Mindy: Welcome to the BiggerPockets Money podcast where we talk to Amanda Han and discuss whether the lucky winner of the HGTV Dream Home can actually afford to live there.
Mindy: Hello, hello, hello. My name is Mindy Jensen and with me as always is my HGTV sweet steaks entering co-host, Scott Trench.
Scott: I did enter Mindy, but today, I think it’s going to be a reality check.
Mindy: Scott and I are here to make financial independence less scary, less just for somebody else. To introduce you to every money story, because we truly believe financial freedom is attainable for everyone, no matter when or where you’re starting.
Scott: That’s right. Whether you want to retire early and travel the world, go on to make big time investments in assets like real estate, start your own business, or figure out how to deal with the tax ramifications of winning a large sweep stakes. We’ll help you reach your financial goals and get money out of the way so you can launch yourself towards those dreams.
Mindy: Scott, we have created a new segment called the money moment. This is the segment where we look at a money hack, tip or trick to help you on your money journey. Today’s money moment, did you know that a lot of private auto insurance policies and many major credit cards provide coverage for rental cars, particularly when rented for personal use instead of for business? Check the policies to make sure, but chances are good that you can save money on your car rental and skip the expensive insurance coverage the rental company offers. Some of the best travel rewards cards provide rental car insurance that may let you skip the rental company’s collision damage waiver. If you have current car insurance that includes collision, comprehensive, and liability coverage, your auto insurance policy likely will cover you in the event your rental car is damaged in an accident. Of course, you should check with your insurance company to make sure before you waive that policy from the car companies.
Scott: And Mindy, in my case, both my auto insurance and my credit card cover have coverage here. So there’s no reason for me to sign up for that insurance option when renting a car.
Mindy: Yes, same with me. But make sure that you rent the car with that credit card, otherwise you are out the ability to use that coverage when you if should you have an unfortunate accident.
Mindy: All right, Scott, today we’re talking to Amanda Han about the tax implications of winning the HGTV Dream Home. And I think it is a pretty fascinating conversation. I learned a lot about sweepstakes and prize winnings and I am excited to bring this episode to our listeners.
Scott: Yeah, I thought this was great. You know, and look, if you’re skeptical at first, oh, HGTV sweep sleep. No, no. This is an incredibly informative discussion that has really advanced tax strategy and planning all around the context of course of the the good problem of having won a very large piece of real estate. How do we begin reducing the tax burden. And there are the applications to this discussion could be in any part of real estate investing or personal finance. So really fun, really fun, really good discussion. Uh what a privilege to learn from Amanda Han.
Mindy: Before we bring in Amanda, let’s take a quick break.
Mindy: HGTV has been giving away a grand house every year since 1997. This year’s home is located in our backyard, Morrison, Colorado, and it’s a stunning home, coming in at 4,360 square feet, three beds, three baths on 2.4 wooded acres, plus a new Jeep Cherokee and $100,000 in cash from Ally Bank. That sounds so awesome, right?
Scott: It does sound awesome and it looks awesome. If you go to HGTV’s website or the Food Network website and look at these things, there’s like a four-minute video that goes through the house and it is just spectacular. Crazy views, huge rooms, open area. The kitchen is incredible, all that kind of stuff. I am usually not a big uh, uh, I don’t usually get sucked into these types of things but I spent, I watched the full video twice and then I showed it to my wife. Um, so it’s a pretty awesome house.
Mindy: I was waiting for you to say, I don’t really get sucked into videos about houses, CEO of Bigger Pockets, Scott.
Scott: I don’t get sucked into videos about um nice houses, uh luxury homes that I would purchase. So, unless they’re Airbnbs.
Mindy: It is a luxury home. It’s absolutely stunning. And Scott, did you enter the sweepstakes? I did. It was super easy. It took like a minute.
Scott: I did as I did as well. And by the way, this is not sponsored by HGTV. Uh we just we just uh find a really funny topic and uh yes, I entered twice.
Mindy: Oh, twice. I only entered once. Uh, I guess I have to go back and enter again. So you have the potential to win this super awesome prize. But today we’re not talking about it. We like we just hyped it up, but that’s the end of the hype up. Now our big question is, can the average person actually afford to live in this HGTV Dream Home? And what are the tax implications for a winner of a multi-million dollar prize package? Today, we’re speaking with Amanda Han, tax genius. Amanda, welcome to the Bigger Pockets Money podcast.
Guest: Oh, hi Mindy, hi Scott. Um thank you so much for having me here. I’m super excited. I don’t know if I can live up to the genius content. Um but I’m definitely excited to be here and kind of talk about the tax side of things. Um but you know, it it’s a hard conversation to have especially after all this wonderful stuff you just said about the winnings and now I’m kind of like the bad um tax person coming here with um bad news. So, yeah, um definitely, definitely, let’s talk about all that, all that uh goodness.
Scott: So so tell give us, let let’s just jump right into it. What what is the bad news? right? Why why would winning that have any type of bad news whatsoever that I have to think about?
Guest: Well, so in the tax world, uh there’s a rule that’s, you know, all income is taxable, uh whether legal or illegal and um and that includes uh awards and winnings and things like that. So what’s going to happen guys is the uh when this special person wins, maybe it’s Mindy, maybe it’s Scott, maybe it’s me, I don’t know. Can I enter if I’m not in Colorado? Um, uh oh, I can. So I will definitely enter then tonight. Um, so what’s going to happen with the special winner is that the IRS is going to uh uh come and be like, hey guys, you know, we won, when we won our uh big house and um, by we means, yeah, give me some of the earnings. So, so over our prices like any other income is subject to taxes. Um, it’s going to be taxed at the same rate as whatever your ordinary income is going to be for the year. So, um, you know, I think we said earlier it’s about a $2 million, $2.7 million award. Um that naturally puts somebody at the highest tax rate, uh which currently is 37% for federal taxes.
Mindy: So, what I’m hearing you say, the total prize package is $2.7 million and Uncle Sam is going to come knocking on my door and say, I want 37% of that.
Guest: Approximately, yeah. And also the state too, right?
Mindy: Oh, that’s right.
Guest: The state, the state also wants uh their share of the taxes too. So, yeah, 37% for federal, um 4% for the state of Colorado. So that’s a big chunk right about a million dollars, a little over a million dollars of that is going to go towards taxes, um without any proper planning, that’s, you know, that’s the government’s share.
Scott: So if I in other words, if I if I win this house and the 100 grand and the Jeep, I’m gonna I’m gonna have to pay a 1.1 million dollar tax bill just to keep the house in that year.
Guest: Yeah. So this is really interesting. I actually had to do some research on this because believe it or not, I don’t have clients who’ve actually won these kind of big prizes. So it’s not like something we deal with all the time. So, uh, so Matt, my husband and I uh researched into it. Um, so when you win awards like this, um, they actually require that you pay the tax before you take possession of the property. So, if you’re choosing the, um, the real estate or the cheap or whatever, you can’t just take the money, I mean, you can’t just take title and then later on pay the tax. Um, they actually want the taxes paid upfront. Um, so yes, for the average, you know, American who wins it, um, hopefully you have, you know, some cash stocked up or you have wealthy relatives.
Scott: 1.1 million dollars in cash.
Guest: Yeah, some wealthy relatives who’s going to help with uh, with getting that money uh, you know, setting it aside for you.
Scott: So can I, can I is there another way I could do this? Like I don’t have 1.1 million dollars in cash right now and would not want to sell parts of my portfolio. Could I take a mortgage against the property, for example, to pay the taxes?
Guest: Yeah, this is an interesting question and this is one that, um, you know, Matt and I were talking about the other day like, well, what if, you know, clearly we have a house that’s free and clear, right? Let’s say $2 million of a house. Um, can we go to the bank and get financing? Will some, will a bank lend me $100,000 with this house as a collateral? Um, or not even, you know, maybe not a bank, maybe just another investor, right? like a private lender or something. Um, so I think the question would be yes, you could probably get a loan for something like that. But here’s kind of the small hiccup though, um, I think according to the rules, you can’t take possession of the home until you actually pay at least the withholding part of the tax and so that’s maybe a little bit tricky, right? Would, would a bank lend on something with this home as a collateral when you’re actually not on title yet, you know, you will be after they give you the money and you, you know, get the taxes withholding all squared away.
Scott: So in a practical sense, I would have to take a hard money loan for $1.1 million dollars against the asset and then refinance into a 30 year mortgage if I, if I actually wanted to keep the home after winning the sweep stakes, is that right?
Guest: Yeah, yeah, that that’s one way to do it, right? Hard money or something that’s maybe not secured by the property itself because at that moment, um, you don’t actually own the home yet.
Mindy: Is that it’s a kill in here?
Guest: No, I think this is a really good dose of reality because somebody might think, oh, I just won the $2.7 million dollar prize package.
Mindy: Wait, I have to pay taxes? Yeah, yeah, I’ll get to that later. Wait, I have to pay them up front? Well, then I can’t afford that. I mean, it’s all fine and good to talk about the idea of going to get a mortgage to pay off this $1.1 million tax burden. But who’s going to give you a mortgage when you make uh $60,000 a year? Who’s going to give you a $1.1 million mortgage when you make $60,000 a year? I’m guessing um nobody.
Guest: Yeah, and I think that was part of the question is like, you know, does it, is it feasible for someone like the average American to actually, um, you know, keep the property, right? When we’re talking about um the the taxes associated with it. So even though the house itself is free and clear, so we might have a million dollar tax bill. So you need to be someone with enough equity or income or creative financing to get a loan, a longer term loan, right? for this million dollar uh tax debt to be able to pay it off with your income or other sources during the year. And um what’s really interesting, this whole exercise, I think you guys for inviting me here. So as part of this exercise, um, we kind of did some research because it’s not something we do all the time. Um, but I actually grew up in Las Vegas and when I was really young, I remember, um when you go to the casinos, they’re all these like nice cars, you know, like convertibles or just these really nice cars. I remember my dad telling me like, you know, the people who actually um uh win these cars, they don’t typically drive off with them because they have to pay taxes on it. And unless they have the money to pay the tax, they’ll just take the cash option. Um so this is really interesting for me, you know, back then I didn’t really know what he was talking about taxes, but now with this exercise we’re going through, kind of brings everything together, right? Whether it’s winning a car or a house, we have to figure out a way to pay for the tax before we can actually accept the award that we want.
Scott: So what what is the cash prize option if I decide not to go with the house?
Guest: Um so the the cash, my understanding of the cash prize option is that you get $750,000 of cash, that’s what it’s, you know, the value of the home is, and then plus or their deemed value in cash terms. Um you still get the $100,000 from Ally Bank and then you get 75,000 is the value of the cheap. So if you took all of that, you get 900 and what, 925,000 in terms of like the cash amount. So, um, if you take the cash amount, um, it doesn’t mean you don’t have to pay taxes, so you still have to pay taxes, they still will withhold the taxes, but it’s a lot more feasible because HGTV can withhold the taxes on that and then just give you the, you know, the cash for the difference. Now, um, I was saying earlier the, you know, for someone who had a $2 million of income, the tax rate is about 37%. The good thing is for withholding purposes, withholding meaning what they want right now up front, it’s not at 37%, they only want to withhold 24%. So that’s what you’re required to pay in at the moment you get the price. So 925,000 if you go with the cash prize route, um they’ll probably withhold about 220,000 and then you’ll get a check for the rest, right? So then you only like about $700,000 is what you’ll get. Um just they looking at federal, right? We’re not talking about state or any of that.
Scott: So why why is there such a spread between the value, the $2.7 million value of the house, the um, uh, the the chief and then the $100,000 from Ally Bank and the, the cash prize option. What why do you think that is? Is that customary in a lot of these, you know, jackpot scenarios?
Guest: You know, I don’t know if it’s customary because, you know, I don’t, I mean, that’s not something we come across a lot, but that was also my question too. It’s a huge difference, right? You’re talking about 2.7 million versus 900,000. Um, and I don’t know if it’s just part of the game they’re playing, right? How many, what’s the likelihood that the winner of this house can’t come up with the cash to pay the tax. Um, and some of the risks associated with now owning this home, how will you maintain it or will you going to sell it? Um versus maybe the average American, right, who we think the winner is going to be are more inclined to say just give me my cash and, you know, I’ll do what I will with it. Um because that’s kind of my only option, right? Absent a rich uncle who has money waiting for me.
Scott: So what would, what would you do if you won the prize?
Guest: Oh man, I I would try really hard, um, to keep the house. I might start raising money from investor friends uh because you know whoever I know that has some money laying around. I love your idea Scott about hard money. I mean, obviously, the downside of hard money is the points and the interest that we have to pay, but if I can float that for, you know, what to three months, um, you know, it’s a big difference of getting $2.7 million worth of something versus $900,000 of cash, right? Comparing both of those, um, before taxes. Um, and then yeah, then I have this huge property that I probably won’t live in. Um, you know, it’s probably too much for what I would need, but I, you know, that could be like a rental for me. I can get some good cash flow, short-term rental or get some depreciation out of it or I might sell it, you know, and then take the 2.7 of cash. Um so yeah, that’s what I would do. I would aggressively try to find the way to pay for the taxes.
Scott: You wouldn’t rehab it?
Guest: I, that’s probably way above my abilities to rehab something. This go big. Did the burbs. Yeah. There’s no need to rehab this this house. I think, okay. Yeah. I I think that I’m kind of aligned with that like I would want to, if the difference, if the spread is really like a $1.7 million dollar in difference between the value of the house and the cash prize, I’d do everything I possibly could to take possession of the house in some way and then I’d I’d have a, I I recognize I have a a massive tax bill I’d have to pay at that point in time. But then the gain, if I turn around and sell it, there is no tax burden, right? Because I’ve already, I’ve already paid the tax on the the value of the property, right? Unless there’s a, unless I buy it for, I assume it at a 2.7 million valuation and sell for 2.8. Um, only that 100,000 would be taxed, right?
Guest: Yeah, exactly, exactly. So that’s the benefit of that is that, you know, a lot of, I mean, if you sold it immediately for cash, your tax bill if there’s any on that is gonna be very little, right? Assuming there’s not a a whole lot of appreciation that happens in the interim. But you know, I think part of too what we we can look at is the timing of it all, right? Because what happened, we have an immediate, so whoever wins this is going to have like an immediate tax problem, which is okay, they must withhold or after write them a check for 24% of my $2.7 million winnings. Um, but thereafter, right? I got my rich uncle, I got hard money loans, I pay that off. Now I have the rest of this year to figure out how I’m actually going to reduce my tax bill on that 2.7 million. So if I’m a real estate investor, we look at all the traditional strategies like I’m going to have more rental properties, um or even for this property, if I turn into a rental, I’m going to accelerate depreciation. I, I think this one comes with all the furnishing and all that stuff, right? So all these things I’m going to accelerate right off depreciation, bonus depreciation so that I’m creating losses to hopefully then be able to offset at least part of this $2.7 million of income.
Mindy: Okay, you mentioned a while back planning. Is there any way to plan this out so that you can reduce your tax burden or is this just you’re stuck with the tax burden?
Guest: No, I mean, so yeah, so that’s what I was saying like if, so let’s say I win this house in in March, I have a way to kind of pay for the taxes, right? Withhold the taxes because they because the government requires me to do it. Between March and December, that’s where my planning happens. So I can think about is this going to be, am I going to turn into a short term rental? I’m going to accelerate all the depreciation and bonus and right off from this property. And if I’m able to create a $700,000 loss or a million dollar loss and to the extent I can use it to offset this income, now I don’t have $2.7 million of income, I only have $1.7 million that I have to pay taxes on.
Mindy: Okay. But that doesn’t have you living in the house. That has you using it as a an income property, as a rental property. You also used, you threw out two numbers, 37% and 24% for what you owe and what you, what HGTV is required to withhold for you. That’s 13% difference on 2.7 mil, 2.7 million, that’s um a lot of money. So if HGTV is required to withhold only 24% but I’m going to owe the 37%, do I have to pay quarterly estimated taxes on that chunk?
Guest: Um typically you don’t. So quarterly estimated taxes you can go under what we call safe harbor role. That’s one of the methods of paying quarterly meaning you’re going to pay this year based on prior year’s taxable income. So again, assuming this is just like a, you know, the average American, maybe makes 60, 70,000 a year last year, they didn’t know any taxes, then they should be fine. It doesn’t mean you don’t have to pay, you still have to pay it. So in your example, Mandy, if you decide to move into the property, there’s no depreciation, right? We’re not writing off the furniture. It’s all just your personal home. Um so yeah, then you better think of, you know, another rich uncle or someone to help you pay for the tax, the rest of the taxes come next April.
Scott: So Mindy, what what would you do? We did, we never, we never got to hear your, your um preference here.
Mindy: Well, until Amanda came on and said I had to pay my taxes before I could take possession of the property, I would have said I’ll take possession of the property and I will then immediately sell it because I am a real estate agent in Colorado and I would save my listing fees and I would list it and make tons and tons of money. Uh now that Amanda threw cold water on my plans to get rich, uh what would I do? Honestly, I would probably take the cash because I don’t want to liquidate enough of my current holdings to pay the taxes upfront. I mean, that’s a large amount of tax and I wonder if people except for those, of course who listen to the show, I wonder if people realize that’s what they have to do before they can take possession of the house. I mean, you make all these grand plans and then HGTV is like, that’ll be $1.1 million dollars, please. And you’re like, whoa, whoa, whoa, what are you talking about? Now I have to change all my plans again.
Scott: Well, HGTV isn’t saying that, it’s Uncle Sam, right?
Mindy: Well, well, but Uncle Sam is making HGTV withhold it, so they are, they’re not just going to hand you the keys.
Scott: Yeah, absolutely. Mindy, you, you are an agent in um in this area. Where what do you, do you think it’s, the house is worth? I guess two and a half million after um, you know, after factoring out 70,000 for the Jeep and 100 grand in cash and the Ally bank. Do you think it’s worth 2.5, 3 million?
Mindy: You know, I would have to actually see it. HGTV should call me and let me get, you know, have the keys and walk through it and and really go through and see if it is worth that. I would imagine that they aren’t putting a $2.7 million price tag on this prize package and then it’s only worth a million. I would imagine that it’s worth pretty close to what they have, uh, what they have priced it at. Um, 100,000 from LA Bank is really nice and I don’t know what a Jeep Cherokee goes for, but yeah, this house, I mean, it’s a beautiful house. Morris in Colorado is just outside of Red Rocks. Uh, the venue, like it’s a gorgeous place to be. It’s a gorgeous part of the world.
Scott: Fair enough. So we have some question marks there. Um how much do you guys think we would need to, someone would need to make in order to qualify for a $1.1 million mortgage just to keep the property if they were able to float the debt and then refinance out?
Guest: And so it’s more than, so they’ll, yeah, so maybe a million dollar in mortgage, right? Because that’s what they’re using just to pay the, the taxes on it. Um but also the property tax for, you know, the property tax, um utilities, upkeep. I think when I looked, the property tax was actually pretty inexpensive in Colorado. Um came out to be like 20, 30,000. Does that sound about right to you guys on a 2.5 million dollar home?
Scott: Yeah, that sounds about right.
Mindy: So, yeah, I think the question is what, you know, how much income do we need to afford a one, you know, maybe like a one million dollar mortgage.
Scott: So a million dollar mortgage at 6% for 30 years, just principal and interest is $5,996 a month. That doesn’t include your taxes which was just said was like 20,000. Uh so let’s call that 2000 a month. So now you’re at seven, that was $6,000. Now you’re at uh $8,000 insurance. I have no idea what it costs to insure a $2 million house but we’re looking at, you know, nine, $8,500, $9,000 a month just for your housing costs. Yeah, I think I think you probably I I’m doing back of the napkin math. I could be way off here. perhaps someone could correct us in the comments, but I I think it’s going to be around 325,000 annual household income to qualify for that mortgage.
Guest: Oh, so close. I got 324.
Scott: My napkins went out pretty well.
Guest: But someone can correct us in the comments. We might be off. I mean, it would depend on the interest rate you’re using and all that stuff. I used, I think I used uh uh what did I use? like a 6, 6.3% rate.
Guest: Definitely not the average, that the average household income, um winner, right, that we’re that we’re thinking of like the $60,000 income person to be able to afford to keep this property.
Mindy: Right. So let’s look at this. I make, let’s say I make $100,000 a year and I, which is clearly short of this $325 and so I want to take possession of the house and then try to sell it. At this price point, it’s going to take longer to sell because you have less people who can qualify for this mortgage. You need to make $325,000 a year to be able to qualify for this mortgage. I mean, a lot of people at this price point are just paying cash for it because they’re super rich, but that’s narrowing your field of buyers by a lot. So the house is going to sit on the market longer, meaning you have to pay, uh, if you have a mortgage on it for the taxes, you have to pay that every month until you can sell the property. You have to pay your real estate agent, you have to pay the buyer’s real estate agent, you have to pay all sorts of closing costs. There’s a lot of things involved. It’s really making that 950 look a lot more attractive because they’re taking 200,000 off the top and now you have 700,000 free dollars that you can now just go and spend or invest. We would probably invest if you’re listening to this show as opposed to trying to jump through all these mental hoops and and actual hoops of trying to sell a house that you can’t afford to live in.
Scott: Amanda, going back a minute here, how much, so so the strategy is coming together in my mind here is what Amanda said, take possession of the house, refinance into a 30 year mortgage. If if you can find partners or have the means, you buy that, you buy, buy the property, you take possession of the property, pay your taxes, refinance into some sort of sustainable debt like a 30 year mortgage if you can, um, and then put it as an Airbnb and depreciate and accelerate that depreciation on all those different components. And Amanda, you you threw out a pretty high number that you thought you might be able to get to on that depreciation. Do you have a ballpark guess of what, you know, kind of the range you would you would think an investor might be able to depreciate on this property in the first year?
Guest: Um, I mean, it’s really difficult, right? Because every property is so different. We don’t really know what the land value versus the building, but if we just said, let’s say this property is, you know, 80% building and we said, if we can accelerate just the building part of it itself, we can take 30% of it, that might be about $600,000 um of accelerate depreciation in the first year. And then from that, you add in, I don’t know, any other furnishing or you know, whatever the other values of, right, this this I think the terms said this came fully furnished with, you know, all the artwork or whatever that is. So, um, any of those you can add on top of depreciation. But yeah, I think even without that, you know, maybe you’re looking at about $600,000 that you can offset against part of this taxable income. Um, it’s not going away, right? We still, I mean, we started with 2.7, so we’ve reduced it by about 600,000, but you can also reduce it by all these other operating expenses that we were talking about, right? Insurance, property taxes, all the other holding costs too.
Scott: And would that all hit, if I took possession in April, would that all hit in 2023 for depreciation or would it be a rolling 12 months? Like part of it would hit in 2023, part of it hit in 2024?
Guest: Yeah. So it’s both, um, with cost segregation, what you’re doing is you’re accelerating part of that building into 5, 7, 15 year assets. On those, we can take bonus appreciation. So even if you took possession later in the year, it’s still for this year, 80% bonus. So that part doesn’t matter as much. Um it’s still a very big right off up front. But the building, whatever is remaining that we didn’t or weren’t able to accelerate, the building itself is a month by month calculation. So, yes, the earlier in the year you take possession, the higher the potential depreciation on the building component.
Scott: Okay. So so I, so the strategy is forming together in my mind is even if I didn’t bring in a dollar of Airbnb income and my mortgage is six grand a month, if I can get 600 rand depreciation, I’m pulling down the the tax bill by 250 grand at the end of the year and getting a refund check. So it seems like it makes a lot of sense to hold on to it for at least one year to get that depreciation um and to offset some of that, some of that uh that first year tax it. And then maybe sell it as soon as that depreciation benefit is largely out of the way. Um even though there will be a gain to recapture at that point, you’re at least spreading that out from your huge income year into another year.
Guest: Yeah, is that right?
Scott: Yes. Now that’s, yeah, that’s exactly right. So you are taking a deduction this year where you’re at the highest rate and then next year when you sell, you might have some recapture but theoretically you don’t have as high of a tax rate for next year. Um,
Guest: I mean, if you’re doing short term rental or even long term rental, we always recommend you have actual rental income. I know you said I have zero rental income. So it’s more than just saying it’s going to be a short term rental, right? Especially when you’re talking about such a large dollar amount, you want it to actually operate as a short term rental. So, you know, hopefully that means people, you know, guests and tenants coming in and out during the year, so you’re operating it as a property. Um but also too, like maybe next year you sell it and you do a 1031 exchange because this one property doesn’t cash flow well, but you can 1031 into a, I don’t know, self storage or an apartment building that cash flows better, right? And then you don’t have to worry about the recapture of the taxes in that scenario.
Scott: Well, let me ask you another question. Do I need to be, do I need to have real estate professional status to use depreciation on a short term rental to offset the winnings of my, of my house from HGTV?
Guest: A great question and um the answer to that depends on whether we are really talking about a short-term rental or a long-term rental. So, um if indeed Scott, your master plan is to do the short-term rental route, then the answer is no, you don’t have to be a real estate professional. You can use short-term rental losses to offset award winnings. Um, as long as you meet material participation hours. So there’s a lot of different ways to qualify, uh but the most common ones we see is you spending at least 500 hours on the short-term rental property. Um so if you meet that, it doesn’t matter how many hours you might be working at bigger pockets or wherever, you don’t have to be a real estate professional. Now, if you are turning this into a long-term rental, then yes, you or your spouse will have to be a real estate professional, otherwise it does not offset the award winnings because they’re in different buckets.
Scott: Wouldn’t I have a hard time convincing the IRS that this house needed 500 hours of work? Um I mean, so what if, if you’re thinking work as a like rehab work then sure, right? because it’s already turn key and beautiful. Um but for short for an operator, I think you’ve talked to any short from one till, I mean, there’s a lot of work to be done in terms of dealing with guests and bookings and all that kind of stuff, right? So if you meet 500 hours in the operational or the management side that could work. 500 is one of the ways to meet material participation. There’s other ways, there’s seven, there’s actually seven other ways. 500 is the most common one. Um another one that you can do is you spend at least 100 hours and nobody else spends more time than you. So Scott spends a 110 hours, the cleaning crew only spends 80, nobody else spent more than 110, then you are also able to meet the material participation.
Guest: So this is one of those rare situations where cleaning the toilet could be a $500 an hour activity or much more. So so this is the real answer to the question. If if you win the HGTV home and you what I would do now that I know know all this is I would float the tax bill with a hard money loan or some kind of bridge financing from friends, family, whoever I could get to to invest in that project to pay them a couple points in interest, quickly refinance out of that into a mortgage a sustainable long-term debt, immediately put the property into um a short-term rental status, do all of the work myself until I got up to 100 hours or 500 hours um or meant one of the other qualification standards that are actually pretty hard or kind of have have some lots of room for interpretation as I understand it that Amanda was was mentioned briefly there. Um, hire a CPA, perhaps Amanda to do the uh cost segregation and accelerate tons of depreciation. and then after a year or so when those benefits run dry, um 1031 exchange the property into a portfolio that um was was what what was in line with my long-term investment objectives. Is that close to what you would do, Amanda?
Scott: Yeah, I mean that’s what I would, that’s what I would try to do, I think. But I don’t know, I mean, if I’m actually the winner, I might take a short cut to, I might be more like Mindy where I’m just like, hey, I’m going to take the cash prize and, you know, the velocity of money where I can just use it right away into whatever other deal that, you know, might generate better returns. Um but but other than that, yes, Scott, that’s a, that’s kind of a, you know, a great outline of the strategy. But I do want to um throw in some more bad news and I’m sorry I’m like the bear of bad news today on this dream home episode. Um, so currently we have a limitation that’s called the excess business loss limitation. Um, I don’t know if uh you guys are familiar with it or if our listeners are, so that’s just yet another limitation on how we can use losses. Um uh basically at the heart of it is says that you can use uh business losses to offset business income, right? No limit if you’re material participation, real estate professional, all that good stuff. Um, but uh there is a limit when it comes to using those losses to offset non business income. So non business income, up so business income would be like realtor commission, you know, you have a business, that that’s all great. Um, non business income would be things like W2, um retirement distributions and things like award winnings. So those are non-business. So right now there is another layer of limitation if you’re married. Um I think for this series about 540 or 560, so that’s the maximum you can use in terms of like real estate losses to offset those types of income.
Guest: So if we have $2.7 million, even if we accelerated $600,000 of a loss, we could probably use about 540 or 560 this year and then the rest we’ll have to be used in future years.
Scott: Okay. So then I have to just make my money, I have to make more money on my Airbnb in that first year to have more income to offset some of that.
Guest: Yeah, yeah. Not the end of the world but I just want you to think that you can offset, you know, like two million dollars of of income from taxes!
Scott: This is terrible news.
Guest: I am sorry. I’m like a bear of bad news today.
Mindy: No, I think that this idea that Scott floated with doing this and this and this and this and this and this and this sound great for Scott who has the mental bandwidth to take it on and the mental capacity to understand what he’s doing. I think that’s wonderful for Scott. I think it sounds super complicated and I am in the stage of my life where I am de-complicating things. So I just want anybody who’s listening who’s like, uh, I don’t want to do all that stuff Scott’s suggesting to to say it’s okay to take the 950 cash prize and pay your taxes off top, save enough to pay the rest of them when the tax man comes with his handout because he will and then just go and invest it, spend it, whatever you want to do with those winnings. It’s valid to choose that as well. So Scott’s idea is awesome and Scott can do all of those hoops. Scott, I hope you win and I hope you document all of the hoop jumping so that we can have a really fun series of videos.
Scott: One one last question though on this. How about donating it? Can I just donate the property? Can I if I want to donate the house without if I, if I choose to donate them property to a charity for example, could I avoid having to pay the million dollars in possession taxes and not have to donate the cash prize but instead give them give the charity a two and a half million dollar gift.
Guest: Yeah, that’s an interesting take. I honestly hadn’t thought about that. So, um, so what you’re saying is I’m going to win all this stuff and I don’t want to pay the taxes. I’m going to donate, let’s say the property to charity and then I will keep the cash prize, the 100,000 from Ally Bank and is keep the cheap.
Scott: Yeah, yeah, that that sounds like a pretty, yeah. That would be a really good person to do something like that.
Guest: Yeah, I mean yeah, because you’re giving up a lot, right? you’re giving up a lot but, but yes, definitely on the on the donation side, um the the deduction you get is the fair market value of the asset that you donate. So if the value of this home is $2.5 million, you get a $2.5 million charitable donation deduction. Um, you know, anything the tax role, there’s always limitations to how much of a donation can also set different types of income. So it’s not on an unlimited basis, like we hope it would be. Um but but yes, that definitely is a way to reduce some of the taxable income um by looking donations. And I think, um, you know, I think Mindy, you’re right, there’s not like a right or wrong answer here, right? It’s just kind of personal preference, what your capacity is in terms of finances and you know, bandwidth on on whether you want to jump through the hoops. But even if you’re someone who took the cash prize, um if you take the cash prize, the simplicity of it is there’s already cash there they’re with holding it for you, but it doesn’t mean that you are going to be on the hook to actually pay taxes next April on the whole 925,000, right? We can still use the same strategy. So you walked away with 700,000. It’s a down payment on $1.5 or $2 million worth of other real estate. You can buy real estate, use the new real estate with depreciation, cost aggregation, short-term rental loophole, you know, whatever the strategies are and still create losses so that by next April, you’re paying very little taxes or you know, a lot less taxes, right? So you can use the same strategies in terms of tax reduction regardless of whether you’re doing the, you know, cash prize or the hard asset in terms of the awards.
Scott: If you are a real estate professional or willing to do what it takes to meet the standards on the short-term rentals, you can use those depreciation, the depreciation and losses in real estate to offset your income. Yes, so that’s, it’s kind of comes out to what your general strategy is. Right? If you’re a long-term rental investor, you want to try to be a real estate professional. If you’re short term, you could help with the short-term rental.
Guest: Okay, one more question about donations. If I decide to donate and it’s 2.5 million to my favorite charity, you said I can’t take all of that at once. Does that donation roll over the the like forward against income or is there a limit to that?
Mindy: Yeah, so if you, so yeah, let’s say you made um 2.5 million offer donations, you can only use a million dollars of it, the remainder that you don’t get to use, it carries forward, so you can use that next year to offset your taxable income.
Guest: Wait wait I want to donate the house. I’m going to miss this. I donate 2.5 million, I have a tax bill for 2.5 million. I only get to declare 1 million against that. I still owe taxes on 1.5 million gain in that first year.
Scott: Yes, and this is the the reason for that is because there are limitations to the charitable donation deduction. Um so depending on what you’re donating, lot of times for different type of assets you’re limited to maybe 30% of your adjusted income is what the deduction is in any given year or if you’re donating other stuff, it might be limited to 50% of your income. So, um, that’s why, you know, in the tax world, it’s it’s not always simple and rosy, unfortunately, there’s all these little pitfalls and roadblocks that they throw in front of you.
Guest: This is terrible news.
Mindy: I’m sorry.
Guest: I’m like a bear of bad news.
Scott: No, I think this is really important to be knowledgeable about these choices you’re making. HGTV is great at promoting this house and showing you how amazing it is. They aren’t maybe so good at at sharing your tax burden and how all of this affects you if you decide to choose the house. So Amanda, I appreciate your time today to share all of these. I don’t think it’s a wet blanket. I think it’s a dose of reality that people need because the the sweepstakes companies don’t highlight the realities that that you face.
Mindy: Yeah, and I think it’s more of, you know, um, when you’re watching these sweepstakes, right, on TV or or what not and you’re envisioning the winners, they’re happy family moving in to this forever home. Um but yeah, I mean the reality is, you know, the reason people take the cash prize is because of all these other that they may have to deal with or um, you know, if they really want to maximize the benefit is kind of going through the various routes like what Scott was talking about, turning into rental, right? in both of those scenarios, we’re not moving our families in to live happily ever after these stream homes.
Guest: Yeah, so I think the answer to our question, can the average American live in the HGTV Dream home? I think the answer’s no.
Mindy: All right. Amanda, thank you so much for joining us today to share the realities of what happens when you win a multimillion dollar prize package. We appreciate your time and we’ll talk to you soon.
Guest: Yes, good luck to you both on winning.
Scott: Good luck to you as well. Let us know when you enter.
Mindy: All right, that wraps up this episode of the Bigger Pockets Money podcast. He is Scott Trench and I am Mindy Jensen, wishing you luck in the HGTV sweepstakes.
Scott: If you enjoyed today’s episode, please give us a five star review on Spotify or Apple. and if you’re looking for even more money content, feel free to visit our youtube channel at youtube.com/biggerpocketsmoney.
Mindy: That was awesome. I really learned a lot about the tax implications. I really am going to double down and say the more I think about it, the more I just want the cash. The complications are too much for me, um but I hope that you win and I would love to see all those complicated tax jumpings that you’re doing. If you do win, can you please make a video about it?
Scott: If I win, we’ll make a video about it. That’s for sure. No, I I think but I think, you know, it’s two and a half million, $2.7 million and I think that the advantages of playing the tax game on something that large are big enough. You know, that’s that’s many years of salary um for for for, you know, most of America in tax savings. So I think I would play the game or attempt to the best of my ability if I could figure it out.
Mindy: I think that no matter what you want to do, play the game or take the money and run, as long as you have a plan and stick to it, that’s the best strategy.
Scott: Absolutely. By the way, I I do want to emphasize that for losses on real estate to offset ordinary income, we discussed this at length. Um you need to be a real estate professional or a re real real estate professional status in order to uh to have that work. And many investors do not qualify for that. So that’s something to talk to with your CPA. if you’re considering using depreciation with rental properties to offset a large gain in from other types of income in your portfolio. So that’s it that’s that and and look CPA’S have different stances on that. Some folks are very aggressive and say go for it and some folks don’t on the same situation. So be smart about that one and know that that uh you’re making a decision there and there’s a subjectivity to it to some degree in some cases.
Mindy: Yes, a good rule of thumb is if you have a full-time job that isn’t as a real estate agent, you are probably not going to qualify for the real estate professional status. Of course, every situation is different. If you want to make a case, uh talk to your CPA because they are going to be the ones who are defending your uh your tax return when it gets audited if the auditor doesn’t like what they see. So uh you have to be the one who is comfortable with your returns, but generally, if you have a full-time job, you’re not going to qualify.
Scott: Yeah. And I think Mindy, I would, I would clean the toilets at this Airbnb for 100 hours if I needed to in order to make $250,000, reduce my tax burden by $250,000 on the property in in a year. That’s 100 hours of cleaning toilets, that’s $500 an dollars an hour um per per from cleaning. So I’ll take it.
Mindy: But you know what? I wouldn’t have to because I would just take the money and run.
Scott: Oh, oh, we almost forgot to say what Kalen, our producer said she would do with the property if she won it and hers is the best answer. She would say, I want the cash prize, but HGTV, you got to let me take possession in the property for a single weekend night and throw a massive kegger with a big, with a bunch of bonfires in that backyard, um, before I take that cash prize. And that I think is really the best answer. Um tax advantage, I don’t know, but that’s the best one.
Mindy: Fun for sure.
Scott: All right, now you can get out of here.
Mindy: Bigger Pockets Money was created by Mindy Jensen and Scott Trench, produced by Kalen Bennett, editing by Exodus Media, copywriting by Nate Weintraub. Lastly, a big thank you to the Bigger Pockets team for making this show possible.”}
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