Scaling a Real Estate Business: Tax Strategy, Cash Flow and Investor Trust

“I’m not going to be the guy who’s just preparing a tax return for you and then disappearing for a year.” Kyle Paxton, CPA

In this episode, Kyle Paxton, CPA and tax director at James Moore, talks about scaling a real estate business from individual projects to a full portfolio. Kyle explains why tax strategy should be a year-round planning tool and how owners can avoid the cash flow surprises that slow growth.

The conversation covers a lot of ground. Kyle walks through how depreciation timing can free up cash on a multifamily acquisition, why entity structure determines whether a tax strategy works at all and how gains, recapture, state taxes and brokerage 1099s catch owners off guard.

He also shares the signs that tell him a business owner is financially sophisticated, why real-time data matters more than ever and how operators who raise outside capital can protect investor trust through clear communication.

Resources

James Moore Real Estate CPAs

Your CPA’s Take on Real Estate on YouTube

Watch: Scaling a Real Estate Business? Stop Looking Only at Projects.

Transcript

[00:25] Faith: Hi and welcome. Today we’re talking with Kyle Paxton, CPA and tax director at James Moore, and today we’re talking about project to portfolio. Kyle, it’s so good to have you today.

[00:25] Kyle Paxton: Always a pleasure, my friend. Great to see you. Happy to be here.

[00:25] Faith: This is actually our first episode on the channel.

[00:47] Kyle Paxton: Very exciting.

[00:47] Faith: I know.

[00:47] Kyle Paxton: I told Faith before this, this one’s going to be a scratch. We’re a trial run. We’ll get better from here, but we’ll see how we do.

[00:47] Faith: It’s always fun with you, Kyle, so I think we’re going to have a great time. I think we should just get into questions today because we have a lot to cover, if that’s okay with you.

[01:04] Kyle Paxton: It’s good.

[01:04] Faith: We’re going to start with tax strategy as a planning tool. The first question we have is, what’s the difference between proactive tax planning and filing after the fact?

[01:04] Kyle Paxton: Yeah, absolutely. It’s a great question and it’s one we’re dealing with right now as we’re entering the peak of tax season.

[01:23] Kyle Paxton: So clearly, proactive tax planning is very, very important for cash flow. We’ll talk more about cash flow, and a big theme of me and my practice is avoiding surprises, right? Surprises are no fun. We see them all the time. Sometimes they’re good surprises. Sometimes they’re really bad surprises.

[01:42] Kyle Paxton: So in total, we’re trying to avoid surprises. That’s what proactive tax planning is all about, making sure that you don’t have significant negative surprises that are impacting your business. And I would say accounting historically, from the compliance side and tax preparation, the compliance activity is a check the box, we filed the tax return, we move on to next year and nothing really comes out of it, right? And so really as a firm, at James Moore, what we’ve been trying to do on our tax side is really pivot away from just the compliance, check the box, file the return.

[02:13] Kyle Paxton: Now the reality is AI can do a good portion of most tax returns. And really taking the tax picture and using it to establish what can we do better going forward, and parlaying that into more of an advisory type of system where we’re meeting quarterly. We meet on the back of that tax return: here are some changes we can make. Now three months later, here’s how those changes are panning out. Oh, we’re getting close to year-end, here’s what we can do right before year-end.

[02:42] Kyle Paxton: So it’s just really creating that relationship to where your accountant, who has a lot of visibility into your business numbers and understands the numbers, can really help drive the business and be a key member in driving and growing the business. So we’re really seeing that come to the forefront now in the AI wave and everything else, that pivot from backward-looking tax preparation to, okay, this is something we still have to do, but how can we parlay this information into something that’s useful going forward?

[03:11] Faith: Nice, I love that. The next one is, how can tax strategy actively support expansion?

[03:11] Kyle Paxton: Yeah, this is big, right? I had already mentioned cash flow. This is a cash flow game. A lot of concepts in tax are timing differences and you’re playing with the time value of money, right? Generally speaking, I want to delay income as much as possible and I want to push my expenses up to free up cash right now.

[03:44] Kyle Paxton: I operate a lot in the real estate space, right? It’s a big bulk of my clients. It is a really good time to own real estate for tax purposes. Under the Tax Cuts and Jobs Act and now the One Big Beautiful Bill as a whole, those have both really stimulated real estate from the tax perspective. And so a lot of these concepts come to the forefront or are easiest to explain in the real estate space.

[04:05] Kyle Paxton: So you think of a multifamily property you acquire. When you bring on that multifamily property, you have the core building, the land, all the internal components, and then a lot of times you’re making significant improvements to bring rents up to market value. Timing that project, being intentional about when that project’s completed and what tax strategies we want to implement around depreciation to try to accelerate some of those deductions, can free up a lot of cash now for both the operator of the real estate and any other investors that are involved. So, expanding that out more, depreciation for me is the low-hanging fruit of that because it is a deduction that’s not necessarily tied to cash. If you finance a purchase, you can still potentially get a tax deduction for the full cost in year one.

[05:00] Kyle Paxton: So you have a phantom tax deduction that’s not necessarily tied to a cash outflow from your pocket. So that one for me is low-hanging fruit. And then we talk a lot about the timing of, and how, owner compensation is structured, what is your accounting method, how are your entities structured, just to make sure you’re mitigating tax or funneling income in the right channels to help best optimize your global cash flow. Getting long-winded here.

[05:27] Faith: Super interesting. I’m learning so much just even talking to you. That’s why people should work with you. It’s amazing.

[05:27] Kyle Paxton: I like to think so.

[05:27] Faith: Yeah. Okay, so the next one is, how should owners structure entities to support growth and protection?

[05:27] Kyle Paxton: Yeah, this is big.

[05:45] Kyle Paxton: And this is one of the first things I unpack with new clients, right? Obviously I have the caveat: I’m not an attorney. I’m a CPA. I’ve got to look at this through the financial lens. You have the whole other world of legal jargon that I can opine on and what I see around, but I can’t give any legal advice. So ultimately entity structure, I think, first and foremost defaults to the legal team.

[06:10] Kyle Paxton: Now, I love working with attorneys in creating entity structures, looking at restructuring your portfolio, all that stuff, because how you structure your entities is number one on if your overall tax strategy is even going to work. And we run into this problem all the time with clients we onboard, where they were given bad advice on a specific LLC on what election should be made for tax purposes.

[06:37] Kyle Paxton: And then they come to us with, “Hey, I’ve got a big transaction coming up. My last accountant wasn’t super responsive,” or “I don’t feel like they have the expertise,” whatever that pain point is, “and I have this transaction in 5 days and I need help making sure I minimize tax.” And it’s like, well, you’re too late and you have a huge problem coming.

[06:55] Kyle Paxton: So those conversations aren’t fun. And then it also puts me, from the new client perspective, quite often I have to come in and be the bad guy at the start of a relationship with a client where I say, “Hey, either what you did last year from a reporting perspective doesn’t align with what the paper tells me your entity structure actually is,” or it gets back to, this was just set up poorly and you’ve been leaving money on the table for a long time, or you owe an additional amount of tax for whatever reason this year.

[07:23] Kyle Paxton: So there’s a lot of that that comes to the forefront very quickly with our client relationships. And it’s something that we reevaluate at least every couple years through this tax compliance process, really making sure we’re understanding why are our clients paying tax and is there anything from an entity restructure situation to help mitigate that. And then the biggest thing is just getting back to that proactive tax planning.

[07:54] Kyle Paxton: You’ve got to keep me in the loop as deals come up. A lot of times the LLC is formed, the transaction is executed and then it’s like, “Oh, by the way, we started this this year.” And then I’m kind of trying to catch up on how does this fit in the global picture, does this make sense, whatever.

[08:14] Kyle Paxton: So our highest value client relationships are the ones where, again, I get back to this: I have a lot of intimate knowledge on your business. Bring me in on these decisions and let me help you.

[08:14] Faith: Yeah, and I think the next question works perfectly with this, which is, how does poor planning create unnecessary financial stress?

[08:34] Kyle Paxton: Oh, yes. Well, I’ll use the easy tax example because this is what we’re dealing with right now, right? A lot. And a lot of times I see this, and I’m going to gravitate again, it’s my comfort zone here, back to the real estate example, right? So I talked about how depreciation is a timing difference. You potentially can get a large deduction on a parcel of real estate in year one. As you hold the investment, you’re potentially having taxable losses every year, and then five, seven, however long down the line, you go and sell that investment and you have a taxable gain there.

[09:03] Kyle Paxton: The taxable gain is not just the spread of what you sold it for less what you paid. You potentially have to recapture that depreciation. And depending on where the property is, where your owners are, where your employees are, you may have state tax problems.

[09:25] Kyle Paxton: There are times where states require the actual entity to pay tax directly to the state instead of the individuals, which we’re typically used to in those structures where everything flows down to the individual. And then a whole other layer of that is if you have any foreign partners involved, but that’s outside of the realm of this conversation.

[09:46] Kyle Paxton: I’m getting down a rabbit hole on one example here, but tax is a big one where, without that proper, intentional planning in front and projection work, whatever it is, you get hit with that one form that comes in that you weren’t expecting, or you didn’t get good data on what was going to be on that form from a bank, or whatever, and it causes surprises.

[10:11] Kyle Paxton: And one other thing, just getting back to the relationships and keeping everybody in the loop here, I see tax become a problem for cash flow purposes a lot through financial advisors and those investments you have with any of the big-name brokers. You get your 1099 when that comes out at the end of February for all the stock sales you had last year.

[10:36] Kyle Paxton: Maybe you knew about some of them, maybe you didn’t, depending on how your portfolio is managed, and there are often big surprises buried in there. Obviously the stock market ebbs and flows significantly, and those first few come through every year and you’re like, “Uh-oh, it’s going to be a high-income year,” right? Or they come through and you’re like, “All right, from a tax perspective, performance down a little bit last year, but maybe we’ll have less surprises.”

[11:00] Kyle Paxton: So anyway, I’m fixating on the tax component here because it can be such a big swing in cash flow. And I say it a lot: I don’t like tax driving economic decisions in a lot of the deals our clients work with. But it’s got to be somewhere in your mind as part of the picture, and a lot of times it isn’t, and that’s where the pain really comes from.

[11:31] Faith: And speaking of new clients, when you meet a new client, what’s the first question you ask that tells you how sophisticated they are financially?

[11:31] Kyle Paxton: Well, I tend to be kind of a go-with-the-flow fella, Faith. So I don’t have a roster of questions necessarily, right? But the biggest tell for me initially is two things.

[11:51] Kyle Paxton: I meet with a lot of business owners one-on-one on that initial meeting. Sometimes it’s the CFO, sometimes it’s the business owner and CFO. I get a lot from whether the business owner has a good back-of-the-napkin pulse, that 30,000-foot view, on how their business is doing. A lot of times when I’m reviewing financial results or tax returns on the back end, if a business owner can tell me, “Yeah, that feels right based on what I know,” I see that as sophisticated.

[12:17] Kyle Paxton: Because we see a lot of people who can’t do that, and they’re blindsided by those surprises. So if you have a good back-of-the-napkin pulse on how things are going, that’s sign number one, and kind of low-hanging fruit. And not just “do I have cash in the bank, yes or no.”

[12:35] Faith: Yeah.

[12:35] Kyle Paxton: And then the other thing that’s becoming more and more prevalent: I’ve already talked about AI, so getting into data availability. Right now, we’ve never had access to more real-time data, right? At the snap of the fingers, you can get whatever data set you want in front of you with the right tools.

[13:00] Kyle Paxton: And so a big tell for me in that is, I’ve talked about how we’ve been gravitating as an industry, the accounting industry, from super backward-looking to more forward-facing. At this point, you should have data for today for your business, in one way or another.

[13:21] Kyle Paxton: It doesn’t have to be perfect, beautiful financial records, but if you use QuickBooks, you can import bank transactions and they classify 95% of them for you, right? It takes a couple clicks, you can get hundreds of transactions in there and you have a decent picture from a financial perspective.

[13:39] Kyle Paxton: So we’re big on this at James Moore. We have a data analytics team. We build out a lot of dashboards internally. It’s huge in every part of our process, and I really want to see that with the clients I work with. And if it’s not there, make sure they understand that that is something that we can help with. I’m not the most savvy, but I know enough to be dangerous and I know the right people to get in the room.

[14:03] Kyle Paxton: But I think the biggest thing here is, are we having a conversation in July where we’re still not sure about what happened last December? That shouldn’t be happening right now.

[14:03] Faith: Right.

[14:03] Kyle Paxton: There’s just too much. And I recognize our business owners have a lot they’re taking care of, and they’re forward-facing all the time, “where do I get my next dollar,” but having real-time data is huge for that decision-making and just streamline that whole process.

[14:26] Faith: Nice. Okay, so what’s one of the most common cash flow surprises you see?

[14:26] Kyle Paxton: Yeah. I think this gets back to a couple things. We talked about the tax. That’s kind of low-hanging fruit and something I see all the time, but it comes down to this: a lot of the spaces I operate in have a heavy modeling concept, right? When you’re getting ready to bid on a job, or if you are starting up a new real estate fund with that multifamily property we talked about earlier, there’s always some sort of model involved.

[15:03] Kyle Paxton: And bringing in data here, there are so many places where the model can go awry. Your overhead gets out of whack, you have those change orders mid-job that drive up the cost of the job, you have those weird state tax issues that pop up.

[15:22] Kyle Paxton: You don’t properly vet your professional teams. Attorneys and accountants aren’t necessarily cheap, and there’s so much that goes into that overhead. Every year we see payroll get more and more expensive. The dollars go up, up, up in that and can cause a squeeze.

[15:41] Kyle Paxton: So it’s making sure that the model is projecting for all of those potential catches and factoring in that payroll increase. Will you have key employee turnover? That’s going to drastically change the picture of your business. So just building in the proper buffer to be able to stomach anything like that, it’s big.

[16:05] Faith: Okay, so speaking of that, what should owners be preparing for this year?

[16:05] Kyle Paxton: Ooh, that’s a good question. We’ll see here. I think we’re in uncertain times economically. I feel like you can say that every year for the last 10 years, but there’s a lot going on.

[16:28] Kyle Paxton: I keep talking about AI and the tech wave. That’s going to be a colossal impact in every business. And so I think this isn’t really tied to financial, but it is in a way: our business owner clients who aren’t either embracing AI or figuring out how it helps them in their business are going to get left behind in some capacity.

[16:53] Kyle Paxton: There’s the moral component of all this. I’m sensitive to that. I understand some people have their opinions on this, but the reality is it’s here, it’s happening and 95% of our clients are implementing AI concepts in some way in their business. So I think that’s the focus from my perspective. And I want to get back to this: a big focus is just making sure your systems are optimized to where you can get real-time data now and make good proactive decisions.

[17:22] Kyle Paxton: Since life is changing so rapidly at this time and data is changing so rapidly at this time, having fresh data is huge for big business decisions.

[17:22] Faith: So what you’re saying is, it’s not normal to not hear from your CPA?

[17:22] Kyle Paxton: Yeah. Exactly.

[17:22] Faith: They’re actually very invested and hands-on, which I don’t think a lot of people have experience with.

[17:46] Kyle Paxton: I try to be. And that’s a big thing in onboarding new clients now for us: I’m not going to be the guy who’s just preparing a tax return for you and then disappearing for a year. If I am, that’s fine, but you’re probably not going to get the value of what you’re paying for.

[18:07] Kyle Paxton: Like I said, I’ve got a lot of knowledge across different industries and across our client base, working with so many successful business owners, with a great team around me at James Moore. Being able to bring that expertise and help better your business is where we bring our value, and I don’t want to hide behind that.

[18:29] Kyle Paxton: I need to be an active part of your business to show you my value. So if you’re not going to meet me there, you’re not going to get the highest value out of our relationship.

[18:29] Faith: So this kind of leads into the next one, which is, how do you know when to say yes or no to growth opportunities?

[18:29] Kyle Paxton: Well, this is a problem I personally struggle with, so I don’t know if I’m the best person. I’m a yes man.

[18:53] Kyle Paxton: I like to say yes to things. I’m not going to answer this question concisely, I don’t think, but getting back to whether you’ve built in… Growth is exciting. It’s everywhere, but it’s about being intentional about growth. We have a mix in our teams of people who really like change and who really don’t like change.

[19:21] Kyle Paxton: So I’m still spinning this question of how do I say yes to every growth opportunity, which is what I’m actively doing. But it comes down to making sure that changes are intentional and implemented really specifically, in a way that everyone on the team can get behind, right? With any growth opportunity, and I’m going to gravitate toward technology here, it’s having that core champion team who’s piloting and ironing out the kinks, and then they’re the ones tasked with getting the buy-in from everybody else.

[19:54] Kyle Paxton: So that next tier of people and so on and so forth. And then parlaying those new technologies to understand: can I take on more jobs without sinking my team’s capacity? Am I freeing up capacity by implementing these strategies? And in my models, have I built in those buffers to make sure I hit the target margin? And then execution-wise, are the people in the right place with the tools they need to get the job done and deliver?

[20:23] Faith: I love that. So what is the final best piece of advice you could give operators who want long-term longevity?

[20:23] Kyle Paxton: Speaking of operators here, and keeping with your real estate focus, and you can expand this to any business: keeping whoever is financing your operation, if it’s not you with cash, happy is the key to your success, right? We see this all the time in the operator space, talking about real estate funds and my multifamily example.

[21:00] Kyle Paxton: You might be a general partner with a hundred limited partners. You’ve gotten them to invest their $100,000, whatever it is. You gave them your pitch deck, your spiel, you’re a great salesman, you sold them. But then are you actually going to execute on the targets? And then the biggest thing comes down to communication.

[21:19] Kyle Paxton: I find a lot of investors across industries who are putting money in deals may know nothing about that industry going in. That sales pitch sold them, or their friend said, “Hey, it’s a great time to own real estate for tax purposes, so sprinkle some money into my friend Johnny’s fund here and we’ll see what happens.”

[21:40] Kyle Paxton: But then they’re sitting in the dark on performance. They’re sitting in the dark on when they’re going to get their K-1 for tax purposes to report on their tax return. They’re in the dark on what the number is to report on their tax return. And so just the same as those surprises creep up for the operators, they creep in for those investors too, who aren’t on the front lines of the deal.

[22:01] Kyle Paxton: And then that erodes investor trust. Word gets out, you have a PR nightmare from your entity, and then getting those same people to reinvest in the next deal, or a new person to invest when they can Google “Kyle Paxton fund” and see all the slander about me, it’s huge. So I think for growth, outside of just making sure you can actually execute on your business plan or your deal or whatever, it’s about building the trust with those financing relationships, whether that is investors in various shapes and sizes or having a good, strong banking relationship and clear communication around that.

[22:31] Kyle Paxton: Those are big. I can help with that, too. I can interpret a lot of the financial stuff for the bankers and create that trust: “Hey, I know what I’m doing, the operator knows what they’re doing, you can support both of us and feel good about it.”

[22:55] Kyle Paxton: Those are the things, I think: just building trust throughout your chains.

[22:55] Faith: Yeah, that’s awesome. Well, I really enjoyed speaking with you today, and I know you’re really busy and I really appreciate you taking…

[22:55] Kyle Paxton: What’s going on right now in February? I don’t know what’s going on.

[22:55] Faith: Something in your industry is happening.

[23:12] Kyle Paxton: Something like that. Yeah.

[23:12] Faith: So we’re actually going to have Kyle back for episode two, and we’re going to talk about tax planning in a shifting market, which I think is going to be super interesting to talk about in March, after all the chaos is starting.

[23:29] Faith: And then our next guest is going to be Daniel Roccanti, who’s a CPA, and he’s coming on Thursday, March 5th, and we’re going to be talking about driving financial clarity in real estate. So a lot of exciting things happening on the channel. Again, Kyle, I love talking to you always.

[23:29] Kyle Paxton: Always a pleasure, Faith. And that Daniel guy knows what he’s talking about. You should tune in.

[23:46] Faith: Yeah, I know. All right, well, we will see you guys next time.

[23:46] Kyle Paxton: All right, take care.

 

Hear the Full Conversation

Kyle’s advice comes back to one idea: the earlier your CPA is involved, the fewer surprises you face. Watch the full episode to hear his complete take on tax strategy, entity structure, cash flow and investor trust, and subscribe to Your CPA’s Take on Real Estate so you don’t another episode.

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