 your piece of the rock on ThinkTech, Hawaii. I'm your host, Abe Lee. I have been licensed as a real estate agent since 1973. I'm the owner of Century 21, our properties, Hawaii, and work with close to 100 wonderful real estate agents in sales. I started Abe Lee seminars in 1980. I have taught over 11,000 students to get their real estate licenses and taught continuing education classes to the licensees to help them to maintain their real estate license every two years. Our show is dedicated to helping buyers and sellers understand the process involved in real estate transactions. Our special guests will talk about legal issues, escrow, title, getting a loan, surveys, home inspections, insurance, contracts, wills and trusts, and much, much more. And today, we have a really great guest who's a CPA, and a realtor, and a surfer, and a motorcycle biker, if you can imagine one person here, and a dog lover to boot. So his name is Mike Bates, a good friend of mine, and a wonderful person. So Mike, thank you so much for being with us today. Happy to be here. Great. So we're going to start off, as we normally do, tell us a little bit about your background, where you're from, and where you grew up, your education, family, et cetera. OK. Well, I was born way back in the last century in Seattle, Washington, lived there briefly. My mom was from Hawaii, and my dad was from California. And they got married and had me there. And I lived about 18 years of my life in the mainland, and then moved to Hawaii on the big island, where my mom is originally from. And from then on, that was about 1980. And I've lived here on various islands, primarily Oahu ever since. So tell us about your background, because your work background is very interesting. OK. I majored in accounting at the University of Hawaii. After you major in accounting, the next step is to pass a CPA exam and then get a job working in a CPA firm to eventually earn your CPA license. And I did that in the early late 70s, early 80s, early 90s. And I eventually got licensed. And working in a CPA firm is that you learn a lot, and you also work a lot. And a lot of people, like myself, when they get the CPA license, they go off into private practice working as a chief financial officer for a company. And I worked for two companies. I worked for a company that owned what used to be the Kaluakoi Resort on Molokai. And then I started off in Honolulu working for that company. And as the Japanese investment bubble popped, I was physically relocated to Molokai for a few years. And that was cool, but it was also pretty rough being away from friends and family for Monday through Friday. And then I came back here and I worked for a trucking company for a few years. And I had my CPA license, or sorry, real estate license from 1994. And around 2000, I just figured I'm going to go into real estate because CPA work is too hard. For the amount of money you make, you really got to work hard. Oh, good. So you got your license before you even activated it, so to speak. Yeah, the Kaluakoi Resort had land to sell. And the owners wanted me to get my real estate license just for general knowledge. I didn't do any sales there. But that was a blessing in disguise because as I eventually got burned out on working for private companies and CPA firms, I was ready to move into selling real estate. OK. So when you got your real estate license, where do you start off? And what has been your progression in your real estate career? I started off not doing very much for quite a while and just primarily friends and family, a couple of transactions a year when I was lucky. And around that time, real estate internet activity was just picking up. And I got the idea to get leads by building a real estate website. And there were just a handful of companies that had good websites at that point in time. So I did that. And it was not very hard at that time because there wasn't a lot of competition. So I had some pretty good years with real estate leads. And I still have a website and still get leads. It's not the same as before, though, because almost every real estate has a website now. But I know you specialize in featuring special neighborhoods at a time, like Palo Lo or Kailua or Kani Ohi. And I know you got a lot of leads because people were interested in those areas. So really, you're one of the pioneers in doing website blogging, so to speak. Yeah, I could say that I didn't invent the ideas. But I've emulated them and copied them. And as you know, there was a time when I had a lot of business in Makaha. I did a lot of. I remember one month I did about eight sales in Makaha. They were small, so I didn't give a chop of them. But it's good to have business and then hopefully pick up some of those when the owners decide to sell, when the buyers become sellers. And so I've gotten a lot of business from people coming back. And Palo Lo, yes, I specialize in Palo Lo. I have a lot of knowledge about Palo Lo because I've lived there for 16 years. Also, I'm getting more and more information about Hawaiian homelands. And those are pretty tough because of finding qualified buyers, not only financially, but on Hawaiian ancestry. And there's just a lot of issues. Dealing with the Department of Hawaiian Homelands is very difficult. So it's challenging to get the job done. And the clients are really appreciative, though. Sure, you're right. Good. So Mike, tell me what's some important things that you do when you work with a client? Because they understand that you're a CPA, so there must be a degree of trust. Because they did a Gallup poll years ago, and CPAs were considered to be one of the most trustworthy professions, along with pharmacists, if you can believe it. But what do you do when you meet with a client? I don't necessarily tell them I'm a CPA right away because some people already have accountants and have been, or they might have the information on their mind already, or they already have an accountant advising them. If they have questions about, for example, the capital gain exclusion, how long you have to live in the house before you can sell it and qualify for the capital gain exclusion, then I'll tell them that. And a lot of times people aren't clear about 1031 exchanges. They think they can sell their residents in 1031 exchange into another residence. And so I'll help them, and then I'll ease into the CPA. And another big thing is HARPDA. Any non-resident, US resident who's not a Hawaii resident is generally, there are exceptions, but they're generally subject to HARPDA. Which blows them away. And I explained that HARPDA is almost always too high. I've never had someone who I worked on their HARPDA refund where they didn't get a refund. They're never under withheld. They're over withheld. The HARPDA rate is 7.25% of the selling price of the home. Yeah, so the federal government with the FERPTA is about 15%. And then there's another 7.25%. So the consumer, I'm not a consumer, but the foreigner gets whacked for a huge amount, and they usually will get a refund unless they bought it really early and they have tremendous appreciation. But if they don't have that, then they'll get refund. Yes, that's right. Yeah, good. So at least you specialize in that area. So Mike, what do you advise your clients as far as record keeping is concerned? Because I know in real estate as anything else with a business that you have to keep good records. What kind of records do you recommend that say, owner occupants keep? And then let's go to owner investors. Okay, owner occupants keep your purchase, or the closing statement from when you purchase a property and keep records of your improvements that you make on the property. And what else? Those are probably the big things that I can think of off the top of my head. For investor, it's different because you're going to have depreciation and you wanna keep accurate records of your depreciation because depreciation on a rental property is 27.5 years. So if you buy a property a day and you sell it 15, 20 years from now, you might not have all those depreciation records and that can be a problem when you come to calculating your gain because the depreciation is a annual deduction from your net income. And as that accumulates, that's called accumulated depreciation. So what you have over, for example, 10 years, if you have $1,000 depreciation a year and then you sell after 10 years and you have $10,000 of accumulated depreciation and that is subtracted from your basis. Your basis is the cost of the home plus improvements and then you subtract depreciation, accumulated depreciation. If you don't have that information that could trigger an audit, if you don't include the accumulated depreciation in your calculations when you sell. So let's get this straight then. I'm an owner-occupant. My cost, let's say I bought it for $200,000. Then I put $50,000 improvements into it. So now we got 250 grand basis then and that's your cost basis, right? Correct. And then if I started for $500,000, then the gain, the tax on the gain is from $350,000 to $500,000. Is that correct? Yeah, so that'd be $150,000. Right, now attention, yeah. So Clinton, when he was president, get this one, not one time, but homeowner's exemption of a gain for single people and for married people and how much is that deduction worth and tax-free money? I credit you for remembering who was the president. That's fine. Yeah, so the capital gain exclusion for single persons is $250,000 and for married is double that, $500,000. The requirement is that out of the past five years you must have lived there at least two years. So you could have lived there the first two years you bought the home and rented it out for three or vice versa or you could have just lived there the whole five years but you have to have had two years of residency. So if you're looking for the $500,000 exclusion, then both persons, husband and wife or whoever the two owners are, have had to live there at least two years. Now there are some exceptions. They're very rare. I can't recall what they were off hand. I think it was like family issues and things like that where people were allowed to get the full capital gain exclusion, but I wouldn't rely on that. So the general rule is two out of the last five years at a minimum of residency. So let's take this house again, $350,000 with 300 basis, $50,000 sale, right? What happens is I sell it for $500,000, so $150,000 is free, tax-free, right? Now, can I do that again and again? You can do that every two years. Wow. After you sell it, you cannot take that exclusion again for two years, but if you're selling the home today and you can't take it for two years, if you buy another home today, then it's gonna take two years of residency anyways before you qualify for the capital gain exclusion. So that means that you can do this every two years and report the gain and Uncle Sam cannot tax you. Yeah, well, it's called an exclusion, yeah. So that portion is excludable from taxable income. So you can do that every two years, every time if you have gains. Right. That's wonderful. That's better than the old tax law. It is. Probably nobody but you and me remembers your own rules. Okay, and if they put any improvements, of course, that's deductible. It's not an expense, but you add it to the basis. Correct. Now, correct me if I'm wrong, but there's two things that you can deduct from your personal residence and understand it was what your interest deduction and your property taxes. Although it's the only two items that we can deduct on an annual basis from our tax returns. For residence, yes. Yeah, that's all that come to my, those are the big ones. Mortgage interest and property taxes. Mortgage insurance also for people who have mortgage insurance. Ah, yeah. So those are deductible on schedule A of your form 1040. Okay, I didn't know that one. Okay, now let's go to investors then. So let's say the investor buys something for say 300,000 again. Now, do you have to then determine as an accountant, as a homeowner, how much is attributable to the building portion and to the land portion and why is that important in the depreciation scheme? Okay, land is not depreciable. So if you're an investor, then you're only gonna depreciate the building portion of the property. And that usually works out well, at least here in Hawaii because if you, if your depreciation causes you to show a net loss, if you have such a large depreciation number that it's a net loss, that doesn't really do you any good. So you're close, you're better off just breaking even or having showing a small profit. And another thing is, if you have that high depreciation, then when you go to sell the property, you're gonna have a lower basis because you depreciate it, your accumulated depreciation is higher. And I've had some people who have been really stung by that that they had their own accountant do it their way. And then they said, I just had this happen this year where they had their own accountant doing a high rate of depreciation. And then their basis was really low when they sold the investment property. So I was calculating their heart to refund and it wasn't that much because, because the basis was getting pretty low comparable, compared to what they paid for it. So let's talk about the depreciation for investors because that's a huge tax deduction. So if I depreciate the building value over so many years, and I think you said 27 and a half years for residential property. That's right. Is that 39 years for non-residential property that you depreciate? You got me. I'd have to look it up there. There is a 39 year depreciation that applies to something, but I haven't done it in so long. So basically rental, residential rental, you're gonna do 27.5 years. So let's say we were 27 and a half years, and we depreciated the full amount out and then I sell it. So there's a gain on the purchase price to the sales price, but there's also a depreciation recapture then for the amount that you depreciated over the years. And a lot of people don't know that, do they? Yeah, they don't. So we'll go on an extreme example. Let's say that you buy a property and you own it for 28 years. So in that, in that case, you've fully depreciated the building though. So the land is not depreciable. That's included in the purchase price and the purchase price includes the land and the building. So the building portion will be fully depreciated. And typically I kind of choose the building value based on property tax records. I look at the ratio of the building to land and sometimes if the land is too low, then I'll just arbitrarily, I'll come up with some formula and say maybe 50, 50 or less because yeah, I don't want to see somebody depreciating too much because what if you have like $5,000 loss every year that doesn't, IRS might look at that and go, why are you renting out a property and showing a loss every year? And then it comes back to buy you because after 28 years that assigned value on your building is going to be zero. So your basis will just be basically the land and perhaps any improvements that you made on the property which add to your increase your adjusted basis. So depreciation records are really important and the client has to tell you what they bought it at and then you got to figure out, okay, at what value, what percent of the purchase is attributable to the building and to the land and then keep an annual record of the depreciation that you've taken, right? That's right. And over, it seems like it's not a big deal but over, if people don't keep their tax returns and other information 10, 15 years from now they might have no idea. So now I've heard some people say, okay, let's go to you talked about the 1030 on exchange as a means of not paying taxes but actually deferring taxes. And that's the difference. It's not tax free, but it's tax deferred. Uncle Sam will get the taxes sometime. That's right. But yeah, so are some people, they depreciated building out completely and it's a really expensive property. Do they do an exchange just to avoid the depreciation recapture? They do, but then as you had mentioned you're deferring it, which means you're postponing that capital gain. So if you're a justice basis on this property is 100,000 and you 1031 exchange it into another property let's say for simplicity, let's say they're equal value then that other property would only be $100,000 basis also. So when you sell it, it's not gonna be a higher amount. It's gonna be the same. Yeah, so you're still gonna be stuck with that low basis. So ultimately, if people have, if people intend to pass property onto their relatives then I would recommend they hang onto them and when they pass away, then they get what they call and what is the name of that? A step up in basis. Yeah, so then they have a step up in basis and on the day that the owner passes away now a person inheriting the property isn't gonna run out to an appraiser on the day that their loved one passes away but they keep track of that date and then they call an appraiser and have the property appraised and that will be their step up basis. And then whenever they sell it and obviously a home bought 30 years ago might have been a $100,000 price tag which and it might be a million dollar now. So if somebody has that step up basis then they can sell the property and have minimal or no capital gains pass. Okay, so let's go to this. This is really important that I think some people don't know. So you bought at $300,000, it goes up to million at the time of death of the parents and then there's an appraisal done called death appraisal. And so it goes up to a hundred grand on value. So the kids the next year sell it for a million. There was a gain from $300,000 to a million but because you get a step up, the IRS says, hey, you sold it for a million, there's no tax. That's right. Is that right? Correct. Oh, wow. So we should tell our clients, go ahead Mike. That's really good. And sometimes you'll see people going, now if they need the money, they need the money the owner of the house, but if they don't sometimes they're thinking, I should sell this before I die which is not a good tax strategy. It's better off to hold on to it, have it in a trust or I guess a very clearly written will. So everybody knows who's gonna get the property. And then they'll get stepped up basis and not have to pay taxes on it. So that's really an important tax angle that you can give clients advice on probably better than a normal Joe Blow real estate. Yes. So I'm a firm believer. I'll tell my agents, my clients talk to a CPA because I know it has to be dangerous, but I'm not a CPA. So you need to talk to a CPA, right? So I try and keep it, I just give them the basics because I don't wanna stick my leg too far into the mud and get tied up on something later, find out that something didn't apply to their particular situation. Sure. So really real estate becomes a very complicated process if you are not careful and you don't keep records, right? Yeah. That's right. Okay, so I have a few more questions, Mike. So we know that there's taxes when you've sell your personal residence, but 250 grand for a single person, half a million for a married couple, there's no tax. But then for the investor, if they sell something and it's appreciated, then if they sell that property, say from the bar for $300,000, so for a million and then they buy something equal or higher in value, then they defer the taxes. Is that correct? If they do a 1031 exchange, yes. Yeah, okay. Another interesting thing that I'd like to add is that if let's say if they, their property is, they sell for a million, but they don't wanna buy something more expensive than they can still do the 1031 exchange, but on the difference, they will pay the tax. So for example, they sell a million dollar property and they roll it into a $900,000 property. It still qualifies for the exchange, but part of that sales proceeds will be subject to capital gains tax. Which will be a little bit of best of both worlds because you got 900 grand that went into tax deferred or tax delayed and you pay tax on 100 grand, but hey, you got some cash. Right, and you can get the property you want and you're not just looking for something that costs more. Right. And I think you made a good point is that some people think that they can trade their exchange, their personal residence into an exchange and you cannot. Is that right? Right. Yeah, cause people think, oh yeah, I'm gonna mirror exchange, I'm gonna move into that house. I tell them, excuse me, you need to talk to an accountant cause I don't think you can do that. And there's special rules about converting an investment property and exchanging it and then moving in and become your personal residence. Yeah, as far as I know, there is no exact rule, but the rule of thumb is that if you do a 1031 exchange, so your investment property into another investment property, use the new one, you should continue using it as an investment property for at least a year before you decide to move in and change it over to being a personal residence. Now I've been told that we only have a few more minutes, but I wanna talk about your love and your passion for dogs. Cause you donate a lot of money out of your commissions to a nonprofit called Hope for Dogs Rescue. Is that right? Yes. Tell me how that works. Okay, so Hope for Dogs Rescue is a nonprofit that they, you can guess where a lot of the dogs come from, they come from the Y-nice side cause they'll take dogs from anywhere. And even sometimes when people have to surrender them for various reasons. And yeah, they have a lot of people who really care about dogs and they'll volunteer to take care of them and take them to the vet and get them healed up. And then they look for suitable new families and they interview the folks and they make sure that it's gonna be a good fit. And they have a lot of expenses because sometimes the dogs need medical care and they don't put any dogs down. They'll try and keep every dog alive unless it's just beyond their time but they won't put the dog to sleep though. And you donate part of your commission to Hope for Dogs Rescue? Yeah. Yeah. And I've taken a lot of pictures, well Mike sent pictures to me and I posted on Facebook say thank you Mike for making another donation. And by the way, you have how many dogs? My own dogs, we have three. My big one is a great Dana. He gets all the attention and probably about two thirds of the people in Fallola Valley, they might not know me but they know my dog. Yeah. Okay. And besides that, I wish we had more time but Mike's an avid surfer and he also has, he's an avid motorcyclist and I've seen posts on Facebook about him riding around with a bunch of guys on a motorcycle. So Mike, thank you so much for being with us today. It's been a pleasure and very informational. And I gotta tell you, Mike is one of these that are really unassuming, really quiet, but very effective. And I really appreciate working with Mike. If you want more information about Ably seminars and wanna know more about the school, please go to ablyseminars.com and of course, share this video with your friends and let them know that there's a really good video on real estate and taxes. And Mike Bates is our special guest. Mike, thank you so much. I really appreciate it. My pleasure. Thank you. Okay. Take care.