David Erard is a partner at Armanino, a top 25 independent accounting and business consulting firms in the US. David has more than 20 years of experience in the accounting industry, including seven years at a Big Four firm (two years of which were spent at their national tax office in Washington, D.C.). He provides consultation on business matters and related tax provisions of partnership/LLC operating agreements, distressed debt matters, Real Estate Investment Trust (REIT) tax consulting and compliance matters, net investment income tax considerations, and assists in structuring and implementing transactions executed by private equity firms and other real estate investors. David holds an M.S. in accounting with an emphasis in tax from Brigham Young University and has lectured on several occasions at the USC Gould School of Law Tax Institute.
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00:00 The Data Driven Real Estate Podcast Welcomes David Erard, CPA, Armanino
01:34 How distressed debt has changed since 2009
10:57 What are the common concerns real estate investors have in 2021?
15:09 Suggestions for investors facing hardships and nonpaying tenants
17:35 Tax provisions to watch at the federal and state levels
19:38 Big year for foreclosures?
25:16 Are some asset classes facing more distress?
27:30 Will 1031 Exchanges be eliminated
37:53 Are opportunity zones still beneficial?
39:30 Differences between a 1031 exchange and Opportunity zones
46:41 What opportunities should real estate investors focus on in 2021?
Aaron Norris 0:06
Welcome back to the Data Driven Real Estate Podcast, the podcast for real estate professionals dedicated to driving business using data. I'm Aaron Norris, along with Sean O'Toole with PropertyRadar, and this is episode 36. On the show this week, we have David Erard of Armanino. Armanino is one of the top 25 CPA in business consulting firms in the United States. And David comes with over 20 years in the CPA practice with some very unique specialties and things like distressed debt and working with REITs. This week, we talked about a lot of changes happening in 2021, under a new administration, taxes at both the national and the state level, things that small businesses and real estate investors are worried about, and even down to ten, 1031 exchanges and opportunity zones, you will not want to miss this week. We are very excited today to have David Erard with Armanino. Welcome to the show.
David Erard 0:53
Thank you. Nice to be here.
Aaron Norris 0:55
David, you have a very interesting specialty we'll, which we'll get to in a second. But if people aren't familiar with Armanino, can you tell us a little bit?
David Erard 1:02
Yeah, Armanino is a full service accounting firm, we're probably more mostly well known up in Northern California where the firm started and where headquartered. But in the last couple of years, in particular, we started moving into different markets. So, big presence in Southern California now as well, started to move in to Denver, Texas, Idaho, a few other just opportunities that we really liked to get, get involved in some other cool spots throughout the country.
Aaron Norris 1:34
Okay. And you have worked and spent plenty of time with the Big Four accounting firms, as they say, and I read your list of specialties. And it's it's pretty unique. I don't think I've ever seen this specialty attached to a CPA, distressed debt matters, real estate investment trusts, trust tax consulting, How on earth did you fall into these specialties?
David Erard 1:54
Well, it worked. So, I started with one of the Big Four and worked there for several years. And when I moved to a different firm before Armanino, continued working with a lot of the same clients. And as those clients started to evolve their, the way I think about it in say 2006, 2007, 2008, a lot of the big players because of the distress started having difficulty raising new funds in kind of the areas that they had been focused on in the past. And so, we started to see with the least for the couple of our clients a big shift toward distressed debt and toward REITs. And so, we went from really not working on any REITs, say, in maybe 2007-ish, to having like our main client base being REITs and REITs focused and distressed debt focused funds. So, it was a function of what, you know, as the clients evolved and, you know, reacted to the last downturn, we had to evolve with them and learn about REITs and distressed debt and just kind of learn a whole bunch of nuanced things. You know, distressed debt by itself is fairly nuanced. When you marry a distressed debt with a REITs or a Real Estate Investment Trust, there's a whole lot of other issues that come along with that. So, it was really call it a little bit of a baptism by fire back when we just had to, to keep up with our clients or keep, hopefully keep in front of them to some degree. And we have to, had, had to go, had to really dive in and learn those things. And it was time, it was quite a challenge. But I've got to say it's been, It was really an invaluable learning experience and has really served me and you know, the team of people I work with very well.
Sean O'Toole 3:46
Most of your clients on that front are still going to be larger, you're not doing, helping the mom and pop investor for the most part. So, you're working still with more institutional size clients?
David Erard 4:00
Let's say as a general proposition, yes, the clients tend to be larger but as a, with Armanino, we don't really say have a specific client size we target and I've worked with kind of firms that are just starting and doing their first deals, also worked with like individual investors who might like a piece of property that's subject to a troubled debt. And so, I've worked through a few transactions where that's, that's one means of getting to the asset that people want. So yeah, by in and large, I would say that space tends to be occupied a lot more by bigger players than smaller, but I've certainly seen the smaller players go in and we've helped them navigate a few of the little nuances. You got to deal with.
Aaron Norris 4:45
California is like New York when it comes to distressed debt, if you can do it in California, you can do it anywhere, right?
David Erard 4:52
Somewhat regulated. Yeah.
Sean O'Toole 4:54
You know, so Armanino has, you know, like Accounting, Tax, Audit, etc. Where do you fall within that kind of, you know, purview?
David Erard 5:06
I'm a, I'm a partner in our tax practice. My specialty is Income Tax, State Taxes, Federal Taxes, REITs, Private Equity, those types of things. And I tend to partner with other partners within the firm who have the same industry specialty as I do, we've got a really, our audit practice, especially we do a lot of work with this with lending funds. Our consulting groups on the technology side does a lot of work with private equity starting to get a lot more traction with real estate. So, it's really just within the firm, I'm a Tax partner, but we try to attack things can have on an industry basis, instead of as, I'm going to go in and try to be a tax guy and only help a client on a tax thing, rather be a little bit more holistic. So, hopefully, I can speak well enough about some of the other issues that clients will deal with and know when I've got to bring somebody in. But we've we've tried to, intentionally me, Armanino thinks the same way, as a firm, we're really not trying to come in and say be just a really good tax person, or a really good audit person or a really good consultant, we're trying to come in and be a really good partner to our clients with, with whatever help they may need with their businesses. And, you know, some, some, you know, some firms are really big and sophisticated and have a lot of infrastructure behind them. They have people that deal with things, others don't. And so, we're trying to figure out, we, you know, sometimes our role is to coordinate with a very sophisticated CFO, who's really well versed in all of the tax and audit issues. Other times it's coming in with a firm that's just getting into a space and a lot of how do I do this type of questions.
Sean O'Toole 6:46
It's great. Aaron didn't know this when he booked you, but we I've actually been an Armanino tax client for many years, so.
David Erard 6:55
Glad to hear that.
Aaron Norris 6:59
So, no 'gotcha' questions, no.
Sean O'Toole 7:02
No, no, that means I can.
David Erard 7:04
I think, I think it's the opposite. Aaron, I think it's fair game for anything.
Aaron Norris 7:09
Okay, great. How does it feel to be a CPA headed into 2021?
David Erard 7:14
Oh, probably the same way, it feels to be a lot of things heading into 2021. I think we're, we're all having to adapt to things that you know, are unique in my lifetime, certainly, you know, with starting from, you know, with Armanino, we're really fortunate to have a really good technology platform to work from, you know, so we've had some adaptation to people being outside the office and having to work remotely. And we've been forced into that. Some of our clients, so it seems a lot more of the adapting has just been with clients who have tended not to have the best infrastructure, and they really like paper-based systems. And, you know, how do we get information when you're just talking to somebody who might go into the office one or two days a week for a limited window to sign checks, and if they have time to get us the information, we need to do the tax and audit work. So, it's a, the adaptation has been a lot of different things. And we'll probably delve into some of those as we talk through different items on the cast here. But there's just been, it's a, figuring out that the probably the biggest challenge, quite honestly, is figuring out, you know, we were able to get our jobs done day to day. So, that hasn't really been the challenge. More just, you know, how do we maintain our culture without people being together? How do we, you know, how do we go out and meet people in the market when you're not out, able to meet people in the market. So, you're just kind of adapting some things to make up for the lack of in-person contact. And you know, quite honestly, the in-person contact is really one of the more fun parts of any job. I think that's what makes any job worth doing. It's the clients you work with the people you work with the culture of the office, those watercooler discussions, so, it's figuring, a lot of the adapting is just trying to figure out how to maintain some, you know, make sure people know that we care, making sure that you know, everybody's got different challenges because of the way we're having to do things in schools being closed to just a lot of it's a we've tried to be as flexible as we can be and still meeting the needs of clients and without, without overwhelming people.
Aaron Norris 9:33
Real estate is a very paper-heavy industry. So, that's a challenge if you're working with clients that aren't paperless.
David Erard 9:43
That is true. It's, it's a little bit the opposite end. Sometimes, it's Silicon Valley, which has a lot of really new, a lot of slick stuff that they're really comfortable with and it's safe for real estate. It tends to be maybe a little slower to adapt and take on new things. and new ways that we are seeing. But one thing I'm really pleased with is both on the client-side and internally, I really am proud of the way everybody has been able to adapt in the way that we have been able to get through 2020. So, going into 2021, I feel like we're still holding on a little bit and trying to get through the nuance of not doing things the way that we would like to and being in person. We've got a year under our belt of working this way. And it's, it's at this point, it feels like we're closing in on the end of a marathon, we hope things get back to being the way they were or you know, whatever new normal turns out to be of hope we get there sooner than later. And, you know, I'm optimistic about what I see with our people and our clients. But I'm also realistic about theirs, you know, it's been a hard year. And we were just kind of still feel everybody's got a little bit of fatigue, both on the client side, and then our team site.
Sean O'Toole 10:57
What are the, what are the big, you know, what are the most kind of common, especially among your real estate customers, what are the kind of the common questions and concerns you're seeing now, that are kind of unique to this environment? You know, I'm sure PPP and how that works for especially in the landlords and some of these other folks and, you know, tax credits around or, you know, forgiving rent. And, you know, I don't know, there are other things along those lines.
David Erard 11:26
Yeah, I would say it really depends on the type of real estate and maybe the market that the clients are in, you know, hospitality has a much different set of issues than multifamily. And the PPP programs and the relief packages, if you follow what those have been geared around is keeping people employed. And so, from, if you're just say, a lessor of, you know, residential or commercial property, you're not it's not an employee heavy type business. And it's a, it's a lot of the PPP incentives really haven't been call it overly available to real estate. And the ones, you know, the industries that are getting hammered, really are getting hammered, you know, the hospitality. You know, it's, it's very hard to, you know, I think there's some, hopefully, some sunlight ahead for that industry. But you know, for them, it's been one set of issues. And then for the multifamily, it's been a different set of issues, you know, with multifamily, there's, there's kind of a few things that are affecting them. One would be because of the way people are working remotely now. The market, a market or a location that would have been really attractive two years ago might not be, just for example, if you had an apartment building near a convenient metro stop somewhere near a major city would have been a trophy asset, right, something that you knew to high demand for it. With the change in demand for public transit and people working more remotely, you might see a different set of things that people are really looking for. So, instead of like convenience, and access, you might be looking for a living space that also has a very convenient workspace, you might be instead of somewhere with a really nice gym, and really shared common features, you might be looking for something people may not be as interested in having to share space. And so you know..
Sean O'Toole 13:23
Yeah... open space.
David Erard 13:25
Yeah. So, adapting to kind of changes in demand because this is like this type of demand change is something I've never seen yet. There's going to just be some definite shifts in what kind of real estate people are interested in using, you know, from a, from an operating perspective, a lot of businesses have had people working remotely now for a year probably questioning what, what their real estate needs are going to be in the future. So, it really depends on what type of real estate you have, which market you're in what made the asset attractive before and what might make it attractive now. And so just kind of adapting that way is what I see. Again, with, with my client base, I really haven't seen, I've seen a few cases where they've been really keen on the PPP programs and there's a few clients that have really benefited from those. The other, you know, there's been a lot of clients who haven't. And there's a lot of challenges right now with, you know, stays on foreclosures or evictions and things like that. So, you know, people if I'm handicapping at high level, you know, depending on, it really depends on your facts and circumstances as to how much of an impact this had on you. If you had, as an example, you know, a low income area and you had tenants that may not be as concerned about credit scores and things like that, you're probably going to feel a bigger impact than somebody that has, you know, a really nice building with really nice units that have good working spaces, because it's just going to be a little bit of a change in demand. And there's also going to be a little bit of a change in tenant behavior.
Sean O'Toole 15:09
Right, right. What strategies are you seeing or suggesting, you know, for those folks that are having, you know, hit and or, you know, have that loss of income now, maybe you're at a point where they're struggling to make their underlying debt payments, is there any strategies there that's helping these folks in hospitality and the hard hit multifamily?
David Erard 15:33
I think the one strategy I would always advocate is just be be open and communicative with, with lenders and other parties, if you have obligations that you're not able to meet. I don't think it's going to come as a mystery to anybody that like, for example, if you're a movie theater, yeah, I don't think your landlord would be surprised if you were to start talking to them pretty regularly about what, what can we do here. But right, so, and by the same token, I think landlords have been a little bit concerned about being approached by people that didn't need help under the notes. So, landlords are really trying to figure out who it is that needs help, or who's just trying to get themselves, you know, a little bit of a spiff. So, what one, back to the original point, I think one thing would be just be, be open and be in communication with the people that you have obligations to. So, that'll give you the best chance of succeeding and getting them to cooperate with you. I certainly wouldn't ignore notices as painful as I'm sure they are to deal with and assure, you know, it stinks to not be able to meet your obligations. But I think being open and realistic about what you can do, and you're pulling whatever levers you can pull if you're, when you're really in trouble.
Sean O'Toole 16:56
Yeah, I think that's great. Great advice. And it's interesting there, how you said how some are just using it as an excuse to get better deals, I know, I have a bit of commercial. And, you know, the only real tenant that gave me problem. So, this was my national, you know, credit quality, like the one that the banks want to see when they go to loan you money. That was the one that gave me trouble, all the local ones that the banks don't want to see, they were all great, worked really hard, worked well with me. And all the rest. And of course, the national credit quality tenant was the one that was a pain.
David Erard 17:35
Yeah, it's interesting. And it's because of that dynamic, I think, you know, there's gonna be a lot of landlords that are going to be skeptical, as you know, the first time they're approached. So, I think if you keep, if you have a consistent message, and you stay to that message, and you're doing everything you can, and you're being transparent, that's probably the, the best path, you look for opportunities to get relief. I mean, there were some good tax provisions to be able to monetize losses that got put into some of the relief bills. So, to kind of monitor what, what options you have.
Sean O'Toole 18:09
Can you walk us through those real quick?
David Erard 18:12
Sean O'Toole 18:13
At a high level, not in super detail. But yeah.
David Erard 18:16
Yeah, at a high level, very high level, one of the flavor of some of the relief bills on the tax side, was to give the ability to get, to monetize operating losses in a way that you hadn't been able to because of some law changes in 2017. So, you were able to carry losses back that you wouldn't have been able to carry back under the existing rules. They, they took away some limitations on your ability to use business losses, to offset other types of income and pay less tax. So, just those types of things. And again, I don't want to go too deep into the weeds on it, but just they the flavor was they tried to give a way for people to more easily monetize losses.
Sean O'Toole 19:03
Specifically there, right. So, if you had, you know, losses in 2020, where you were actually negative, you could go back and apply those to prior years, and then actually get cash back that you'd previously paid in taxes.
David Erard 19:15
Sean O'Toole 19:16
A good way to sum that up.
David Erard 19:18
Yeah, you're the perfect scenario would have been, that you had a lot of income coming in to, say 2020 from the prior year or two. And then in 2020, you were able to, you had a loss that you're then able to carry back and reclaim some of the tax that you had paid.
Sean O'Toole 19:36
Yeah. Okay, good.
Aaron Norris 19:38
I know Sean gets asked this question almost every day, you know, when are the foreclosures coming? You have a different perspective from the distressed debt side. What are you seeing?
David Erard 19:47
Well, it's, so, surprisingly, it's not gonna surprise me that we see more of it. I think it'll trend that direction. I am actually a little bit surprised that we haven't seen more yet. And some of it has to do with stays, like I mentioned before, there's it's, I think it's a good thing. But there, it's, it's hard to evict people and it's hard to foreclose on property with the, with some of the relief things that local governments are doing. So, I think that's, we may, once those stays are lifted, and once things, you know, part of it too is the courts, it's hard to get on docket right now. And it's hard to get things through a system that isn't working at full speed. So, you know, you may see more of that, and you may see more, you know, as a lender, you might see more of your, you know, your borrowers getting into distress and looking for ways to exit. And so, with, with distressed debt, you could look at it either as kind of on a single loan basis, how do I deal with a borrower who's in distress, or more, what I see more institutional players doing is might be looking at a portfolio of debt that, uh, you know, an institution wants to offload, figuring out how to price that, buying it and then working it as best you can. And so the, the opportunities I think, are going to be for the, for the folks who are smart enough to price it right and find a good, you know, opportunity. There's, there's, there could be all kinds of opportunity with distressed debt for, you know, attractive purchases. And again, if you talk to most private equity type firms, they would tell you that a lot of their gains are on the buy side more than the sell side, you got to buy things at the right price. So, if you've got a good system and a good way of valuing debt, and really being able to look at collateral and being able to, the deeper you can dive into the data and the more you're able to analyze it effectively, you know, the better you can calibrate your purchase price, say one difference, I'm seeing, at least within my own clients now, say between now and the last downturn, the last downturn, there were just a lot of heavy distress with a lot of institutions really offloading things that are very, you know, attractive price from a buyer standpoint. I haven't really seen that as much yet. Maybe it'll get there. I mean, from, from a more global perspective, I hope it doesn't get there, but you know, just looking. So, understanding how to price it. And then also understanding the nuances, at least from the tax side, the accounting side, distressed debt has a whole host of issues that we think a lot about, and your clients I think are, there's a little bit of a training or education on the types of issues that come along with that, because you need to understand, like how these things affect you as the buyer, if you're going to be effective at working the best deal. Yeah, there's, there's times when you're also going to need to understand really how these same issues affect your borrowers or your tenants. So, that you know, what, what would the effect to them and you know, what the important things are going to be for them to negotiate.
Sean O'Toole 22:55
Are you seeing transactions at all yet this round?
David Erard 23:01
In distressed or just generally?
Sean O'Toole 23:03
David Erard 23:04
Starting to see if I've got a few clients that are launching distressed funds? So, I am seeing some movement that way, I've got some clients that never stops doing distressed funds. So, they're gonna keep doing it. But I would say I haven't been seeing quite as much of a lurch in the direction of distressed as I did last time around, but it might be a little too early in the cycle still, and we may get there.
Sean O'Toole 23:27
I got a lot of calls last March of like, 'Hey, Sean, we used you last time, and I'm starting $100 million fund or a $500 million dollar fund, and we're gonna go out and buy', I'm like, maybe a little early. And that was a year ago. So, it's still still doesn't feel like it's really coalesced yet. I'm not 100% sure. It's not as clear to me that it will, but we'll it'll be interesting to see. I mean, you know, you think you would have seen some like an hospitality or something by now, but it seems like, you know, banks and everybody's been pretty patient so far.
David Erard 24:06
Yeah, surprisingly patient to be honest. There hasn't been in the last time in 2006, '07, '08,'09. Whichever year you look at. I think there was a little bit of an overreaction and a knee-jerk. And you know, that, that created its own set of issues, and actually impressed in a good way. I really haven't seen that much this time around. And maybe, maybe we learned something a decade ago or maybe, maybe there's other reasons for it. But we're not at a point yet where I see like distress that being you know, everybody's doing it type of thing.
Sean O'Toole 24:46
David Erard 24:47
It's more it's been more targeted by clients who have had experience with it.
Sean O'Toole 24:51
Well, certainly the regulatory framework changed last time around from forcing lenders to get bad assets off their book as quickly as possible. To forcing them to make every accommodation possible to a borrower, so, that just that alone tells me it's going to take on the residential side quite a bit longer. Of course, the rules didn't change nearly as much on the commercial side.
David Erard 25:15
Aaron Norris 25:16
Do you see any specific asset classes that people are raising money to really go after? That they're excited about?
David Erard 25:24
Yeah, there's some, like I mentioned, some starting to look to launch distressed funds. I think others are really looking at that, there's all kinds of funds that are being launched. And so, I think it depends on what the expertise is of a given client, I can't say I've seen one, you know, I can't see I've seen all of my clients migrating in the same direction or looking at the same asset class. Now, multifamily has been really strong for the last decade, and I see it still being strong, it's very desirable asset class that I see a lot of, say, but for 2020, it was a pretty quiet year until we got close to the end, and then started seeing, you know, a lot of deals closing close to the end of the year. I think that trend will continue. I think, you know, now that people maybe have our legs under us, and probably in a position to make some decisions, I think you'll start seeing more activity. And I don't, you know, guess what, maybe one reason I'm on this side of the desk and clients are on the other side is maybe I'm not quite seeing what they're seeing as far as where the real opportunities are yet. But I would expect that there's going to be, you know, in the industries that have been the hardest hit hospitality, like we talked about, maybe some of the commercial buildings, particularly, not so much industrial, but you know, office, I think you'll, you'll see some serious, some real tweaks there to what people like, how the office spaces are configured, what is a desire, a good target asset, you might see different plans, have talked to some architects and engineers about, you know, the types of conversations they're having. They've been through a year where a lot of it was repurposing space to put people farther apart, have less people in the office at the same time, more sanitation, tape stations. And so, having, I think, you know, the open plans where you have 100 people in a room in a war room, that doesn't, that may be going the way of the Dodo, but you know, who...
Sean O'Toole 27:28
It already was to some degree, I mean, there's plenty of studies saying, it's not a great way to work and concentrate, it takes us something like 15 minutes after an interruption to get back into the zone. But, so, yeah, very interesting. Um, let me shift gears just a little bit and talk about, you know, some of the changes we might see coming. I think, you know, one that gets talked about a lot is elimination of the 1031, which is part of Biden's you know, proposed tax changes. Did you see a lot of movement last year of people saying, Well, I don't think that's going to happen, but it might. So, I'm going to move some stuff around or people kind of not too, haven't been too worried about what have you seen any, any action by clients around that?
David Erard 28:24
I've had a number of clients that did 1031 exchanges, but it said, I thought it was more in the normal course than it was specifically because they were concerned about losing the opportunity. I think it's certainly something for people to keep an eye on. We, I haven't really seen anything formal on that yet other than proposals. If it starts to get real traction, then certainly be aware that may accelerate some 1031. So, that may prevent some 1031s from happening. But I'd say at least from what I've seen so far, the, the notion that it may go away hasn't really changed behavior, but it may be that is, in part because we've heard it's been several years now that I've continued to hear that that's something they're looking at taking away. And there might be a little bit of, you know, boy who cried wolf type of feeling where it's been, yeah, you've told me I'm going to lose it at some point. If I lose it, I lose it, but we're aware of that site. So, I'm not really seeing a huge reaction to it. But once pencil meets paper and or I guess the computer version of that bills are written, we may see some change in behavior and people wanting to accelerate those but to date, I have not seen the potential loss of 1031s driving a lot of people to do them.
Sean O'Toole 29:49
And what's, what are the chances? I mean, I was shocked. I was actually benefited from one of these but shocked that sometimes when these you know, tax law changes go into, you know, effect, they can be retroactive, you know, so you're doing a 1031 exchange right now, let's say this gets a bunch of steam on it by the end of the year, what are the chances that it's retroactive for you know, 2021 is that something you see happen a lot, very often, very rarely?
David Erard 30:23
Very rarely on the federal side to have a scene things take retroactive effect. Usually, there would certainly expect some notice of that if that was the intention. But some states like California have been a little bit more, or let's say maybe a little bit less considerate about making things retroactive. But on the federal side, I would expect if I'm handicapping it, and this is not insider baseball, because I don't know. But if I'm handicapping it, I would, I would expect any change like that to be effective on the date of enactment or maybe they'll give a small window and they'll say, maybe starting in 2022, that, that, that's no longer going to be part of the code. That's what I would expect.
Sean O'Toole 31:09
That happens, there's a gold rush, I mean, there'll be a big rush to move stuff around, it'd be really interesting. So, it's something for our investor customers just to keep an eye on both for their own interests. And for all the activity that might happen if it does leave a window.
David Erard 31:25
Yeah, and I think another thing for investors to keep their mind on, which is eyes on which is in the same kind of vein, you know, I'll try not to be political here. But I would say it's not hard to overlook the fact that the former president was a real estate guy, and that there's a lot of people that don't have the most favorable, favorable opinion about the former president. And so, I think there's not, there's gonna be maybe some political wind to do things that would be detrimental to real estate. Be in reaction to that. And it is from an out I'm not certainly a political analyst or anything, but I think with the prior administration made a point of kind of undoing and poking the eye of the administration before them and a few things that they changed. So, if, if you're, if you believe, like I do, that there's a lot of childish, like motivation into politics that we see. It's not hard to imagine that there's going to be a few changes coming down, down the road that are not going to be favorable for real estate.
Sean O'Toole 32:33
Yeah, I worry about that a little bit. My only, like consolation, or, you know, that I take there is that, there's an awful lot of powerful democrats that are, you know, heavily invested in really, you know, Pelosi's he's husband, plenty of others that are, that are very real estate heavy, too. So, fingers crossed, we're, we're safe. But yeah, you never know.
David Erard 32:58
It's just, it's kind of just a question of whether I know it hurts me, but it hurts you more. So, I like it, is, that could be the flavor.
Sean O'Toole 33:07
Aaron Norris 33:08
We're trying to follow all the changes. So, the CFPB is reviewing qualified mortgage rules. I'm interested to hear if a state taxes changes at all. And here at the State of California, and they're a reporter got back to me today about AB-1199. And excise tax on property owners in California who own more than 10 properties. So, real estate...
Sean O'Toole 33:30
Aaron Norris 33:30
Yeah, rental income. So, they're definitely, real estate is seen as that bucket of some money that they can go after, you know, with rent control things in place, it's, it could definitely put the squeeze on some investors, you have, do you take a lot of questions from real estate investors that are nervous about not just national, but state tax regulation?
David Erard 33:50
Oh, for sure. And I don't think that's limited to real estate. I think there's one of the reasons I think, you know, California or New York, some of the states that do impose a lot of income taxes and other taxes. I think there's gonna be a lot of questions about whether people want to stay there and whether businesses want to stay there. So not so much specific to real estate, but just as a, you know, from the regulatory environment, to the tax environment to the desirability and affordability. There's just a lot of reasons why people are maybe looking at different markets as being attractive. I mean, I feel Idaho, Utah, Texas, Florida, you know, don't mean to limit it to just those states for any of your listeners who live elsewhere. But there's a lot of states that I think are seeing a lot of new residents because of the you know, they offer with those the people moving out of these these certain states, he has a better opportunity and a better environment to live and run a business.
Aaron Norris 34:53
But then there, they move there and find out they're in the same financial situation. So, maybe you should expect some things happening there as well. I don't know. Like Las Vegas, right?
Sean O'Toole 35:02
A lot of the states are in not in great shape, either, right? I always love how California gets called a welfare state, but it's one of the few states that contributes more to the federal government than it takes. So, most of the company, states calling California a welfare state are actually welfare states.
Aaron Norris 35:22
I, is Las Vegas still considering an income tax? I forgot to look at that before the show.
Sean O'Toole 35:27
Aaron Norris 35:27
Sean O'Toole 35:30
It takes a constitutional amendment anyways.
Aaron Norris 35:32
Okay. Yeah. Doesn't mean that's not gonna happen in another state, we're all sort of facing these holes in budgets, as I guess the point, so.
David Erard 35:40
Yeah, I agree with you. And I think the thing that people, that you people might want to keep an eye on is just there are, there's a lot of trends that are emerging from, you know, in reaction to the last year, year and a half. Yeah, some of it, I think was under way a little bit where people are looking for ways to escape high tax high regulation, that trend is going to continue. And other part of it is and maybe adds on to it, and snowballs that a little bit is with people, companies now discovering that they can do this with the remote workforce, you think there's going to be less importance on maybe where the workforce is located. And there's just a little bit of a different business dynamic as well, as you know, some other things that I think will contribute to growth and some of these other states.
Aaron Norris 36:27
Do we think being able to write off state taxes will come back?
David Erard 36:34
Yeah. Honestly, if I were trying to add, advise the Democrats, I would certainly say that, that's something that would be viewed favorably by most of their constituents. You know, the flip side, I suppose is, if you're advocating the other direction, you'd say, you know, the rest of the country maybe shouldn't be subsidizing higher tax states for charging higher taxes and reducing the federal taxes of their residents that way. But, yeah, honestly, if I were advising the, the democrats on this one, I would say, you know, that's something you should really look hard at, because it would be viewed very favorably by a lot of people that support you.
Aaron Norris 37:21
Sean O'Toole 37:22
Yeah, I think we'll see that one comeback. And the argument, you know, that is on the other side is a little bit of a red herring, because most of the states that benefit from SALT are actually the ones that contribute more to the federal government than they get in return. So, despite the feeling that it's, it contributes less, and I don't know how true that actually is.
David Erard 37:45
Yeah, I think most political arguments are red herrings. I agree with you.
Aaron Norris 37:53
What's, uh, I'm just curious, opportunity zones. Do you have a lot of clients that took them very seriously? I think a lot of California investors I know, got excited, they read it. And they're like, oh, California doesn't apply. I have to pay taxes, now. Did you have a lot of people dig into that or shine it on?
David Erard 38:11
No, I think it was a very popular thing, actually. And it was, it's one of the few things I can remember in the last decade that's gotten a lot of bite, by, bipartisan support for it. And it even if you don't have say, a state benefit, the Federal benefit might be compelling enough for people to do it anyway. Because that, the way that program works is you, you end up deferring the tax on the gain from say, the first sale that gives rise to the gain that you reinvest. The real benefit of the program is that when you have the second sale, after you've been in for 10 years, you don't pay federal tax on that gain, as long as you've met all the requirements. And that's a, it's a really, I thought it was a really clever, really intriguing program. And I have seen quite a bit of interest both from clients who want to invest as well as from clients who want to set up the funds and bring investors in.
Sean O'Toole 39:08
Aaron's also done a good job of pointing out that it doesn't have to be like-kind. And so you have this ability to transfer, you know, asset classes and move and that also I think, is an underappreciated piece of that.
Aaron Norris 39:24
I've had quite a few conversations with Crypto and Tesla stock owners for some reason, I don't know why.
David Erard 39:30
Yeah, and if you, one other nuance, if you compare it to a 1031, is with the 1031 you have to reinvest everything. And the first dollar that you don't reinvest is taxable kind of on down. So, 1031 you really have to reinvest everything where with the opportunity zone program, you only had to reinvest the gain portion. So, the big, you know, that was a really big attractive thing because it required a lower investment and I just thought it was, again, I thought it was a very clever program.
Sean O'Toole 40:02
You transfer your gain out, and then, but you can put the basis back in your pocket. Interesting. I didn't even know that one. So, that's great.
Aaron Norris 40:11
Early on, I was doing some research on it. And I interviewed some people in downtown Riverside, where I live, is an opportunity zone. And it happens to be our Mayor's innovation district. So, a lot of attention, I met with economic development people, and I happen to know a lady in town that was buying a lot of real estate. I asked her like, do you know about this? And she's like, I have no idea what you're talking about. And then I talked to a few businesses, I knew where moving into her building, I'm like, if you're raising money, do you realize that you could be raising money for your small business, you don't have to own the real estate, you could be doing this? They're like, no idea what you're talking about. I just don't think the word ever got out. So, you could have two businesses being taking advantage of opportunity zones, and nobody was paying attention. It's sad.
David Erard 40:50
Yeah, and it's, it's tough because it was, as with any program, and I'd say the same thing of the PPP and some other things, you know, they're they get so difficult to administer. And there's so many like, foot faults and steps that you have to manage. So, I think part of it, maybe people weren't familiar with it, the other part of it might be people hear about it and start to look into it and realize, wow, this is really going to be complicated. And so, there's there's probably some a lot of people that get driven away from programs that could benefit from simply because they, they are necessarily so complicated.
Aaron Norris 41:26
Some some things I would definitely like to bring up to ask you because I need a reminder. I've had some people in 1031 exchanges think that I didn't identify them 45 days, you know what, I'm just going to do an Opportunity Zone. From what I understand that is not the case, you can't switch from a failed 45-day of 1031 exchange and flip it to an Opportunity Zone, you'd have to do that before the 45-days identification period.
David Erard 41:54
I'm actually not sure on that one. Because they think with the opportunity zone program, you actually have, you know, a window of time after the gain is originally recognized to reinvest. I'm not sure if you have a I'll call it a busted 1031, where you go into something intending to do it. And then for whatever reason, you can't, you know, there, you'd normally have just, it's just a taxable transaction instead of a 1031. Exchange. I'm not aware of a restriction on being able to then turn around and take that gain and put it into an Opportunity Zone. It's possible that, that there is a limitation I'm not thinking about, but I'm not aware of one.
Aaron Norris 42:32
Because of the hot market, I only want to bring it up because the Opportunity Zone you actually have more time to, to identify and then also to do you have to do a fair amount of improvements. Can you mention that? What is it, you have to improve it by 50%?
David Erard 42:46
Yeah, I think you have to put in 50, or 50, or 100. And I'm sorry, I don't remember, but you have to spend a lot to renovate, or you have to put a lot of money into the asset. So, it isn't like you can just go buy a rental building and start renting it. So, you actually would you have to go in and make some substantial improvements to the building part of the property, you have to put money into the business. So, it isn't just, it isn't just that you buy something and you're good, you actually have to there are some things, there are some steps you have to take and drawing a little bit of a parallel to the rules. REITs have these income and asset testing requirements that you have to meet. There's something similar to that in the Opportunity Zone world where you have to look at income and asset testing and make sure that they're complying with the opposite on requirements, so.
Aaron Norris 43:39
It ends up on your desk, that's a lot of work.
David Erard 43:42
It does. Some, some of those do and others, you have clients that invest and we also represent a few firms that are doing the Opportunity Zone funds. So, from a testing standpoint, advising, you're telling them when they need to do what, you know, it has been a bit of a challenge, because especially with some of the well-intentioned COVID relief bills, you know, the periods that you have to do things kind of shift a little bit as they give you a little bit more time to do X or Y because you know, from, say, March of last year to July of last year, in particular, the world was a little bit frozen. So, yeah, we get involved in helping people manage through that process. But it just people should be aware that it is a process.
Aaron Norris 44:27
I was fascinated because they launched the opportunity zones, and they continued to legislate around it. So, they launched it and they kept on changing the rules. That's very uncomfortable.
David Erard 44:36
Oh, it is. But if, if you look at that tax bill from 2017, it was a very significant bill. Yeah, we were still getting guidance on some of the more complicated provisions in January of this year. So, it's, it's not just Opportunity Zones. It's all of it whenever you have a really robust tax legislation, that the guidance that follows that is going to be coming out for years.
Sean O'Toole 45:01
And then some cases probably and the rest, even after that.
David Erard 45:05
Yeah, and probably a little bit early for cases on anything right now, and especially with the courts being working at full steam, I think they just get it like the normal judicial type of guidance that you might get, you're not going to see in a normal kind of cadence.
Sean O'Toole 45:21
Aaron Norris 45:22
Don't want any clients that become a case, right? That's not always a good thing.
David Erard 45:26
Yeah, unless they win, then you're happy about it. But you'd rather not fight the battle if you don't have to.
Sean O'Toole 45:32
Aaron Norris 45:32
You don't want to be the subject of a private letter ruling?
David Erard 45:36
Yeah, not not an unfavorable one, for sure.
Sean O'Toole 45:38
Aaron Norris 45:40
Now, Opportunity Zones, have lost some benefits. If you did an Opportunity Zone, was it by the end of 2019? There was an opportunity to get, was it a 15% credit towards the taxes owed? Is that how that worked?
David Erard 45:53
Yeah, so that, what they did was if you just because of the way the program was laid out, and the timing, if you invested, I think it was before the end of '19 15% of that gain that you originally recognized, you got a relief. You didn't have to pay tax on, it gets dropped down to 10%, or 5%. So, there's a little bit less of a spiff as time went on, which made it a little bit of a balancing act between do I dare kind of do this not knowing what all of the rules are yet, but knowing I want the full spiff or do I wait and see, make sure I really understand the State of Play have more defined rules. And understand that I'm going to get the trade-off is I'm going to get a little bit less of a benefit.
Aaron Norris 46:36
You saw people call it contacting you about the opportunity, though?
David Erard 46:39
Aaron Norris 46:41
Okay. What are other opportunities are real estate investors bugging you about these days?
David Erard 46:48
Oh, I think everybody's keeping a close eye on, you know, what happens with tax legislation. So, I think the general feeling is that tax rates are likely to go up and not down. And understanding whatever carve outs there are is going to be important. You know, the carried interest has been another one, like something like 1031 exchanges that, you know, we've been hearing about for quite a while that people you know, the, that tax break may be taken away. And for those of your listeners that aren't familiar with that term, I've heard it called Carried Interest or Promote or, you know, Profit Participation, there's a few different ways you'll hear it. It has to do with normally a fund sponsor. If their deal is successful, and everybody does, well, the fund sponsors do better as the deal does better. So, a fund sponsor might get 5% of the profits if the deal is like, you know, successful but not great. And they might get 20% of the profits if the deal is really good. And you know, the numbers vary by deal and by sponsor, but the idea is that the better the deal does, the more the sponsor earns, as a carried interest or a promote or profit. And so, there's been the notion for a while now that whatever they're earning really should be considered earning and not something that's, you know, the equivalent of a capital investment. And so, that's of all of the things I guess I'm getting the most questions on or hearing the most about, it's probably how likely is it that they actually make those rules effective. In 2017, had to build, that they did look at things of like a three year holding period or less, is being subject to not to capital gains rates, but to ordinary rates for certain situations. Real Estate wasn't as affected by that as maybe a hedge fund would have been because of the type of gains you would get on a real estate deal relative to a hedge fund that selling securities or something like that. So, getting a lot more questions now about what how likely, is it that rule changes? What should I be ready for? Do I need to tweak my agreements? How should I be thinking about things? So, I have all of the topics that I'm getting, you know, questions on, it's like, where tax rates going? What are going to be some carve outs or, you know, other? What benefits do you expect us to lose? And then at the top of that list is will, will carried interest end up on the chopping block? And are we going to end up being treated as ordinary income on that, instead of, you know, capital or section 1231 gain, which is the way it's worked historically.
Aaron Norris 49:30
Through offering therapy sessions, like right after CPA sessions, I see.
David Erard 49:36
Or just happy hour, I don't know.
Aaron Norris 49:39
How are you communicating all this? There could be a lot of changes here. Do you have a plan on you know, how you're wanting real estate investors to plug in and sort of figure out what's going on?
David Erard 49:49
Yeah, if I'm trying not to cry wolf on stuff. So, if you if you pay attention to the news every day, your life is gonna be a lot more more stressful than it is if you pay attention to time to time, or have somebody monitoring the right things for you. So, one thing I tell people is maybe don't pay attention every single day. But on when, when there's news of, you know, a proposed bill or something starts to look a little bit more formal, we'll certainly be communicating that with our clients, letting them know what we're seeing and hearing. Like I said, that hasn't been a whole lot that I felt like I had to communicate yet. Other than, you know, there's a lot of changes that might happen when they do and as these things get more clear, we'll let you know. But I worry a little bit about, you know, taking a proactive step to something that you don't need to. And I don't mean for that to sound bad, it's good to be proactive and not reactive. But you also maybe don't want to go through the expense and brain damage, you don't want to change your business, you don't want to make a hasty decision, because you're worried about what might happen. So, I'd say I would try to tell people to stay the course, focus on mate running the business as well, as you can run the business, you know, do the best that you can, if there's a situation where we start to see something concrete definitive, then if there's a need to plan around that we, you know, we'll do what we can. But you know, again, I would try not to get too focused on possible changes and stay focused on making sure you're doing the best you can run in your business.
Aaron Norris 51:30
Very good. Anything else we should know, headed into 2021? Before we end.
David Erard 51:36
Oh, I wish I had something smarter to say. That's just, I think, the Vegas, again, from a business standpoint, I think just I worry the most about keeping preserving culture, while we're all working remotely. And I think, you know, we've been on survival mode, and we've been able to stay the course so far. But you know, from a culture standpoint, from a people standpoint, the best advice I can give is people really matter. You know, on the client side, your team really matters. Relationships really matter. And so, we've kind of had to put some of maybe the normal relationship management stuff that we would do on the, on the side, because we can't be, we haven't been able to be in person. So, I'd say going into 2021, I would just want everybody to be mindful about how 2020 is affected all of us. And really be aware that ultimately, everything we do is centered around people and making sure we're doing right, the right things for people and the best probably the best advice I could give.
Aaron Norris 52:39
Sounds good. If people want to get a hold of you, where should they be going?
David Erard 52:43
So, you could find me on the Armanino website, that's armaninollp.com. Name is David Erard. It's a little funny last name, E-R-A-R-D. Or if there's a way I can send you an email address to put up. But it's just my first name firstname.lastname@example.org, if anybody wants to reach out, and my phone number is 949. Hang on. Sorry, I'll have to look it up actually, cuz I don't call myself very often. The phone direct dial would be 949-396-1551.
Sean O'Toole 53:23
Aaron Norris 53:25
Thanks so much, David, for joining us.
David Erard 53:27
Thanks a lot.
Aaron Norris 53:29
Thank you for listening to the Data Driven Real Estate Podcast, you can find show notes and links to some of the resources mentioned in the show at datadrivenrealestate.com. Click that join the community, and you'll be forwarded to the PropertyRadar community where you can ask questions about the current show and even see upcoming guests and ask questions there. We'd love to engage with you in the community. So check it out. Please don't forget to like, favorite, subscribe and share on your favorite platform where you're listening to the show. It helps us out a great deal. Thanks for listening, and we'll see you next week.
Transcribed by https://otter.ai