00:10:00] ordinary income.
1031 Exchange Deferral
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Fabrice Metan: And item number five would be the 10 31 exchange. Which allows you essentially not to do away with the taxes completely, but at least to defer the taxes on the capital gains every single time that you sell your property. There's several rules that we're not going to discuss in this particular episode, but essentially after selling a property, all of your proceeds.
Can actually be invested into a like kind property that allows you to defer the taxes that you were going to pay on your gain when you first sold the property and move them into the next property. That's why several investors continue to just kick the can ahead, right? Every single time they sell a property, they go in and invest in the next one and the next one, and the next one.
Step Up Basis Legacy
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Fabrice Metan: And because we talk about 10 31 exchange, I don't think we can mention that without speaking about the step [00:11:00] up in basis, which is more of a long term wealth strategy. As you continue to reinvest those proceeds from one property to the next, time goes on up until you're no longer here. When someone actually in inherits that real estate property from you or those properties from you, they get what's called a step up in basis, which means that the actual value of the property, the basis resets to the current market value.
So, simple example. You buy a property today for $300,000. You sell the property at, say, $400,000. You're supposed to have a hundred thousand dollars in capital gains, but you turn around and then reinvest those $400,000 into another property that then resells for another 500,000, which now you're supposed to have, again, $200,000 in capital gains.
But you go ahead and reinvest that into another property, and then a few years [00:12:00] later you pass away. And your kids inherit the property at that point, say the property is actually valued at a million dollar. By that time, they get a step up in basis to where instead of the, the property being say, $700,000 at the time when you first bought it.
That property is now in the market valued at a million dollar. That is the basis that they have in that property. So if they go ahead and sell, there's literally zero capital gains on that transaction. This is the reason why real estate generally is an asset that goes from generations to degeneration.
BRRR Tax Free Cash
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Fabrice Metan: And last but not least, our very last strategy. Which is more about accessing tax free cash flow from your real estate using a very popular method called the Burr Method, which essentially is BRRR, and [00:13:00] stands for buying a distressed property, renovating it, renting it out, and then refinancing based on the new higher value.
And pulling out the cash out of the property. But here's the beauty of it. When you pull the cash out, because it's technically a loan from the bank, those proceeds are tax free. Now you get to actually tap into the cash flow sitting into your property at no cost to you from a tax standpoint. Those are the magical things that you can do with real estate.
Recap And Next Steps
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Fabrice Metan: So those are the seven real estate tax strategies that we try to teach our 7, 6, 5 entrepreneurs to help them understand how they can invest in real estate and use that investment to essentially considerably reduce or completely eliminate the income that they make in their business, their other investments, and et cetera.
All right, so I know I [00:14:00] threw a whole lot of information at you, right? So let's recap those seven real estate tax strategies that you can use to reduce your tax bill. Number one was depreciation. Number two was cost segregation, where you can actually accelerate the amount of depreciation that you take in the first year that your properties are placed in service.
Number three is qualifying for real estate professional status so that those losses can actually be used against your ordinary income. And number four is using the short term real estate strategy in case you cannot qualify for real estate professional. Number five is the 10 31 exchanges every single time you sell your property, where the the proceeds can actually roll into the next property.
And number six would be the step up in basis, right? As you continue to roll those proceeds into the next property, you want to think about your. You know, your, your heres and everyone who might actually inherit those properties from you. [00:15:00] And then last but not least, number seven, the Burr method, which allows you essentially to have tax free cash flow pulled from all of your properties.
And so that's everything that I wanted to share. And those are the properties that we use when helping our 7, 6, 5 entrepreneurs figure out ways to reduce their five to six figure tax bills. So next time you're speaking to your professional, make sure to show them this list. And see what you might be able to use in your situation.
[00:16:00]