Ep. 10 | Purple Diagnosis (tax deferral)
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Speaker 2:Welcome everybody back to Teaching Tax Flow, the podcast, episode 10. Here we are. Double digits, almost the end of the year. Exciting times. Right?
Speaker 2:Exciting times. I'm John Jopolsky here on the Teaching Tax Flow team. Standing to my right here is the fabulous Chris Pachero, CPA, and then all the acronyms, we're not gonna go into that whole thing again. How are you doing, Chris?
Speaker 3:I'm doing wonderful. Happy holidays. Excited to talk about part three of our four part series, favorite year end tax strategies for each of our four color coded diagnosis.
Speaker 2:And today, we're talking about Barney. Oh, I mean, purple. We're talking about purple. Last last week was Spartan green. Mhmm.
Speaker 2:Before that was red. So red being the 25% or higher marginal tax rate. So that MTR, that acronym we say all so much, green being the 20% or lower, and now purple tell Chris, tell me a little bit about purple. Right? It it's highly utilized.
Speaker 2:It's used a lot. I wouldn't say the most, but it's used a lot. Give us a little rundown on what that is.
Speaker 3:I would say the purple diagnosis is used by the vast majority of taxpayers. It purple is my favorite color, by the way. Fun fact.
Speaker 2:Oh, I did not know that. I really thought
Speaker 3:it was green. Shout out to my deal, Cell Pilots. We got purple we have both purple and gold in our color coded diagnosis, but that's alright. We need
Speaker 2:a clear. What about a clear diagnosis?
Speaker 3:Oh, I don't know. That would be, like, for ghost or something.
Speaker 2:That's like saying that's like saying a CPA has a crystal ball. We obviously know we know a crystal ball in the real estate room in Panama City, but you don't have one related to everything tax.
Speaker 3:I wish I did. Episode 10, double digits, purple diagnosis. Purple stands for tax deferral, and that means that a taxpayer could benefit from tax deferral. I would say that purple is probably the purple and red are both used way too much in my opinion. We have that four step process where we first run a tax projection, then step one, diagnose using color coded diagnosis.
Speaker 3:Two, prescribe three IQ tests for implement. That's teaching tax flow, part of teaching tax flow one zero one. A lot of people identify themselves as a purple diagnosis without even knowing it. They probably don't even know what purple diagnosis is, and they probably don't have a high enough marginal tax rate to substantiate what we call purple diagnosis.
Speaker 2:I'm I'm gonna assume that they don't know what it is because it took you all twenty years to come up with it. Right?
Speaker 3:That's true. That is true. So purple die who's the ideal marginal tax rate for purple diagnosis? There really isn't a number. We talked about red, 25% or higher marginal tax rate, green, 20 or percent or lower.
Speaker 3:But for purple, this is when purple would make sense, when your current marginal tax rate is much higher than your expected future marginal tax rate. Okay. So if your current marginal tax rate is now you said we don't have a crystal ball, but we and we don't know exactly where tax rates are going to go. That's a different episode.
Speaker 2:So, really, this is somebody getting a a temp check on themselves, say, this year, and they're like, wow. You know? This year, I'm 28 versus just making numbers up. I'm 28%, lot higher than usual. Next year is definitely where I'm very confident it's going to be less.
Speaker 3:This might be Very confident. But tax deferral typically means that the in that that the the tax is not paid currently and that but the growth of those assets are gonna be taxed at a higher rate. So purple's not bad. It's just way overused in my opinion, but that's why we're educating. That's why we appreciate all of our listeners giving us a little bit of time and an open mind to figure out are you a purple diagnosis.
Speaker 3:Excellent.
Speaker 2:Excellent. And and on that note too, I mean, kind of following a little bit of the structure that we do have on these casual fantastic conversations. Let's talk about y'all's favorite. So I know it's hard to pick favorites. You know, we don't wanna we don't wanna play the card too much, but I'm I'm positive there's almost one in there.
Speaker 2:One or two, maybe three. I think there's only two we can use. So Mhmm. So hit hit us with the highlights. If you have to pick one, what would that be?
Speaker 3:Well, I'm gonna preface this by saying we're talking about year end tax planning, strategies, tax planning prescriptions. So any of the prescriptions that are typically done after the end of the year, as we've talked about before, have that those prescriptions have what we call a p as in Paul, attribute, meaning post year end. This one that I'm gonna talk about today, first of all, spoiler alert, you know I love that term. We already had our deep dive episode into it on episode three.
Speaker 2:Oh, now I know what you're gonna say.
Speaker 3:Yep. We had a we had a deep dive. Today, I'm gonna talk more about from a 30,000 foot view and not get into the nuts and bolts of the strategy. This strategy could straddle, two tax years. So it might be something that gets implemented in 2023 for 2022, but the time frame for the strategy is is really based on a sale of a property.
Speaker 3:So my favorite year end purple diagnosis tax prescription is the ten thirty one exchange. The reason I like the ten thirty one exchange is that it's very multiple. Ten thirty one exchange is one of those rare prescriptions that fits multiple color coded diagnosis.
Speaker 2:Does it actually check on all four of them? So the red, green, purple, and gold?
Speaker 3:No. It does not. But it checks on three of them. It checks on the red diagnosis because you are getting you're avoiding paying the tax on the profit. So you're you're in a high marginal tax rate.
Speaker 3:Purple tax deferral. So you're deferring the tax that you would pay on a ten thirty one exchange. The reason it hits gold, it's kind of a hidden, benefit, is the potential for tax free income and growth. And you might say, well, how is that possible? Did you say how is that possible?
Speaker 3:Maybe you said
Speaker 2:it to yourself. I mean, I might have I might have been thinking it out loud. Oh, well, I might have hummed it. I I hummed it. Okay.
Speaker 3:So maybe you hummed it. So how is that possible? Well, we don't like to talk about morbid things here. So we're gonna assume that let's say you bought a property for a hundred thousand dollars. You depreciated it.
Speaker 3:You wrote off some of the cost of 25,000. So your cost basis is 75,000. You sell the proper you sell that property for $300,000. You take a 10 you take that 300,000, put it into a $10.31 exchange. So no taxes paid.
Speaker 3:That property goes up in value and it's worth $600,000. Unfortunately, as you're dancing around celebrating, you get hit by a beer truck. Your beneficiaries then inherit that ten thirty one exchange property. They get to wipe the slate clean on all of the depreciation, all of the deferred capital gain, and start to depreciate or write off the cost of the property using that stepped up basis of $600,000. Let's assume this is a rental property.
Speaker 3:That was a very important thing I should have said. Well, what that means is that all of that tax deferred income goes away, and you have tax free income, meaning instead of that $300,000 acquisition cost of the the new property, your cost basis is now 600,000. I know that's a little complicated to understand, and that's why it's kind of a hidden benefit. The main benefit of ten thirty one exchange is that tax to go income deferral and allows you to deploy more cash into your next real estate investment.
Speaker 2:And that's a fantastic way of describing, really, the implementation strategy of it. On the last podcast, I I believe we're we're saying it was episode three that we did right around Halloween. That one goes into a lot of detail on really what a ten thirty one is and and how to really pursue them and and plan for them. Right? It's not just, oh, you know, here's my cash.
Speaker 2:I need to send my bank account, and here we go. Now we're looking for properties. There's a lot that goes into it, so we'll we'll we'll save the ears this time about, you know, harping on it again. Be sure to check that one out if if you're interested in this at all. I think we even had somebody the other day.
Speaker 2:So, wow, I've I've done ten thirty ones, and I didn't even know really all of that was really built into built into that process. So that was a great a great show.
Speaker 3:I would say absolutely. The 10:31 exchange, we you know, the only thing I'm going to mention is that the reason it could straddle a tax year, but we're saying usually they occur within the same year, is that you have, a hundred and eighty days to execute the the transaction. And, again, I would go back to episode three to get into the nuts and bolts. What I want to talk about is when would it make sense to do the ten thirty one exchange? Well, if you think your marginal tax rate is gonna be lower in the future than it is now, purple diagnosis.
Speaker 3:And guess what? If you were to keep the replacement property in a ten thirty one exchange and it goes into your estate, your marginal tax rate on that gain is then zero because of the step up in cost basis. Obviously, that's based on the tax laws, the way they are written today. So if you don't need the cash immediately from a transaction, a real estate transaction, You jump through all the hoops of doing a section ten thirty one exchange. That's the section of the tax code that that's why we call it a ten thirty one exchange.
Speaker 3:And we know the three laws of teaching tax flow is that is that, tax agencies are your involuntary business partner, and tax laws are written encouraging to discourage certain behavior. So, hey, encourage that behavior of reinvesting. You don't need to pull that cash out. And and if you want current income, then you can actually deploy that money into into an income producing property and and take that that income. You pay tax on that income, but you still pay tax on the net income from there.
Speaker 3:You could have some deductions. And with the ten thirty one exchange, what you're doing is you're exchange it has to be within real estate. You're exchanging like kind property. So like kind property is a pretty vague term. You could you could sell a residential piece of real estate that was a rental property and invest in a different asset class and still complete the ten thirty one exchange.
Speaker 3:It could be a mobile home park investment. It could be commercial property. It could be it could be anything that qualifies as, quote, unquote, like kind within the IRS code.
Speaker 2:So one question too. You know, you did mention a a moment ago too about the hundred and eighty days. Right? So and really choosing when is best or strategically placing, we should say, you know, which tax year you would most benefit from that ten thirty one exchange. So you have a hundred and eighty days.
Speaker 2:Correct? Is that what it was? To to actually from start to finish ish or or somewhere around there?
Speaker 3:Yes. You do. But there are many days that are very important. There is a forty five day rule. So, again, episode three is gonna have all of the exact dates that you have to keep in mind.
Speaker 3:I think the important thing to remember is that if you're entertaining, engaging in a 10:31 exchange, talk to your we talk about your board of directors all the time, your your centers of influence. Talk to the people you're working with and make them aware that you are deeply considering a 10:31 exchange before as as much as possible before you close on the relinquished property, the property that you're selling. Because you cannot take custody of the asset you can't take custody of the net proceeds from the relinquished or sold property that has to go to a qualified intermediary. So don't stress about the forty five day rule, the one hundred and eighty day rule. Focus on, does a 10:31 exchange potentially make sense for me?
Speaker 3:I'm a purple diagnosis, maybe red diagnosis as well. The gold diagnosis benefits are just to add on. I fit that category, and I'm going to engage in a 10:31 exchange. There are times where someone opens a 10:31 exchange with the intent of doing an exchange, and it just doesn't work out. And you have an unsuccessful ten thirty one exchange, and then you just have to pay tax on whatever the capital gain and depreciation recapture is.
Speaker 3:So it you know, that's why I like the strategy. Usually, there's not a ton of expense associated with opening an exchange even if for some reason it falls through. And you can the last thing I wanna mention because we are running a little short on time. The last thing I wanna mention is that it doesn't have to be a one for one situation. You could we've had several clients in our private practice sell one property and buy five, six, seven properties located in several different states.
Speaker 2:So there's a lot there's obviously a lot of flexibility, and it's a a vague term, but flexibility with these ten thirty one. So is there any kind of closing notes that we may wanna mention with this as as far as for your favorite color or scrubbing the diagnosis?
Speaker 3:I would say like I said it before, I would say the the most important thing to do is go through the process, diagnose. If you're that purple or red diagnosis, consider the 10:31 exchange, determine if you are your lifestyle or your situation requires you to have the cash at closing. And if it does not, then a 10:31 exchange would make sense. If you're if you're a green diagnosis and you're a very low marginal tax rate, that's where I see sometimes people enter ten thirty one exchange where there really wouldn't have been a big tax impact. You know?
Speaker 3:So maybe they have capital losses that could offset the capital gains. So you've got to go through that step three in our process. Identify strategy, quantify result, I IQ test, and run a pro form a. Talk to your tax professional. How much would it be or or jump into the TTF ecosystem.
Speaker 3:What would my tax be if I sold this property and did not do a ten thirty one exchange? That's step one. And determine if that tax warrants a redder purple diagnosis. Well, as always,
Speaker 2:here I am having more questions because we've dived in we've dove into this. Even though we talk about this all the time, it's there's always something else that's coming up. So that that's really a a fantastic feature and really the way we craft some of the content on this podcast. So we make it very relatable, the the bite sized chunks as we might say that's why sometimes we cut a little short on some areas, some take a little longer. We have some great interviews that we've done, some that are coming up.
Speaker 2:Again, if you have the opportunity, we greatly appreciate it. Please share this with those in your network. We'd love to hear from everybody. Again, a a great way to get a hold of us directly is through any of our social media channels. Obviously, teaching tax flow, you can search on LinkedIn, Facebook, Instagram as we really build out our our reach, as we should say, as as we really start to build and expand on our ecosystem.
Speaker 2:So as we bring in new partners with this referral partners, it's it's ever growing. Ever ever growing content, obviously, built for our audience. Chris, any final notes?
Speaker 3:I would say thank you for listening. We're excited to spread the word of tax planning and strategy to as many people as possible. And if you like what you hear, please rate, review, and subscribe with a five star review. It would mean a lot to us, and have a great rest of the day. Excellent.
Speaker 2:Thank you so much, Chris. Thank you everybody for joining in once again on the Teaching Tax Flow podcast. See you next week as we dive into gold and wrap up 2022. So thank you much, everybody, and we will see you next week.
