Zero to Hero Strategy

Zero to Hero Strategy | Kitti Sisters

024: Zero to Hero Strategy


Welcome back all of you Cashflow Multipliers! Palmy and Nancy here, AKA your financial BFFs back with another episode about all things passive income, investing, and tax hacks. 🤟

Tax hacks as in a totally legal, not enough talked about way of sheltering your income. No tax evasion here; you know we have a great fear of being separated for too long from our fur babies, and tax hacks are helping us provide the lifestyle they deserve! 

Now that’s something we can both agree on. You have probably heard the famous phrase, “nothing is certain but death and taxes.” 😖😖

That really isn’t the quote you’re seeing in the decor section of Home Goods. 

But taxes are kind of a weird thing.

Like, they are unavoidable, but the more money you make, the more you’re taxed. It’s this weird catch 22 of wanting to grow and advance in your career and business but also knowing that money will be taxed at a higher rate. So why are we hustling so hard?! 😵😵

Believe it or not, some people see this as a badge of honor.

Citing how much they pay in taxes based on their income, from when they first hit that six-figure club to the potential millions of people can and will continue to make.

While having to pay more in taxes based on how much income we earn is definitely something to cringe about, this is just a fact of life. 

So, there’s no real hack to get out of taxes. But when it comes to the world of passive investors there are important things to know.

For us who want to live in this land, or who are thinking about coming on to our shores at the very least, we are here to say with 100% certainty that this notion of paying more taxes based on your income is 180 degrees from reality. 

Everyone loves a good story. 📖 The rags to the riches fairy tale of coming from nothing to an incredible something. That’s why we love when we see people from all walks of life make their way into the world, based on what we believe, or at least what the movie said we should believe, as they make their millions and show every naysayer that they can be somebody and share their wealth with their loved ones. 

But, oftentimes, the wealthiest people didn’t just get where they are based on hard work, smarts, or even good ideas. A lot of them just know the wonderful world of taxes. And more importantly, know how to navigate through them legally and ethically so they pay little to no taxes. 

👉 This is the ‘tax hack’ we are referring to.

It’s our little method we like to call the ‘Zero to Hero’ strategy. ✨

And if the song from Hercules just popped into your mind while we said that, we can totally be friends. 

The Zero to Hero strategy we created has the goal of helping passive investors every day from falling into the same trap of ‘death and taxes.’ This does not have to be your story. Take it from our pal, Warren Buffet. 

So Warren Buffet is the Yoda of taxes and one of the most successful investors of all time. He runs Berkshire Hathaway, which owns more than 60 companies. Companies like Geico, Duracell, and the aforementioned Dairy Queen. And while he ranks as one of the richest people in the world, he probably pays fewer taxes than any of us. I guess he knew about our tax hack.

Berkshire Hathaway’s net worth increased over the years to $63 billion, with $29 billion of that coming from the recent changes in tax law. According to Buffett, there were two primary reasons. One was the Bonus Depreciation for fixed assets. For example, for a $10,000,000 asset, Buffett used to take 10% per year deduction or $1 million per year, and now he takes 100% the first year as a deduction. The second biggest change was a corporate tax rate that went down from 35% to 21%, which he describes as “huge.

A huge win, mostly for him. The corporate tax rate went down 14%! 

The other important word we want to highlight is ‘depreciation.’ ⬅️ ⬅️ Whether you’re new to the passive investor scene, or you’re a seasoned pro, you really need to know about depreciation.

When most people think of depreciation, they usually think of decaying or breaking down. Which isn’t too far from what it actually means. Depreciation is the reduction of the value of an item over time. For example, a 2023 rich mom-mobile, the Mercedes G-Wagon, will decrease in value over time. 

There’s always a new rich mom-mobile on the market. 

As passive investors, you generally will receive profit twice. Once from the cash flow and the other profit at the sale. You might typically expect to pay taxes on the profit, but for apartment syndication, there is tax information that passive investors must understand to realize the tax advantages. And the cornerstone of those benefits is depreciation. And there are three you need to know about: 

  1. Bonus Depreciation 
  2. Straight Line Depreciation 
  3. Accelerated Depreciation 

So let’s take a deep dive into the three, and have you never been caught slipping on your tax paperwork again‼️

No. 1 Useful Life (Bonus Depreciation?) 

It’s a little taboo to talk about, but everything has a life span. From the food in your pantry, to, well, yourself. And to make it a little weirder, now the IRS is getting involved in what they’re also giving a shelf life. To the IRS, different assets have different life spans, so they determine life estimates to determine the amount of time during which an asset can be depreciated. For real estate, they historically chose 27.5 years as the useful life for resident-occupied properties, including apartments. 🏢

The good news is that apartments have a long history of appreciating value over time. And yet, the IRS gives the option to passive investors to depreciate their properties*. When you choose the depreciate option on your apartment, that’s when the tax hack comes to life and the real magic happens. It creates a phantom deduction, which may result in paper loss. A good apartment investment will generate cash flow for you, but you will be able to keep some of that cash flow sheltered through the depreciation deduction, thus paying no income taxes on your gain. 

Pretty incredible stuff, right?

No. 2 Straight Line Depreciation

By now we should know that everything has to have accountability. You just can’t be sheltering cash flow without the paperwork. That’s why for reporting purposes, a property has two components– the land itself and the “improvement.” 

The improvement of the land that is, you’re just not going to have people rent out piles of dirt. 

Exactly. ✅ So it’s everything you build on the land. Swimming pools, parking lots, structures, etc. And when the IRS sees the improvement, that’s where they also associate the depreciation from. Not the land. That’s where you see the 27.5-year number in action. Depreciation can be taken from the improvement but not the land. 

Let’s see you try to depreciate mother nature on her land. 

No. 3Accelerated Depreciation

Moving on to our favorite form of depreciation, that would be called accelerated depreciation. This is a total game-changer for those in the apartment syndication. We like the thrill of the front-end benefit accelerated depreciation. 

We’re also going to reference one of our favorite ways to beat the tax game, and that’s with paper loss. Not in a shady way, but in a “helping you keep more of your money way.” 

Really, that is the only way.

Accelerated depreciation requires a cost segregation study** done by a third-party engineer and/or accounting firm to do the calculation. Trust us, you want to hire someone to crunch those numbers. Because things like carpets, lighting fixtures, stoves, etc. all add up and can be depreciated over a shorter period than 5 or 15 years. As most of us have experienced, broken dishwashers, smelly fridges, and stained carpets all come to pass over time. 

By creating this paper loss form from depreciation, we can offset the current yield from the property for years. It’s even possible to use any excess against other sources of K-1 passive activity gains. Almost like, getting gains.

The hottest new protein powder on the market could definitely be called K-1!

Some of you may be asking yourselves, “what if I still have excess depreciation benefit after offsetting my passive activity gains? Would I still benefit?” The answer is no, you can simply be carried forward until there’s a new year you can use it. 

New year, new passive activity gains‼️

But wait, there’s more. Under the new Tax Cuts and Job Act of 2017, you can now take 100% bonus depreciation deduction in year one of owning an apartment, instead of the previous 5 or 15 years. 😗😗

Now, 100% bonus depreciation is scheduled to end on Dec 31, 2022. However, don’t freak out too much; it won’t end abruptly as much as it will just eventually fade out. 

Like the budding and inevitable downward spiral romance of Kim K and Pete Davidson. 💜🌪️

Exactly, very much a 2022 exclusive. Which is also like bonus depreciation. We have to invest in 2022 to take full advantage of the 100% bonus depreciation! 

Your Loss, Is Still Your Gains 

We’re going to go through one of our assets under our management, 192 units in Fort Worth, Texas. We received an initial quote from the third-party cost segregation engineer firm with these numbers. 

After you account for the bonus depreciation, the yield is $66,470 in the paper loss for investment by the investor (hey, that’s you!) to take against any actual gains from distribution. Hence, depreciation is a powerful tax-deferral strategy. It’s why our passive investor doesn’t pay current year taxes on quarterly distributions for several years. 

This is a huge upside for passive investors who have the option of applying this K-1 paper loss to other passive income streams. And, for our REIT’s out there, all of your K-1 paper loss can be used to offset your ordinary income.

If this sounds too good to be true, that’s why we call it a tax hack.

If you’re sitting there asking yourself WTF is a REIT? Go back and look for the Cashflow Multipliers Episode 16: “Is Being a Real Estate Professional for You?” for ideas, tips, and some real talk on the subject. 

🤩🤩 It’s not a secret we love passive income because, well, it’s all in the name. When you invest in passive income, you can spend your time doing things you love. And there are so many ways and assets to invest in, but especially when it comes to multifamily apartment syndication. By partnering with great deal sponsors, from the passive investors point of view, after you evaluate the deal using your internal investment criteria. From that point on, it’s all about cashing checks and breaking necks. 

Or at least, enjoying the cashflow. 

In addition, multifamily apartment syndication allows you to leverage the deal sponsors’ full-time real estate team and get access to deals with high returns you, otherwise, wouldn’t have access too. 

Okay, if there’s one thing we want you guys to take away from today, it’s that NOW might be one of the best times in history to invest in real estate. Especially if you have significant passive income that is leading to taxable gains. 

It may not be the K-1 protein powder, but it’s a solid idea. It’s definitely not the 100% bonus depreciation that can create large sums of paper losses to offset those gains, resulting in lower tax bills. 

Lowering taxes is always a win. 

We’ve said it before and we’ll say it again, be sure to consult with your trusted tax advisor to know whether or not that strategy would suit you, and please use us as a resource for any questions you might have as well. 

Plot Twist: Multifamily Apartment Depreciation 

Wait, what happened to multifamily apartment syndication? 

Trust us, it’s still there. But multifamily apartment depreciation is perhaps one of the most underrated benefits in commercial assets. This is the cool indie band of the apartment syndication world. Why? Because not a lot of people know about it, and if you know, well, then no doubt about it, you’re probably really cool. 

The greater majority actually neglect to realize its existence and few people on the outside looking in can see past the profit margins that have become associated with commercial real estate. 

Consequently, and to the surprise of many, commercial property depreciation is just as valuable as cold, hard, cash– if not more so. 

Are we saying the commercial property is the new gold? 💰

We’ve been known to say crazier things. 😁😁

Acting as a tax shelter for davvy real estate investors, depreciation contributes to investors’ bottom lines by reducing their taxable wages, adding a whole new meaning to the phrase “addition by subtraction.”

What is Multi-Family Apartment Depreciation?

Let’s break this down in the easiest way possible. 

Multifamily apartment depreciation is a significant tax break awarded to qualifying real estate investors. More specifically, however, the depreciation here is a powerful tax shelter designed to reduce the taxable income of investors who invest in apartment complexes.

Not unlike standard business tax deductions, your best friend, the Internal Revenue Service (IRS) allows qualifying investors in apartment syndication to reduce their tax bill by depreciating the value of their property over a set period of time. That’s an important distinction to make, as the entire value of the property can’t be written off in a single year. 

See? The IRS doesn’t have to be scary, especially when they’re giving you the hook-up tax benefits wise. 

Now there are 3 major types of depreciation, which we already went over.

  • Bonus Depreciation
  • Straight Line Depreciation 
  • Accelerated Depreciation

Instead, the cost of multifamily apartments can be written off incrementally over the building’s “useful life,” which is more than 39 years for commercial properties. That means investors who rent out commercial real estate may deduct a portion of the building’s original cost each year over the course of 40 or so years.

Accounting for depreciation at tax time will reduce one’s taxable wages and shelter their money from the government, effectively netting them more money each year. However, it is worth pointing out that a healthy market often compounds the benefits of commercial real estate depreciation.

Apartment investors can deduct depreciation each year over the building’s useful life, regardless of how well the market is doing. Therefore, when prices are appreciating over periods of prosperity, rental owners can simultaneously claim depreciation deductions while benefiting from the actual appreciation of their own assets.

Commercial Real Estate Depreciation Calculator 

Here’s how the IRS gets involved, in a good way. 

The first step in determining the amount investors may depreciate their property by each year is to calculate the asset’s basis. The basis of a property is essentially its acquisition cost, minus the cost of the land (land is not depreciable in the eyes of the IRS). 

So, essentially, IRS approved land. 

While the cost of the actual land is excluded from the basis, apartment investors may include things like settlement fees, closing costs, and additional out-of-pocket expenditures. 

There are, of course, guidelines the IRS will want you to follow when determining the basis for a property. For this reason, be sure to check with a certified tax professional to ensure you land on the correct basis for your own asset.

Once you are confident you have the correct basis for the property, proceed to choose which Modified Accelerated Cost Recovery System (MACRS) the IRS will want you to use to calculate your rate of depreciation. 

It’s all about getting good MARCS. 😝😝

Renters will typically be forced to choose between two specific depreciation systems: the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). Investors generating income through a business entity typically resort to using the GDS unless there is a specific reason the ADS makes more sense for their situation. The system you use will depend on the year your property was put in service.

Next, factor the previously discussed basis into the depreciation system your tax professional recommends, making sure to account for the amount of years you are able to deduct. A good commercial real estate depreciation calculator will look something like this:

Cost Of The Home – The Value Of The Land = The Basis

Basis / The Amount Of Years The Home May Be Depreciated = Yearly Allowable Depreciation

Now, for us apartment syndicators, we heavily rely on the 3rd party accounting and/or engineering firm to deliver the cost segregation study to us.  

What’s the cost segregation study you ask?

A cost segregation study identifies and reclassifies personal property assets to shorten the depreciation time for taxation purposes, which reduces current income tax obligations. Personal property assets include a building’s non-structural elements, exterior land improvements and indirect construction costs.

Now, the depreciation will end when the investors have recovered the entire cost of the basis (the acquisition costs minus the cost of the land). However, depreciation is a living document and as we turn units, upgrade appliances, replace fixtures, we can still take the depreciation. Definitely, it will be less; however, it’s still there as you upgrade the units. Of course, the depreciation will end once a property is sold. 

Let’s say, for example, an investor was to purchase an office building for $20,000,000. Subsequently, the land the building is located on is worth somewhere in the neighborhood of $6,000,000. Subtracting the value of the land, the investor will have a depreciable cost basis of $14,000,000.

A well-calculated and legal multifamily apartment depreciation strategy is both an important tax shelter and an invaluable investor tool. If for nothing else, commercial depreciation is just as important to an investor’s bottom line as their profits. Therefore, it is of the utmost importance to understand commercial depreciation as soon as possible.

Doing so is the only way to maximize returns in a given year and optimize profit margins. 🙌

Okay, we know that this is a lot to take in. There’s a lot of numbers, new language, and the IRS got involved somehow⁉️😂😂

But, do not fear this is how we learn and grow! Plus, we’re here every step of the way– we know we’ve talked a lot about depreciation, but we definitely appreciate all of you!




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Invest with the Kitti Sisters

Fortified with years of experience, fierce passive investors (we ALWAYS in our own deals), and selected high qualities investment opportunities to help build your long term wealth no matter what stage in life you're on. We will show you the ropes, help you build out a powerful, personalizes strategy, and give you masterful, financial freedom focused on living your lifestyle dreams.

We're Palmy ➕ Nancy Kitti 〰️ The Kitti Sisters

A sister duo team obsessed with all things financial freedom, passive income, and apartment investing + apartment syndication, who turned a $2,000 bank account into a nine-figure empire.  Now, we're sharing with you the behind-the-scenes secrets of our wealth building strategy.

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