Many investors, ranging in all experience levels, read books and attend expensive educational seminars. They come away with ideas, their minds are racing, and they want to implement what they have learned.
It is critically important to engage in learning on a perpetual basis. Growing your mind is key to success and happiness.
I love it when a client comes to me with an idea that allows us to start a creative conversation. It allows me to educate the client on the strategy and have a candid conversation regarding the applicability to their own situation.
The problem is that I’ve been finding educational seminars and books tend to pitch tax strategies intended to hype investors up. Hype sells. Unfortunately, the tax strategies that sound amazing either aren’t that great or don’t apply to you.
I’ve compiled a short list of such tax strategies, and I’m going to explain why some of these strategies don’t hold water.
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3 Common Tax Strategy Myths Taught to Investors at Educational Seminars
Myth #1: You can always deduct your passive losses.
A newer client of mine called me up earlier this year and was somewhat upset with the result of their tax returns. They had attended a seminar where a good majority of the day was spent talking about tax reduction strategies. Specifically, the presenter harped on the fact that everyone can use the losses generated by their real estate activities and offset their income.
When my client looked at the return I prepared, they were confused as to why their real estate losses weren’t being used to offset their income. After engaging in a deeper conversation, I learned that the educator failed to mention the requirements to actually take the loss.
On a high level, if your adjusted gross income is above $150,000, you cannot take passive losses generated from your real estate rentals unless you qualify as a real estate professional. My client works a full-time job and therefore will not qualify as a real estate professional. As a result, the passive losses are carried forward to next year.
But the seminar instructor left that part of the equation out. That part of the equation is the “dull” part. That part of the equation doesn’t sell.
Myth #2: Always use the actual expense method for the home office deduction.
Many CPAs will want you to use the actual expense method over the “easy” method if you have a qualifying home office. The actual expense method allows you to deduct a portion of your utilities and phone bill and even depreciate some of your home.
When CPAs find more deductions, you inherently think the value of their service has gone up. You’re happy because you see a smaller tax liability. The CPA is happy because you paid your invoice in full and quickly.
The truth is that the actual expense method may be more trouble than it is worth. After all, it takes time to document everything for a home office.
If you are in the 25% tax bracket and the CPA estimates that the actual expense method will yield $1,000 over the “easy” method, the tax savings you are looking at will be about $250. A solid chuck of change.
But how much time will it take you to compile the documentation? Is the CPA charging you for the time they are spending you on the phone with them walking you through everything? What is your time worth?
For some of my clients, we found that while their savings from using the actual expense method would be several hundred dollars, it simply wasn’t going to be worth their time.
The other pitfall with the actual expense method is that you are shifting interest and taxes on your primary residence to business expenses. If you are using the home office for your real estate rentals and you are unable to take the passive losses, you’ve moved more deductions into that “suspended passive loss” category. Your tax liability has now increased.
The “easy” method simply says that your deduction is $5 per sq ft of home office space annually. This will yield a small deduction, but remember that there can be ulterior motives for having a home office. One such motive is providing you with the ability to deduct transportation expenses between your rentals and primary residence.
Myth #3: You should use a C-corporation and rent out your home for quarterly board meetings.
Establishing a C-corporation sounds like a savvy thing to do. Then you learn you can rent your home out to the C-corporation for board meetings, allowing you to claim even more deductions.
Related: 3 Reasons You Should LOVE the Home Office Tax Deduction
My first question when posed with this creative idea is “why are you using a C-corporation?” There are very good instances to use a C-corporation, even if you own rental property. But those instances can be quite rare.
Generally, investors don’t know why they should use a C-corporation. They learned about it from a course or book, and they were told that it was a great idea. Besides, being able to rent your home to your C-corporation makes you look savvy.
While this is certainly a viable strategy given the right circumstances, I have found it to be more of a headache than it’s actually worth. Combine that with the average investor, and this strategy is generally not feasible.
Take Advice from Those Who Practice What They Preach
Those three myths are the top three strategies that I’ve heard being pitched in various educational resources or seminars.
I don’t want to sound like I’m bashing this type of education. There is absolutely nothing wrong with selling education. Education has immense value. Even the worst book or educational event can give you at least one new idea that can add $1 million to your net worth.
Just be wary and proceed with caution, especially if you are a do-it-yourself investor. You should only take advice from those who are actively practicing what they are preaching.
Ask yourself next time you read a book or attend an event, “How does this person make money?” One who makes money due to their marketing and branding genius may not be offering you the most feasible solutions.
Feasibility Wins the Day
Remember, at the end of the day, it’s all about how much money you are saving versus the time it took to save that money. Some solutions sound awesome, and you’ll be hyped up and ready to implement them.
But the solution needs to make sense. It needs to run parallel to your goals, be relatively easy to implement, and not take up an exorbitant amount of time to maintain.
Disclaimer: This article does not constitute legal advice. As always, consult your CPA or accountant before implementing any tax strategies to ensure that these methods fit with your particular situation.
Have you ever heard of these common myths? Any you’d add to the list?
Leave a comment below, and let’s talk.