Business Management

I’m Over Paying Taxes, So Here’s How I Plan to Significantly (and Legally) Lower My Liability

Expertise: Landlording & Rental Properties, Real Estate Investing Basics
18 Articles Written
business, accounting, finances and people concept - confused man with calculator at home

Disclaimer: This is designed to provide general information regarding the subject matter covered. It is not intended to serve as legal or financial advice related to individual situations. Consult with your own attorney and/or other advisor regarding your specific situation.

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I won’t lie. I am frustrated. This whole paying taxes thing, I am over it. Yeah, I know it helps to pay for our overall infrastructure as a country—but still!

In case you are wondering why I am writing about this now, I just filed my taxes on October 15. Yes, I extend my tax return like clockwork on April 15 every year and buy myself another six months. I do nothing for five, and then after using some expletives, I finally begin the arduous task of going through thousands of pages of bank statements and recording everything.

Do you think I need a better system or no? Hmm…

It has become a vicious cycle. One that’s quite dreadful. It is obvious that I need a better system, and I am vetting bookkeepers and virtual assistants now to help with this task.

I want to talk about something else though—something even more frustrating.

I owe about $8,000! Dang.

For context, I owed about $4,000 last year and $10,000 the year before. That is a lot to some and pennies to others, but I still am on a mission to get that number lower—especially because I hear from all these gurus and even large companies that they pay no tax at all.

Here is the good news. I am finally getting a better grasp on how this whole tax thing works and what I can do to improve my position.

Related: The Ultimate Guide to Real Estate Taxes & Deductions

How to Pay Less in Taxes as a Real Estate Investor

Here is how I see it: The biggest roadblock to paying less taxes, for me, is the fact that I have a day job and cannot designate myself as a “real estate professional” for tax purposes. Well… I could but, my research shows that is nearly an automatic audit. Meaning, if you hold a full-time day job, the IRS has a very hard time believing you are a “real estate professional” instead of whatever you actually do as your normal full-time job.

Here are some ways the IRS says you can qualify as a real estate professional (from 2018’s IRS Publication 925).

calculator with less tax and more tax buttons

Qualifications

You qualified as a real estate professional for the year if you met both of the following requirements.

  • More than half of the personal services you performed in all trades or businesses during the tax year were performed in real property trades or businesses in which you materially participated.
  • You performed more than 750 hours of services during the tax year in real property trades or businesses in which you materially participated.

Furthermore, should you be audited, you will need a comprehensive log of all of your activities throughout the tax year to substantiate your “real estate professional” claim. You will need to demonstrate that you actually did perform qualified tasks and how long they took according to the guidelines above.

Take a look at that first bullet point above, again. It references that all of this work performed must be in “real property trades or businesses.” Here is what the IRS says is a “real property trade or business”:

Real property trades or businesses. A real property trade or business is a trade or business that does any of the following with real property.

  • Develops or redevelops it.
  • Constructs or reconstructs it.
  • Acquires it.
  • Converts it.
  • Rents or leases it.
  • Operates or manages it.
  • Brokers it.

Ok, well, what the heck does all this really mean?

If you do not meet these qualifications, then you will have limitations. The limitation most commonly brought about is the $25,000 in real estate losses limitation.

What does this exactly mean?

The rental income that you make does not come in the form of a nice little paycheck like you get from your employer, right? There is no paystub with various federal and state deductions. Your tenant(s) pay you, and you pay the mortgage (if there is one), taxes, insurance, and the upkeep of the property.

tax-tips-2019

Ordinary & Necessary Expenses

The tax code says that you are allowed to deduct for “ordinary and necessary” expenses though. This means you can deduct the cost of the paint used to turn around a vacant room, the cost of a pest exterminator to rid your units of cockroaches, and of course, interest on your mortgage, among many other items. All of these various items get added up and are used to offset your gross rental income.

Here is the problem. At the end of the day, you may still be left with income above and beyond what you are able to offset because of this limitation. That is what happened to me.

Furthermore, there are phase out provisions, too. This $25,000 limitation starts to phase itself out starting for earners of $100,000 on up to $150,000. This is making the $25,000 figure even smaller. This is also a problem for me.

However, one bit of good news is that the losses above and beyond the $25,000 carry over each year. Meaning, you are able to accumulate losses and can use them when you are able.

My Tax Plan Going Forward

OK, so after all this, what is my plan?

My end game has always been to “retire” early on the income from my real estate investments. What I would like to do is eventually quit my day job and truly do real estate investing full time. Once you are able to designate yourself as a real estate professional, the $25,000 limitation goes away. So, soon I believe I will be in a great position tax-wise. I know this to be true because I have built up a good amount of loss carryovers from years past.

At the end of the day, I am extremely grateful to be where I am and living in this great country. If you really take a 10,000-foot-view on this whole concept, it is remarkable to be able to legally knock down your income with legitimate deductions as far as most people do.

Related: Depreciation: Learn the Basics Ahead of Tax Day!

Paying a few thousand dollars in taxes when you have taken in substantial untaxed rental income throughout the year is amazing. Furthermore, taking advantage of items like depreciation on our properties adds to the extraordinary capabilities of this industry that we are in.

Taxes or no taxes, thank god for real estate and the U.S. of A.

[Disclaimer: This is designed to provide general information regarding the subject matter covered. It is not intended to serve as legal or financial advice related to individual situations. Consult with your own attorney and/or other advisor regarding your specific situation.]

Any questions for me about the tax advantages extended to real estate investors? 

Ask me in the comment section below. 

Ryan Deasy, of Deasy Property Group and RentReddy, is a long-distance landlord currently residing in Houston, Texas. Originally from Connecticut, Ryan has employed various strategies and studied unique niches in order to grow and manage his portfolio. In 2012, Ryan purchased his first duplex. Little did he know, he had stumbled into house hacking and, from there, never looked back. In 2016, he moved to Houston and left all of his rentals behind with no property manager. Through many trials and tribulations, he discovered the best way to manage his portfolio was, simply, by himself at a distance. After employing rock solid systems and an all-encompassing team, he has been able to scale his portfolio without missing a beat. Not only is his entire portfolio managed from out-of-state but it is also comprised entirely of rent-by-the-room arrangements. With the appropriate systems and teams in place, Ryan has taken a group of small multifamily rental properties and made them into an exceedingly profitable income source.

    Isaac Agbolosoo Rental Property Investor from Grosse ile
    Replied about 2 months ago
    How does investing in real estate and 401K savings reduces taxes?
    Ryan Deasy Rental Property Investor from Houston, TX
    Replied about 2 months ago
    Yup! exactly what Brad said!
    Brad Shepherd Syndicator from Austin, TX
    Replied about 2 months ago
    Whatever you put in your traditional 401k reduces your taxable income. Investing in real estate can provide great benefits through ordinary expense but primarily through depreciation.
    Wenda Kennedy JD from Nikiski, Alaska
    Replied about 2 months ago
    This is my tough love answer to your post... Are you paying taxes by the Quarter? And why would you file an extension when you owe -- without paying an estimated bill? That just makes your total tax bite much bigger and makes you more visible to the IRS. Do you really want to be their favorite target? You need a really good CPA to babysit you through the process. You need a bookkeeper who gives those numbers to your CPA when they are due -- since you don't seem to be keeping up with the things. You MUST organize your receipts and expenses for that bookkeeper as part of your daily routine. You need to file and pay your estimated taxes every Quarter -- with these two people's professional advice. Your goal should be to NEVER file your taxes late again due to your inattention. Get a grip, man. Clear your mind and desk of all of the messiness. Paying taxes ON TIME is a basic responsibility IF you want to stay in the real estate business. More properties and deals mean more bookkeeping and records. If you're intent on doing investing, you must up your game. Yes, I know I'm slamming you. But, you started out saying that your MO is filing the tax extensions... and poor you... you owe Uncle $8,000 in October... you are finally doing the paperwork in the last week of that extension.. which you should have done a long time ago... and you should have paid the bill last year... and now you want to use your RE to cut your tax bill? Uh?
    Ryan Deasy Rental Property Investor from Houston, TX
    Replied about 2 months ago
    Thank you Brad. Those are great points. i definitely need to be more on the ball for sure! i knew this post would draw up some comments like Wenda's and that is great!
    Brad Shepherd Syndicator from Austin, TX
    Replied about 2 months ago
    Organization and professional advice, I agree. But filing extensions is a common and beneficial practice. The only reason I would file in March (business) or April (personal) is if I thought the government owed me a refund, which I never want since they don't pay interest on that loan. Extending does not make you more of a target. Some would argue just the opposite.
    Account Closed
    Replied about 2 months ago
    I was a real estate professional for tax purposes and has a W2 for a decade. This is the only way I was able to become financially free, this help others do the same thing. Today, I live in california and pay no taxes legally as I no longer have a W2.
    Ryan Deasy Rental Property Investor from Houston, TX
    Replied about 2 months ago
    i would love to talk to you about how you were able to pull this off.
    Farris Gosea
    Replied about 2 months ago
    So confused. If I make 70k a year from rentals how does being a real estate professional help me take more losses?
    Ryan Deasy Rental Property Investor from Houston, TX
    Replied about 2 months ago
    Here is an example of what happened to me. i did heavy rehab on property. aside from the hard money funds i probably spend about 30-40k of my own money in the 2018 tax year. i made about 2000 total income on the property in 2018 because my first lease was sometime in december. all the money i spent, depreciation, interest at 10% on the hard money loan etc is all limited to 25k. clearly i spent much more than that. however, all these extra losses above and beyond 25k now have to wait to be used. it would have been great to offset income at other properties.
    Jay S. Rental Property Investor from Los Angeles, CA
    Replied about 2 months ago
    Nice article !! However there are easy ways through which you csn reduce your RE tax liability to just 15%. No need to go through lot of hassels.
    Ryan Deasy Rental Property Investor from Houston, TX
    Replied about 2 months ago
    thank you! i really appreciate you reading and commenting.
    CJ M. Rental Property Investor from Canton, OH
    Replied about 1 month ago
    What about depreciation? Shouldn't that be a point in the article?