Listeners are in for a treat on this episode of the Business and Barbecue podcast as Tim talks with his friend Michael Plaks, the “black belt” in real estate taxation. Michael is an accountant who has been working exclusively with real estate investors for 20+ years, so he has seen it all and can talk with investors in their own vernacular. Michael and his team offer their clients an annual advisory program which includes annual tax preparation, bookkeeping, quarterly advisory meetings, and strategies in addition to assistance in fighting Uncle Sam if the need arises.
Over the years, Michael has developed several prevailing opinions in the real estate investing realm:
- People confuse income and wealth. An investor owns property long-term, while everyone else involved in real estate is simply working a job. The key question to ask to find out which boat you are in is: “What happens if I stop what I am doing in 3 months?” If your income stream will continue, you are investor gaining wealth. If your income stream would cease, you have a job.
- People shouldn’t buy real estate for the tax benefits. You should be primarily concerned with cash flow and appreciation, followed by tax benefits, not the other way around. There are really only 3 ways to reap tax benefits from real estate, but even those are not guaranteed. Your ultimate strategy should be to purchase a property, do a 1031 exchange for a bigger property, and so on and so forth until you have drastically increased your wealth.
- People should focus first on starting something, and then how to structure it. Michael says that the best idea is to consult with an attorney about what you should do, but from the tax perspective it is best to start earning money before worrying about the structure. He provides listeners with his 3-step process for getting started:
a. Set up a separate personal checking account for your business and use it for all business transactions
b. Stop using cash – pay electronically or with a check
c. Use apps to track your expenses and mileage
Michael and Tim talk through when it is best for a sole proprietor to make his business official and conclude by talking about accurate bookkeeping leading to having a better handle on your business’ financial position.
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Announcer: You’re listening to the Business and BBQ podcast hosted by Tim Herriage. Tim Herriage is an active entrepreneur who built and sold six companies by the age of 40 and enjoys sharing the ups and downs of business and entrepreneur life. As for the barbecue, that’s just something he has a passion for and likes to share as well.
Announcer: Here’s your host, Tim Herriage.
Tim Herriage: All right, all right. What’s cooking everybody? Welcome back to another episode of the Business and BBQ podcast. I’m your host Tim Herriage. I have been missing in action for the last two weeks. My oldest son graduated high school. I turned the ripe old age of 41. Took a little bit of time with the family over Memorial Day. Went on a little vacation. But now I’m back. I’m ready to spend my summer with you. And here we go with another episode of the Business and BBQ podcast.
Tim Herriage: Today we’re going to be talking to my good friend Michael Plaks. Michael is a tax genius. Michael specializes in helping business investors and entrepreneurs keep more money, operate their businesses properly, and most importantly he helps them outsource the thing they’re not good at like accounting.
Tim Herriage: It’s going to be a really good episode. Stick around. We’re going to talk about wealth, income, the difference in the two, and several steps that any entrepreneur can take today to organize their business where they can ask a true tax professional to help them keep more of their hard-earned money.
Tim Herriage: We’ll be right back. You’re going to love meeting Michael.
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Tim Herriage: All right, everybody. Welcome to this episode of the Business and BBQ podcast. This episode has come about because a couple of weeks ago we ran a Facebook poll in the Business and BBQ podcast Facebook group and just say, “Hey, entrepreneurs, what are you interested in?” Right? The number one thing was marketing, so we knocked out marketing that week. To my surprise, the number two thing was tax strategies.
Michael Plaks: You expected it to be number one?
Tim Herriage: Well, a lot of times entrepreneurs aren’t worried about their taxes, Michael, until it’s too late, right? I’m sure you’ll say a lot about that. But a lot of times entrepreneurs really do focus on marketing and sales and products and all of this stuff while they leak away all their profits. But, I’ll get ahead of myself.
Tim Herriage: When I saw the result, I said, “Okay, who can we have?” And within the real estate investment industry, there’s really no one that’s recommended as much as Michael Plaks down in Houston, so we connected, we have Michael on the podcast today. Michael, say hello.
Michael Plaks: Hey. Hello, everybody and in case you haven’t run across me yet, I’m Michael Plaks and I’m known as black belt in real estate taxation. So, here I am in all of mines. There is black belt. There are my sparring gloves because somebody has to punch out Uncle Sam and that’s my job. So, here we are. Okay, I’ve been in this business for 20 years. Known Tim for 10 years, I believe. So, let’s roll. Okay.
Tim Herriage: All right. As an entrepreneur, someone that is involved in… I have some investments. I have a home office. I have a not a home office. I have active real estate dealings. I have passive real estate funds I’m in. I have businesses I’ve invested in that have nothing to do with real estate where I use my IRA. I think there’s so many different rabbit holes we could go down.
Tim Herriage: Just, if you could, Michael, tell the audience a little bit about you and your specialty, and then, I really want to spend the next 20 to 30 minutes talking about, I don’t know, that top five to 10 things that you see people wasting money on. Because it’s my belief, and this is my new philosophy in business, and you’ve known me from times when I was trying to start global enterprises to times that I was just wholesaling houses, and it’s my philosophy now at the ripe old age of 41, that if I just worked a little smarter and kept more, I’d have been a much more happier guy.
Tim Herriage: Keeping more has to do with Uncle Sam and Aunt Iris taking all your money. So talk a little bit about yourself, what you do, and then kind of five to 10 things that you see a lot of entrepreneurs and real estate professionals making big mistakes on.
Michael Plaks: Okay. Tim, you know, honestly I don’t want to talk much about myself. I’m probably the least interesting part of the podcast.
Tim Herriage: I don’t know. I mean, you look pretty interesting to me.
Michael Plaks: Well, except for my, you know, east Texas accent. Other than that, I’m just a boring accountant dealing with real estate. But since my business is exclusively working with real estate people.
Tim Herriage: Right.
Michael Plaks: There are very few people that can claim that nationwide. We work with real estate investors only and 20 plus years, so I have seen thousands of investors in all stages. Some of them we watched growing from zero to big boys and some we watched going from big boys to zero. So we know what works. We know what works and what doesn’t work.
Michael Plaks: I have a lot of observations and also a lot of opinions. I have some very strong opinions and I don’t care if somebody disagrees. I’m old enough to not care, so I’ll gladly share my opinions. My first one starts is, people confuse two things. Which, to me the starting point about when we talk about real estate investments, people confuse income with wealth. Okay?
Michael Plaks: Income and wealth are two completely different things. What people are saying is that I’m real estate investor and you ask, “What are you doing?” I’m a wholesaler. It’s good to be a wholesaler, but you are not an investor. I want to be ready because, again, my opinion… Everybody has an opinion. We are online. Everybody can disagree and everybody will disagree.
Michael Plaks: But my opinion is this. Investor is somebody who owns property. Okay? And owns property longterm. This is what investment is. You put money in and you wait for your money to work. Everything else is a job. Being a wholesaler is a job. Being a flipper is a job. It’s necessary for income, right. If you lost your job, if you need money to pay your rent, yes, you need to do something. Wholesaling is the natural thing to do, but that’s just a job.
Michael Plaks: Why is it a job? Very simple test guide. What happens if stop doing it for three months? What happens? Your savings run out, you’re broke. Okay? What happens with flipping after you sold your flip? Cashed your check. Mandatory post it on the Facebook, everybody gives it five likes. For a minute you know, yes, you just cashed a check. Wonderful. What happens three months later after you spend all of this money? That’s a job. You have to keep doing that. When we talk about it’s job and it’s producing income. Good income. Maybe more fun income than sitting in a cubicle. But it’s still job with income.
Michael Plaks: What you need ultimately if you are building wealth is something that works for you when you don’t. And historically, there are only two things you can do. You can buy real estate or you can buy businesses. Either real estate or businesses. People say you can buy securities like stocks. Yeah, but stocks own real estate or businesses underneath.
Tim Herriage: Right.
Michael Plaks: You either own real estate or you own businesses. We are in real estate world, so yes, you buy real estate. When we talk about investment and longterm strategy, the strategy is, acquire real estate and keep it. As simple as that. Now, people like, I’ll continue being opinionated because people to bring notes into conversation. It’s so popular right now. All the financing notes and stuff is okay.
Michael Plaks: Notes is not wealth either. It’s income but not wealth. Here is why. Nothing grow with notes. I’m all for notes. Great way to make income. But after the note is paid off, you have nothing. There is no income. There is no asset. Absolutely nothing. And you can have a great cash flow, but you have to continue to acquire notes over time. Notes does not grow. Notes are deeply shades and guesses. They reduce from the time you bought it to zero eventually.
Tim Herriage: It’s a declining income stream with a declining asset base.
Michael Plaks: Right.
Tim Herriage: Every month you make less interest and you have less of a note receivable.
Michael Plaks: Correct. So the only real asset, the only real longterm growth is, own real estate. Now, what is that? That’s like everybody’s preference. You can own mobile homes, you can own single-family homes, apartment complexes, commercial buildings, historic facilities, Airbnbs, whatever, but you have to own something that will consistently generate cash when you are not doing that.
Michael Plaks: So when people talk about longterm wealth, longterm wealth is, how do you… Maybe right now you’re not in a position to do that. Maybe right now you have to feed your family, have to do wholesaling. Fine. But your strategy has to be built around, as soon as possible, getting to the point where you can acquire and keep properties.
Tim Herriage: Right.
Michael Plaks: Okay. And I saw you doing yes when I mentioned notes. So, okay, you are apparently in the minority here, right, Tim?
Tim Herriage: Well, I think it comes from experience, right? In 2008 and 2009 when the market was kind of in the toilet, I owner-financed a lot of properties. I said this in one of my episodes. I’ll never forget, it was October of 2017 and I did my balance sheet in my property schedule for my bank and I got really excited because values were way up, my paydown was way down, and I run down the hall and I show it to Jennifer and I’m like, “Look. Look how much we’re worth.” And she’s like, “Wow!” Right?
Tim Herriage: And I was like, wait. I’ve got to take the notes out because we don’t get the difference between what we owe on the underlying lien and what it’s worth. I’ve got to go figure out what those people owe me. And so that little correction lowered my net worth by almost $2 million. It’s like, then you start looking at it, and we were about eight, nine years in to the note, so we had sucked almost all the income out of it. The payments were about to become all principle. So we sold all of the notes and reinvested into rental properties because…
Tim Herriage: So, when you said that, I got all excited, it was because I went through that revelation on my own. I had to kind of figure it out. And I’m not opposed to notes. I bought some notes a couple of months ago, right, that were a distressed note sale from a seller. We bought them for 50% of the unpaid balance. It’s good income. I had a house last month that, I bought it for 100 grand and owner-financed it as is for 140 grand and got 9%.
Tim Herriage: It’s a great income play on a house that didn’t fit my rental strategy. It’s one of those things like, I love doing it, but it’s not investment. It’s not longterm wealth.
Michael Plaks: Correct. Okay. I’m happy to hear we are on the same page as we usually are.
Tim Herriage: Right. Well, experience is a great alignment tool, right? Once you’ve made enough mistakes, you’re typically on the same level with other people that have been doing it for 20, 30 years, you know?
Michael Plaks: Well, let’s continue opinions, I guess. Okay.
Tim Herriage: I love your opinions.
Michael Plaks: Okay. Next opinion, different topic. Not talking about income/wealth now. Switching topics. People talk about taxes. Well, I’m a tax guy, so right. Of course tax is everything. Here is what I’m against. When people, the first thing they start discussing is about tax benefits of real estate. Okay. “I’m buying real estate because of tax benefits.” This is number three consideration, way below number one and number two.
Michael Plaks: When you buy real estate you buy it for two things. The first two you can put in either order, whatever you like. It’s cashflow and appreciation. You buy it for cashflow. You buy it for appreciation. Preferable both. I know successful investors who focus only on one of the sides. Like focus on appreciation or on cashflow and ignore the other side. Ideally, of course, you have both.
Michael Plaks: But tax benefits is the distant third. It’s nice to have it, but it’s the icing on the cake. It’s not the cake. And people so many times I’m seeing it’s like, oh, when we talk about something and realize somebody’s not in a position to benefit in his particular financial situation and I have people that’s, “Then why did I buy that?” And they sell it and think, “What are you doing?” You did not buy for taxes, you bought it to become wealthy.
Michael Plaks: Yes, Tim. You wanted to say something.
Tim Herriage: It’s kind of like when I sit at a restaurant or happy hour and someone will buy me a drink and say, “Don’t worry, it’s a write-off.” And I’m like, I don’t know. And I’ve done it, when I was young, trying to act cool for my friends at a restaurant, “Oh, I’ll buy. Don’t worry, I can write this off as business.” And it’s like, that’s not the reason to spend money. You know?
Michael Plaks: Right. It’s very simple. We’ll talk about. If it’s a write-off, let’s reframe that. What happens when it’s a write-off? It’s not free. Like, somehow people… It’s write-off. It’s not free. It’s not free, it’s discounted thing. What happens, if you bought something for 100 bucks, you wrote off of taxes. Maybe you saved yourself $30 on taxes. So you ended up paying 70 instead of 100. Okay, you bought it at a discount. It’s still not free.
Tim Herriage: Right.
Michael Plaks: What people are saying is, “What else can I spend money on so I get more tax deductions.” As simple as, you only buy what you need. You only spend money on what you need to spend money. Never pay anything just to get a tax deduction. Okay. Like I mentioned, a distant third to get tax benefits from real estate. Let’s briefly outline, what are the tax benefits of real estate?
Michael Plaks: But before talking about that, momentarily I will look back to that income versus wealth discussion. If you are in the income part of real estate, if you’re wholesaling, if you are flipping, there are no tax benefits. That income part not only does not create wealth, it does not produce tax benefits. You make money the hard way by working hard and you pay taxes on top of that and high taxes usually. We have strategies to minimize them, but there are not tax benefits, there are extra taxes.
Michael Plaks: If you are on the wealth side, not only are building wealth by investing in rental properties, but here you have benefits. So briefly, what those benefits are. Number one, you can have… Remember what the reasons are. We’ve got cashflow and appreciation. So, cashflow. You can have cashflow without extra taxes. That sounds strange, but that’s how it works very often.
Michael Plaks: You can have rental property. You generate 1,000 rent per month and your carrying cost, everything included, is 800, so you have that 200 positive cashflow per month. But when you file your taxes it shows that you have no money or you have zero. Why? Because of depreciation and all those techniques that we do. But in reality, in no other business can you… Well, I’ll take that back. There are a couple of other businesses, like oil and gas, where it can work that way. But real estate is the most common business where you can have cashflow without increasing your taxes. That’s clearly benefit number one.
Michael Plaks: Benefit number two. We said appreciation is the second goal of owning real estate. Appreciation means you make more money. When you make more money you usually pay taxes eventually when you make that money, which is when you sell. In real estate we have strategies and you can sell, but not pay taxes on that capital gain. So that’s like second benefit. You can defer it into the future. Sometimes you can avoid it completely. There are different strategies dealing with that.
Michael Plaks: Third one is, as the property grows in value, you can pull cash out of that, you can pull equity and refinance, like do cash re-fi, and you won’t have to pay taxes on that. That’s not a magic rule. Eventually it will cost you more taxes at the end of the deal, but maybe not. Again, if you combine different strategies, you can have the ultimate strategy and I will describe the ultimate strategy, which everybody in real estate should at least consider doing.
Michael Plaks: Here is the ultimate strategy. You get your first property, let it appreciate, then you do an exchange, a 1031 exchange, from that property to bigger property, from that one into even a bigger property, even bigger. And then eventually you own huge property and you die with it. And then that property goes to your children tax free and that capital gain completely erased. That’s your ultimate tax plan and a lot of people are actually doing that.
Michael Plaks: And then of course you have sole-directed IRAs and all kinds of other strategies that are not specific to real estate, but are commonly used in real estate to accelerate your wealth building. What’s your opinion, Tim?
Tim Herriage: Now, you said on like a rental property, if you refinance it, you can pull the cash out without paying taxes on the cashout, but you said ultimately it costs you more. Why is that?
Michael Plaks: Okay. Well, here is what happens. The only time where you would not worry about that, if you are using 1031 exchanges. But let’s take an example. Okay. So you bought property for 100 grand and you have a 75,000 loan on it. After a few years the property value went up to 150, you re-fi that 100. So you’ve got 75 loan, you re-fied it at 100, pulled out 25 in cash. At that point there are no tax consequences. None. You don’t pay any taxes because you pulled that 25 out, but what happens here that confuses people a little.
Michael Plaks: Let’s say you sell this property the next year. You sell it at 150, same price, to simplify the example. And now you have 100 grand loan on that. You pay off the loan and you believe, “Oh, I only made 50.” But what happened is, at that point that 25 that you pulled out is added to your capital gain. Now, my example is not really accurate from technical. I’m trying to translate taxation in the beginner investor terms.
Tim Herriage: Yeah, so you’re talking more like a common misconception, right? People, they think that 25,000 makes it where they made less in the deal, but it doesn’t.
Michael Plaks: Right.
Tim Herriage: Right.
Michael Plaks: When you sell a property, what will end up is, you will pay taxes on that 25 when you sell the property. And people get upset because they’re saying, “I did not bring that much cash from closing. Why?” Oh, well, because a few years ago when you re-fied, you pulled 25 tax free back then, right? Now it’s time to pay for that. It’s time to catch up.
Tim Herriage: Well, if you never sell the house.
Michael Plaks: Yeah, 1031 it. Yes, then you don’t worry about that. Absolutely.
Tim Herriage: So it’s kind of funny you talk about that. My goal when I was the-
Michael Plaks: Yes, I talk funny. I agree, Tim.
Tim Herriage: … was to have a lot of free and clear houses. I used to think, “I really want to own these things free and clear. I don’t want to owe anything.” And after I did my time with Blackstone and I talk to this billionaire friend of mine, his whole thing was like, “Tim, that’s completely wrong. You don’t ever want to pay off a house. Leverage it to the hilt. Get as much low-interest responsible money as you can, because,” he’s like, “That’s tax free.” He said, “What you don’t want to do is ever sell a house.”
Tim Herriage: So now, as I sit here a lot more experienced, I’m thinking, I told my wife this, I want to get to 40, 50 really quality, appreciating, primo houses. I used to buy the 80, $100,000 houses, and now most of my houses are 220 to 300. They’re really, really nice houses. And I told her, I said, “Look, if we refinance,” oh, the number was 40. I want to have 40 houses. And I thought every 20 years I’d refinance a house, or every house would get refinanced every 20 years, because I’m like, then I’m always paying interest, right, which comes off the top line.
Tim Herriage: I run out of depreciation, what, around year 27 and a half? But you’re always able to kind of recapitalize the business in a tax free manner, was kind of my idea. That’s my opinion.
Michael Plaks: I’ll just insert one technical correction here because when you re-fi, depreciation doesn’t change.
Tim Herriage: Right.
Michael Plaks: You’ll won’t have new depreciation because of that. But yes, yes. There are different schools of thought and that’s like general financial concept. It has nothing to do with taxes. Whether you leverage to the max or whether you keep your equity high, that is debatable. It’s like religion. It’s like Ford against Chevy, which truck is better? You will forever argue about that. You will have people making arguments both ways. I’m in the leverage school of thought, but I acknowledge that people who talk about keeping the equity high and leverage small have their points too.
Tim Herriage: Right. So what, as you look at entrepreneurs in general, right? As you look at small business owners, and I know a lot of these investors have multiple businesses, right?
Michael Plaks: Yes.
Tim Herriage: Take a guy like me. Lord, this time two years ago I was filing, I was signing, not just filing, I was the signer on eight different returns and I was a part of probably another four or five returns that I was just getting a K-1 from. What do you see that people could do. Do you think that it’s more important to start right or just course correct as you start to grow?
Michael Plaks: It’s very important to start right, if I only knew how to start right. You know. I did not start right in my business. It took me years in what you call like course correction all the time. That’s what our life is. That’s the way we deal with careers, personal relationships, businesses. Everything is like that. I think the key is to start. If you focus how to start right you will never start anything.
Tim Herriage: Let’s talk about starting because there’s a lot of new entrepreneurs. There’s a lot of business owners that I do business with that are getting paid in their personal name. They come put a fence in my backyard and they run a… Or, no. I’ll use the Bobcat. They come use their machinery to move the dirt in my backyard and then they get paid, they want me to write them a check in their personal name. I always think that’s a bad idea because of self-employment tax and all that.
Tim Herriage: If you’re starting a new business, what’s a basic… Do you recommend just a single member LLC, which by the way, I had one guy tell me that’s like the number one audited thing because it goes through on your Schedule C. Or do you recommend someone form a partnership with another friend, that way it’s a K-1? And just imagine a small budget service business. How do you recommend someone start a little right?
Michael Plaks: Okay. Small time business when you start is, what I say… I have opinions, okay? Again, my opinion is, you don’t do anything.
Tim Herriage: Okay.
Michael Plaks: When you start, you focus on making money. That’s the only thing you should focus on when you start. Once you made money, then we need to think about how to set up your business. This is why I’m saying that it’s very briefly and it’s sounds counter to common conception that everybody talks about how you need to start different structures as a protection, tax benefits, all of that. First, asset protection is not my department. That’s for attorneys and attorneys always disagree about that.
Michael Plaks: I’m one of the top contributors to Tax and Legal Form on Bigger Pockets and I am like very active on Facebook groups related to tax and legal stuff. I even founded our own group, REI Tax and Legal Wizards. Every time there is a conversation like that on Facebook, at real estate clubs, on Bigger Pockets everywhere, attorneys completely disagree. Attorneys joke, and it’s not really a joke. They say, “Ask two attorneys, get three opinions.” And with asset protection, that’s a rule.
Tim Herriage: Right.
Michael Plaks: And I cannot step in that at all because I’m not an attorney, right? So if your attorney says you need to set up something for legal protection, sure. That’s his job to protect you. But one of my favorite attorney friends has a saying, which I love to quote. He says, “Clients who come to me for asset protection do not have asset protection problem, they have asset accumulation problem.” To me it’s like, okay, I accumulate assets first, worry later.
Tim Herriage: No, I agree, right? I tell people all the time. They get tied up in a series LLC or a limited partnership or this or that and my opinion is just always, I tell people, “If you have enough money where that’s an important question, then you have enough money to hire an attorney to give you the answer.”
Michael Plaks: Yes.
Tim Herriage: Right?
Michael Plaks: I agree. I agree.
Tim Herriage: But with a sole proprietor, what I’m trying to say is… Here, I’ll give you a good example. You’ve probably seen this 100 times. This is my accounting paperwork for the week.
Michael Plaks: Perfect.
Tim Herriage: Right? I was on vacation last week, right? All of this is separated into separate companies and separate this and that. The output is not that organized. But I see a lot of small entrepreneurs that could at least go set up another personal checking account for their business.
Michael Plaks: Yes.
Tim Herriage: Where at least they can keep it separate. Talk about record keeping. I see so many people, they don’t… I asked a guy the other day that I was looking at investing in his company and I said, “Well, where are your corporate books?” “Oh, I don’t have an accountant.” And I’m like, “Well, dude, you don’t need an accountant. Do you have an Excel spreadsheet? Do you have Quicken or QuickBooks?”
Tim Herriage: I guess what I’m saying is, let’s avoid the legal opinions. How can one organize their business to make it where, when it is time to come to you, when it is time to figure out how much they really made, what are some quick tips that you’ve… Are there any apps out there that you see people using to track their mileage? Any ideas or something you could share?
Michael Plaks: Sure, of course. Okay. But, I’ll return to the question in a second. I just want, before I forget, insert something here because we started talking about entities and setup, right? And I said everybody, when they ask me a question, “What’s the best strategy,” they assume that I’m going to tell them something about forming an S corp, forming some kind of complicated entity, setting up sophisticated entity structure loopholes. But really, where the most potential is is keeping good records.
Tim Herriage: Right.
Michael Plaks: Something that you just started talking about, Tim. And it’s boring. It’s so not sexy to talk about bookkeeping. It’s like one of the most boring things you can invent to talk about other than tax code and politics. Well, politics.
Tim Herriage: Politics has gotten kind of exciting lately.
Michael Plaks: Oh, yeah. Yeah. Anyways, so that’s where the greatest potential is because where we have problem is, people come to us and say, “Okay, I need to prepare taxes.” “How much you spend on that rehab? Where are you on that?” “Oh, I don’t know. I think I spend about 25 grand.” What does mean about? And first, when somebody says 25, it never means they spend 20 because, you know, we tend to cheat, to fool ourselves, by pretending that we did better.
Tim Herriage: Yeah, yeah, yeah.
Michael Plaks: So if somebody says about 25, probably they spend 35. If you only have receipts for 25, he is throwing away 10,000 more of deductions. 10,000 worth of deductions, he is throwing away like three, four grand of actual cash of taxatings that he could have received. And we are throwing away thousands and then people talk about corporations like, “Got to get corporations.” Get your ducks in a row first. Get your . It’s like, how do you set up? Okay. I prefer simplicity. I call myself a lazy accountant. I don’t want to do more work than I have to and I don’t want my clients to do more than is necessary.
Michael Plaks: So what is necessary is, the first time you set up, start by creating different account at your bank. Go to your bank, open different account. It doesn’t really have to be business account. Could be another personal account, but you use it exclusively for business and give it a very simple but very important credit. Everything related to business you pay only out of the business account.
Michael Plaks: So if a business account is empty, people are saying this like, we have clients and they come to us and they have 12 mortgage payments. We look at the bank statements, there are 10 of them. Where are the other two? “Oh, you know, there were two months where I didn’t have cash in my business account, so I paid it out of personal.” Dude, it’s just a two-step process. Move money from personal account into business and pay from business.
Tim Herriage: Right.
Michael Plaks: Also it’s like, you made some money, you closed on a deal, you want to put down payment on your new car. Great. Again, two-step. Move it from business account into personal and write a check to the dealership from your personal account and then you can of course post yourself next to your new car on Facebook so everybody knows you really are successful because how else you can prove it? Yeah, so number one habit is absolutely start creating account and create a habit of paying that.
Michael Plaks: Habit number two, stop using cash. Don’t pay anything in cash. Avoid cash. People say, “Well, those people don’t take checks, don’t take credit cards.” Everybody can use PayPal these days. There are electronic ways to pay people. You have to find, really the only people who would we would have to pay cash is like Home Depot parking lot people, but I have a problem with hiring these people anyway. I don’t think I’m going to use them no matter how cheap they are. And that’s a different conversation though. Anyway, so avoid doing cash.
Michael Plaks: Third one is, start using app. Like people before said, “Yes, I have shoebox, I throw in my receipts because I don’t know how to use QuickBooks.” You don’t need QuickBooks when you start, okay? Use something simple. Okay. Spreadsheet fine, but spreadsheet still requires some computer skills. There are so many simple applications. Google, put like in Google, best apps for expense tracking, like what people use.
Michael Plaks: There is one called Expensify. Okay. I’m not saying it’s the best, it’s one of the most popular. If you want just one, use Expensify. Okay. Or use, there is like QuickBooks for self employed application. It has receipt tracking and mileage tracking built in to that. For just mileage tracking, there is an app called MileIQ. A lot of people use MileIQ. There are so many apps. It’s so easy to use. Right now, there is really no excuse to not do that.
Michael Plaks: You just take your phone, snap a picture of your receipt or you look at the route, where you are going, just when you get on the road, tap it once, it starts recording and when you arrive, tap it a second time and it created that log for you. Log that. Uncle Sam is asking everybody to show when you get get out of there. That’s his first question, “Show me your mileage log,” and people say, “I didn’t keep it.” I cannot understand why anymore. 10 years ago, I could understand. 10 years ago our most popular product was, I still have it, just lazy to get up from my desk and bring it to show, printed log books where people could write their expenses and mileage, and people complain it’s too much work. But right now everything is on the phone, so.
Michael Plaks: Those three things, create separate account, avoid using cash, and start using apps both tracking expenses and receipts. Now, once you go to the next step, once you start owning properties and doing flips and real estate rentals, now then I have bad news for you because bookkeeping at that level is extremely complicated. Extremely complicated to the point where even if you hire professional bookkeepers, unless they are real estate specialty bookkeepers, they don’t know how to do it right.
Tim Herriage: Right.
Michael Plaks: So for years we struggled with that. We tried to find bookkeeping partners. We tried to hire people to do that, like find different outsource solutions. We ended up creating our own proprietary bookkeeping system on which we put our clients, which is specific for real estate. You don’t need it until you own properties, but when you do, that’s one of the greatest life savers that we can offer people.
Michael Plaks: We have people when they’re first time trained and know our system, the response is always like When Harry Meets Sally. It was like… Yes. Finally I can do things in a reasonable way because what we do is, the hardest part is to enter sales re-fis and purchases from closing statements, so we do it for our people ourselves. The rest is automatically pulled from your credit card and bank statements and automated for you. So, it’s excellent system. But that’s what we have to do for real estate investors who are at professional level. But when you first start, use any app and get in habit of recording everything.
Tim Herriage: So let’s say that I am a
and you make a lot of money. And I want to start buying-
Michael Plaks: What you mean, let’s say? You do make a lot of money.
Tim Herriage: Well, but I’m not a plumber. Let’s just say that I wanted to buy a rental property. Should I buy that rental property in my plumbing company? Should I buy it in my personal name? Or should I go create a new LLC?
Michael Plaks: Before I answer, I have to take a minute to detour. You said plumber who makes a lot of money and they are talking to me, so I have to tell the old joke, which is just like a minute. It says, a CPA calls a plumber and after 15 minutes of fixing something, plumber hands him a bill for $300 and CPA looks at it and is saying like, “Wow, I’m a CPA and I charge less than you do.” And he said, “I charged less when I was a CPA too.”
Michael Plaks: Okay. So what that plumber should do, you’re asking is, should he buy rental property in his own name or a name of a company. Is that right? Again, there are two aspects, legal and taxes. For legal, that’s a question for his attorney. His attorney will probably tell him that for legal protection he needs an LLC.
Michael Plaks: On my end, for taxes, it does not matter. That’s what surprises people, but I’m trying to explain it. Okay, when you have rental property, LLC does not do anything for you on taxes. There are no extra deductions. There is no new tax benefits. You don’t save on taxes anything. The result is exactly the same. In fact, the most common situation, if it’s just you, if it’s you, Tim, or like you and Jennifer are like husband and wife, LLC, you won’t even see it on your tax return.
Michael Plaks: You have it for legal protection, but on your taxes it will look exactly the same as before LLC. With or without, the same result. But people say, “Well, I can put it in a separate company and treat it as a partnership. Fine, but at the end of the day, the result again is exactly the same. Nothing changes with rentals.
Michael Plaks: If you want to address your taxes with entities, that is the game that is played by people like plumber. Okay. A plumber who makes a lot of money, for example. Plumber can benefit from a corporate structure. You can possibly create an S corp and he can save on self employment tax. If he really makes a lot of money, he can maybe create a C corp and save on taxes even more. But that is for people who have what we can active income.
Michael Plaks: In real estate world it’s realtors, wholesalers, flippers. Those people when they make enough money, may need a structure. What I hate is when people give that one rule… The saying is, everybody should do that. They say, “That is a rule of thumb.” Can I see your thumb? Yeah, exactly. What happened to your thumb?
Tim Herriage: Oh, I cut it with a knife. You know, I like to cook a lot.
Michael Plaks: Ah. Ah. As I say, a rule of thumb today for Tim is just perfect illustration because he has a special thumb today. So rule of Tim’s thumb would be, everybody creates an S corp. It’s bull. Not everybody creates an S corp. Even if you are a flipper or wholesaler because S corp helps people only in specific circumstances. And more so, in some circumstances S corp can hurt you then goes into paying more taxes. People are shocked by that, but that’s the case.
Michael Plaks: So you never say everybody creates an S corp. You create an S corp in certain situations. For some people it will help. For others it won’t. But if you are doing rentals, it will never help reduce your taxes. So for rentals you have other tax strategies, but not entities. And by the way, you never buy rentals in corporate structures. Not S corp, not C corp. They are wrong structures to hold rentals.
Tim Herriage: So, you know, I was talking last week, or on Friday, I was on my way back from Jamaica and I put a post of a check, a wire that I had just received an email about. I got $23,000 in.
Michael Plaks: It was pic of a check or a chick?
Tim Herriage: Check.
Michael Plaks: Oh, okay.
Tim Herriage: But it wasn’t a check, it was a wire I received. Which, I don’t understand why people get $100,000 anymore, by the way, but that’s a whole nother conversation. It’s the first check I’ve ever posted. But I posted it for very a specific reason. Not to brag, but to actually talk about how bad it was to get a $23,000 check because in the post I broke it down, and I’m going to find it real quick because I know that you and I have crossed some people on Facebook that were posting a bunch of checks and it just means nothing. Oh, come on, pull up. I want to show all that. I don’t think you saw this. It was late Friday.
Tim Herriage: I said, “I’m posting this check. I just closed a super complicated estate deal where my gross assignment was $40,000.” And I talk about, “I wanted to keep it, but I had to sell the house because the company needed operating capital. So by the time I pay my overhead, my advertising, because I allocate everything kind of on a per deal basis, and account for everything, I make about $16,000 before taxes and I established I end up, it’s about $11,000 after taxes.”
Tim Herriage: And when you look at it, that deal, had I kept it, I would have been out of pocket about 25, $30,000, but I probably would have made $12,000 the first year and then 12,000 the next year and then 12,000 the next year and then 12,000 the next year. So I bring that up because I think the real estate investing industry has to do a better job about educating themselves on the devastating impacts of running a dealer business. Of getting on that treadmill of advertise, pay salespeople, pay office, pay expenses, cash a big check.
Tim Herriage: I’m kind of looking at this and I’m estimating, the last two years my wholesaling business has only run about a 20% net margin after taxes and that’s probably maybe even a little high. It may be about 15 to 18% net margin after taxes. We’re probably running a 30% EBITA, right? Earnings before interest, taxes, and appreciation.
Michael Plaks: Tim, I just have to interrupt you.
Tim Herriage: No, go ahead.
Michael Plaks: Oh, I just have to tell you. If you had a real bookkeeping system, you wouldn’t be saying probably.
Tim Herriage: But I don’t. Well, I say that because I’m one of those… I say this all the time on my podcast. I’m an entrepreneur that is more than happy sharing that I do a lot of things wrong and one of the reasons we’ve sold some companies recently is to clean up the messes. We sell these companies and you cash in and you’re able to clean up your balance sheets enough to where you kind of keep what you want to keep.
Tim Herriage: And even now, I’m stuck. I’m down to four tax returns, no, six, seven if you count my personal, but by the end of this year, I’ll be down to three. And so yeah, you’re right. I should definitely know my margins better and I don’t because that business, that wholesaling business, has so many other things in it that we’re set up wrong.
Tim Herriage: Sometimes, literally, when I’m entering an expense, it’s just a guess. It’s like, “Yeah, I think that expense was for, I don’t know, that domain name over there.” Sure, why not? But, no, I bring that up because knowing your margins, right? On this deal specifically I paid, gosh, I don’t know, I probably paid about 25% on cost of goods sold for labor and sales and acquisitions people. I probably paid 25 to 30% of the income in, well, it was about 20% in advertising, about 10% in overhead, and, yeah.
Tim Herriage: I always look at these numbers on the quarterly basis. I just don’t know where we’re at right now because I just got home from vacation. I’ve got a lot of Jamaican beer running around in my head still. And then, I pay myself a percentage of all the gross personally, because you’ve got to pay for private school, right? Not for me, for my kids.
Tim Herriage: But, yeah, when I started kind of digesting it, it’s one of the reasons I’m really shifting a lot of my focus right now to spending my talents and my energy more on my rental portfolio and less on my events and wholesaling and real estate brokerage and loan company and insurance company and all this other stupid stuff I have because if you can increase those margins, you can do less. You can actually enjoy the fruits of your labor if you can just…
Tim Herriage: It’s like I tell everyone, you know, if you’re trying to make 50 Gs a month and you can operate on a 50% margin, well, okay, you’ve only got to do 100 grand in gross. Right? But if you can get that up to 80%, now you’ve only got to do 70,000 or 65,000. So it’s kind of one of those, I’m personally working on that better, like you just said. I’m personally trying to understand my margins and expenses and fix them to where the business is much more sustainable, which I think then makes my life more enjoyable.
Tim Herriage: So I think that’s a good segue to, let’s talk about what your firm can do. I think you said earlier you only work with real estate investors. So if there’s any real estate investors listening to this, what all can your firm do for them?
Michael Plaks: Well, we can prevent people from becoming Tim Herriage, publicly complaining about not knowing his margins and starting businesses he has to close because of margins and predictability issues. But, okay, on a more serious note though, our experience has shown that the bigger the operation is, usually the messier it is on the internal situations.
Michael Plaks: If you start feeling like, yeah, I spent 20 years in business and should know better. Why mine is not still taken care of? Well, because you have a big business and our observation over the years is literally, the biggest investors have the worst mess. Some of our testimonials came from preachy big well-known investors who tell us that when they came to us first time it was complete mess and that to my point is, what does it mean mess?
Michael Plaks: Okay, I just have bad books. No, you didn’t have bad books. Those bad books cost people sometimes in the three digits in taxes, like up to 100 grand of unnecessary taxes that on a big enough population they were paying because they did not know what they were doing, didn’t have strategies. And not having books creates things when, one of the big investors we started the first year and we asked him, exchanging emails with their bookkeepers and asking this, “What is this $65,000 item? We cannot link it to anything.” They started looking and then figured it out, it actually was embezzled.
Michael Plaks: So things like that happen when your house is not in order. It’s like real people, real stories. And when we started, our company was doing tax preparation like
. We had a skill called REI Tax Firm, like Real Estate Investment Tax Firm. Oh, by the way, anybody want to find it, it’s reitaxfirm.com. Very easy to find us. We don’t do tax preparation by itself anymore because what we found is, the real problem is not taxes. Taxes is the last step.
Michael Plaks: The real problem is keeping things structured, orderly, and organized where you know your margins every minute, where you know where your weak points are, where you know where you’re making the most money and you can adjust. We talk totally about, do you do things the right way from the beginning or do you change your course as you go? You always change your course, but you want to know where to change your course. You need some data. You cannot adjust where you’re going if your GPS is off or if you don’t know where you are.
Michael Plaks: So what we do is, we have all of our clients right now on annual advisory problems, which includes everything. Obviously we do their taxes, but more importantly, we set them up with good bookkeeping system. We have regular quarterly meeting strategy sessions where we discuss, we analyze financials, where we help them advance their business, where they have good picture of what happens with their business, how much taxes they owe. Of course, we open all the loopholes and strategies that exist there. We help dealing with this guy so that if they ever receive any letters or, god forbid, have to be audited, well, we’re here with the red gloves so we can punch Uncle Sam out and defend our people.
Michael Plaks: So here is what we do basically. All-inclusive tax advisory and financial support for investors and since we spent 20 years in that business, we speak the language. We have people, and not just me, like my staff. We have clients, they come, talk to my people, and they start explaining. And my people saying like, “Okay, so you do wholesaling?” “Oh, you know what I do?” Of course we do. Dude, that’s our business. We know what you are doing.
Michael Plaks: It’s funny, sometimes I post on Facebook and occasionally deal with issues like construction and people say, “How do you know that? You’re a tax guy.” No, I’m a real estate tax guy. I know things. I know things about real estate and our biggest thing is, okay, just recently we took… There was an interesting conversation. We were talking with a new client who is first year with us, pretty big operation, and we quoted him our service.
Michael Plaks: And then once they signed up it’s like, “Look, I talked to my wife,” says the guy, the business owner. He says like, “We discussed it and we looked at the number, like how much does your annual service cost, and we asked ourselves, do we expect that we will get back 10 times what you are charging us? We’re looking at that and we said we believe we will.” I was like, “Oh, well, great.” Great pressure for me expectation-wise, but that’s what we are really trying to do.
Michael Plaks: We are trying to bring value to people’s businesses. Tangible value which comes from having control of your financials. And of course, minimizing your taxes is part of that.
Tim Herriage: I absolutely agree. Michael, we’re going to take a quick break. We’re going to come back, and I want to talk to you about some interesting things and finding a passion and a hobby that maybe you could turn into a tax write-off, and of course, I’ve got to talk to you about barbecue. Stick around, we’ll be right back.
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Tim Herriage: So, Michael, I really appreciate you being on today, but I have one more thing I have to talk to you about.
Michael Plaks: Oh.
Tim Herriage: Do you like barbecue?
Michael Plaks: Ah, I was afraid it was going to come to that. You know, I’m Russian not Texan, right? I like barbecue, but I can’t tell you much about that. See, unlike you, I cannot really… I would lie to you if you blind test on me, a plate from a famous place and from Walmart, I probably wouldn’t be able to tell you.
Tim Herriage: Well, we’re going to have to get you up here to Dallas or I’ll have to come down to Houston. I’ll take you to experience. What we’ll do is, we’ll go to Dickie’s Barbecue and you’ll see what barbecue’s not supposed to be and then we’ll take you to a good barbecue place and we’ll show you what it’s supposed to be and then you’ll know the difference.
Tim Herriage: I’ve been to Russia. I’ve spent time in Vladivostok when I was in the marine corp. We were doing some playground stuff and it was the first time I ever really drank vodka until I could not see straight anymore. I’ll never forget, we were just sitting there at the table with the Russian military and, “Comrade, another vodka, another vodka.” And before you know it, all the marines are like seeing double. So I hear you. In Vladivostok, Russia there was no barbecue for sale.
Michael Plaks: No, there is no barbecue. But one thing I can talk about barbecue is this, although it might be another tax tip. Tax tip and barbecue. Barbecue is actually a good example. Which is, can you write off barbecue? Want to talk about that?
Tim Herriage: Yeah.
Michael Plaks: The answer is, if you structure it properly, you might. Here is a question, okay, what do you use barbecue for? Let’s imagine that you host regular barbecue gatherings for your investors, business partners, employees. So what you need for that is, you need pretty nice grill. You may need to have a setup. You need to buy meats and everything else and booze of course. And if you can have a legitimate business purpose, you might be able to do that.
Michael Plaks: But it has to be treated as business setting and done in a business-like fashion. You will have to show, if you ever, if I need to go and fight Uncle Sam on your behalf over that, we need to show them the frequency. We need to show them pictures. We need to tell them, “Look at this picture. See who is here around barbecue. It’s not his family. This guy’s his business partner. This guy’s his private lender. This guy is his student. This guy is his, hey, this guy’s his tax accountant here on the picture.” Okay?
Tim Herriage: So I guess you just touched on the whole reason I started this podcast, was so I could go taste barbecue and talk about it in a business setting.
Michael Plaks: Yes.
Tim Herriage: My brother just commented on Facebook. He said, “They have a good barbecue spot in St. Petersburg.
Michael Plaks: Really?
Tim Herriage: That’s what he said. Because he went over-
Michael Plaks: I am from St. Petersburg. Back when I was there, there were no barbecue places.
Tim Herriage: The world’s changing, Michael, the world is changing.
Michael Plaks: Really.
Tim Herriage: All right. Hey, man, reitaxfirm.com like Real Estate Investor Tax Firm dot com. Is there a phone number people can call?
Michael Plaks: Yes, but it’s better to go through the website. The number is (713) 721-3321, but I would still recommend, visit the website first on your phone or on your computer. You will get an idea of what we do and you can contact us through the website. Of course you can call, but fastest response will be going through the website.
Tim Herriage: All right. Well, Michael, again, thank you for being on the show. We’ll get you up here to get some barbecue here soon.
Michael Plaks: Sounds like a plan, Tim.
Tim Herriage: For everybody listening or watching, we’re out of time. Until next time, keep cooking.
Announcer: Thanks for listening to the Business and BBQ podcast. Make sure you check out our other episodes and stop by timherriage.com to say hi. We want to hear from you. Until next time, keep cooking.