Tax Planning
The Secret to “Making Your Own Math”
By Teresa Bilsky
A business owner is interviewing accountants with a one-question interview, “What is two plus two?” Applicant after applicant answers four until finally an experienced applicant looks directly at the business owner and without any emotional reaction answers, “What do you want it to be?”
Though this is intended to be merely humor, those who are experienced in tax planning smile because there is a great deal of truth in that final answer. Yes, you can have your investment and your money too. You can make your own math. You just need to know where to begin.
We begin each new business, new investment, or tax plan with the exit strategy
Why? Well because we need the destination to formulate the map. Step two is determining the most cost-effective way to achieve that journey. This is where the plan arises to acquire your investment and keep your money.
But how? We use special game pieces we call tax laws.
Tax planning is much like playing Tetris: New pieces are continually falling; existing pieces are continually changing, and you (the investor and taxpayer) are the player. You start slowly with a blank playing screen where you have more control; but the longer you play, the more the pieces add up, obstacles present themselves, and everything seems to speed up.
Know your pieces
The falling pieces are tax laws, tax court cases, IRS interpretations of laws, investments, financial resources, time, your desired effort, input and knowledge.
Start with where you want to end up
» Do you want to acquire wealth through owning and retaining real property?
» How much wealth?
» Do you want to buy and sell to obtain cash wealth?
» How will you make the cash work for you?
» Are you investing to accumulate assets for estate purposes?
» Will you need the properties to provide cashflow? If so, when and how much?
» Do you prefer to work with residential real estate or commercial?
All of these questions tell you what type of tools you will need.
Knowledge
Even though business owners need general knowledge in areas far outside their expertise, remember that investing in real estate does not make you a tax expert. The penalties for tax mistakes – both overpayment and financial losses for underpayment – are serious.
The IRS does not care what you know; they only care about the rules and the money.
Why do the tools change?
The market changes, future earning capabilities change, buyers change, and Congress goes into session and the rules change. However, the most important factor is you. You change. Your knowledge and experience grow. Your portfolio grows. Your plan changes.
Let’s start with some basics: You need to know what your assets are and what they are worth. All of your assets should be working for you in some way. I have yet to see that money stuffed in a coffee can duplicates in any way. Identify your assets and their value, then put them to work.
Understand that the same piece of real estate may be presented with three different values depending on who is viewing the value and the purpose for the valuation.
A written appraisal is based on the opinion of the market value by a professional trained to make those determinations which generally satisfies lending requirements. A valuation of the same property may arrive at a different number because it includes influences such as location, zoning restrictions, life expectancy of the building, and other permanent factors.
Valuations have legal standing because they provide a definitive value. A good example of this is the tax court case for the Estate of Michael Jackson. The entire case was a dispute about the valuation of his assets at the time of his death.
Finally, a financial statement would reflect the value in terms of basis without regard to market value.
Let’s talk money.
How do you keep more of your own money? You plan. The difference between tax preparation and tax planning is the answer to the question of “How much is two plus two?”
Taxpayers in general should not wait for the tax return to be prepared before knowing where they will be for the year. They should already know.
Tax preparation is reporting the results of the decisions you made in the prior year. Tax planning is impacting the outcome.
We begin in the fall because it is late enough to project the income and early enough to achieve the desired results.
Take charge of your pieces to impact the outcome by using the different tools available. If you are planning to acquire real estate to leave in your estate then know that the basis is stepped up at the time of your passing. A stepped-up basis means your beneficiaries get the tax benefit of the value of the asset at time of your death and not the basis you possess in the property, hence the dispute on the Michael Jackson case.
A 1031 Exchange is a good tool to defer taxes on gains. As with any tax tool in the toolbox there are rules. The idea is simple: If you are allowed to defer tax on a gain by reinvesting into a bigger project that generates a larger gain, then government will see a larger return in the form of more tax. This is a great tool but it isn’t designed to help you, it is designed to generate more tax. However, it does benefit you because there is value in the use of money, also known as interest.
The longer you get to defer taxes, the longer you get to use your money. You win. The more you grow an asset to produce a larger income, the more tax you generate, then they win.
Investment in an Opportunity Zone is an advanced tool with rules by way of tax savings; this program encourages you to invest in economically depressed areas. Again, this is for the benefit of taxes. It may sound like the purpose is for the benefit of the community, but everything is about the good ole’ dollar.
You are incentivized to invest in an area that isn’t currently generating much in tax revenue. Your investment grows the community, produces income where there was not much, and taxes are generated. They win. You win by getting a stepped-up basis. You
win by deferring tax on a recognized capital gain.
The game pieces go on and on. Know you destination, know your assets, make a plan, acquire the knowledge, and take control.
Knowledge is power and power is sexy.
