Tax Deductions In Real Estate Investing

19 Replies

Hello, I'm a newbie in this site and real estate investing. I have a question for all you professional investors. I want to know the best way to setup my company in order to make the most money and pay less taxes. I hear someone say they take over 400 deductions every year so they pay less taxes. What is the best way to achieve this?

@Luisito Espanola you take a tax deduction when you spend money in or on your business. The way to make the most money is to do real estate deals that make you a lot of money without having to spend a lot of money. More tax deductions does not equal more earned income. 

It all depends Lusito. a deduction is a deduction regardless of the entity you use, but there are arguments for a C corp or a flow through (S corp or LLC). We use all flow throughs (one S corp we converted from a C and and LLC). The reason being it was easier to manage quarterly tax payments and we are still afforded the ability to defer income via a 401K plan we have within the companies. I would suggest if you are in the 39.6% tax bracket you could consider a C Corp at the lower tax bracket but I don't want to deal with that as I can still defer 25% of wages we pay ourselves up to $50K a year into the 401K plan we have and use that as a tax deferred vehicle to invest in additional property. When you start though, the first thing you have to do is generate income. Then worry about deductions. I would not have any entity until I had some cash coming in. Good Luck!

A couple of things to consider with tax deductions:

1) The expense you avoid is worth far more than the tax deduction on that expense.  Don't accumulate needless expenses just for the deduction.

2) The income you earn will still net out to money in your pocket even after paying the tax. Don't leave income on the table just because you will be taxed on it.

3) Most real estate expenses are deductible in the year you pay them, especially if the benefit is immediate (like a utility payment or property tax).

4) Some expenses are prorated through the life of the improvement, such as depreciable buildings and roof repairs. This is also known as a capital expenditure (although land is not expensed). Even though you will be out of pocket up front for the expense, it will take years to get all of the tax deduction.

5) Choosing your tax strategies with legal entities and exchanges will change the timing of your tax bill and the tax rate at which you pay. Most have tradeoffs in terms of benefits and complexity.

So these are five rules that I used to advise my clients when I was in practice a long time ago. If you keep track of every expense, a tax professional can go over what is usable or not, and how to best put them to use.

Scott

I never recommend making a decision based on the tax deductions. If you are in the 30% tax bracket then for every $1,000 of deductible expenses, you will be able to write off $300 on your taxes. BUT you have still spent $700 out-of-pocket to "save" $300. 

I agree with @Rob Beland , choose real estate that earns you the most money after expenses. Then consult with a CPA to determine how to maximize your deductions and shelter your investments. 

Depreciation is best deduction.  When I started buying real estate the last thing on my mind was tax deductions.  Creating income was priority #1.  Paying taxes shows you made a profit, and show the banks you can borrow $$$$.

Frank

@Luisito Espanola

If you are self-employed with no employees, look into opening a solo 401k as it will allow you to reduce your taxable income by as much as $53,000 or $59,000 if you are age 50 or older. These are year 2015 contribution numbers which generally increase each year based on cost of living index.

http://www.irs.gov/Retirement-Plans/One-Participan...

Originally posted by @Rob Beland :

@Luisito Espanolayou take a tax deduction when you spend money in or on your business. The way to make the most money is to do real estate deals that make you a lot of money without having to spend a lot of money. More tax deductions does not equal more earned income. 

 Thank you for your advice. I will always keep it in mind. I want to learn just what you said. I'm starting from scratch. I'm working on getting my RE sales license right now. I hope to work to get me started. I appreciate your time answering my question.

Originally posted by @Greg Carrier :

It all depends Lusito. a deduction is a deduction regardless of the entity you use, but there are arguments for a C corp or a flow through (S corp or LLC). We use all flow throughs (one S corp we converted from a C and and LLC). The reason being it was easier to manage quarterly tax payments and we are still afforded the ability to defer income via a 401K plan we have within the companies. I would suggest if you are in the 39.6% tax bracket you could consider a C Corp at the lower tax bracket but I don't want to deal with that as I can still defer 25% of wages we pay ourselves up to $50K a year into the 401K plan we have and use that as a tax deferred vehicle to invest in additional property. When you start though, the first thing you have to do is generate income. Then worry about deductions. I would not have any entity until I had some cash coming in. Good Luck!

 Thank you.

Originally posted by @J Scott Hamilton :

A couple of things to consider with tax deductions:

1) The expense you avoid is worth far more than the tax deduction on that expense.  Don't accumulate needless expenses just for the deduction.

2) The income you earn will still net out to money in your pocket even after paying the tax. Don't leave income on the table just because you will be taxed on it.

3) Most real estate expenses are deductible in the year you pay them, especially if the benefit is immediate (like a utility payment or property tax).

4) Some expenses are prorated through the life of the improvement, such as depreciable buildings and roof repairs. This is also known as a capital expenditure (although land is not expensed). Even though you will be out of pocket up front for the expense, it will take years to get all of the tax deduction.

5) Choosing your tax strategies with legal entities and exchanges will change the timing of your tax bill and the tax rate at which you pay. Most have tradeoffs in terms of benefits and complexity.

So these are five rules that I used to advise my clients when I was in practice a long time ago. If you keep track of every expense, a tax professional can go over what is usable or not, and how to best put them to use.

Scott

 Thank you Scott, great rules. I will keep a note of them.

Originally posted by @Ralph Hunter :

I never recommend making a decision based on the tax deductions. If you are in the 30% tax bracket then for every $1,000 of deductible expenses, you will be able to write off $300 on your taxes. BUT you have still spent $700 out-of-pocket to "save" $300. 

I agree with @Rob Beland , choose real estate that earns you the most money after expenses. Then consult with a CPA to determine how to maximize your deductions and shelter your investments. 

 Thank you for your time. Great advice. 

Originally posted by @Frank R.:

Depreciation is best deduction.  When I started buying real estate the last thing on my mind was tax deductions.  Creating income was priority #1.  Paying taxes shows you made a profit, and show the banks you can borrow $$$$.

Frank

 Thank you for your advice and time. Good luck.

Originally posted by @Mark Nolan :

@Luisito Espanola

If you are self-employed with no employees, look into opening a solo 401k as it will allow you to reduce your taxable income by as much as $53,000 or $59,000 if you are age 50 or older. These are year 2015 contribution numbers which generally increase each year based on cost of living index.

http://www.irs.gov/Retirement-Plans/One-Participan...

 If I start a company now. Can I still use this for next years taxes? Thank you for your advice and time.

@Luisito Espanola

Yes if you are self-employed or pursuing self-employment this year, you can open a solo 401k.

@Luisito Espanola Welcome to BP! I agree with what others have said, a 401k (specifically a Solo 401k) can really help in reducing taxes on earned income. Of course maximizing that income is a a better focus than finding deductions in general.

If you start a company and adopt a Solo 401k plan now, you can contribute earned income to the plan for 2015 as well as for any future years you have such income. Those contributions are deductible and will grow in your Solo 401k on a tax deferred basis. With the right plan, you can also take loans from the growing balance as well as invest these funds directly into real estate and other alternative assets such as funding private loans.

Another great option to consider is using a self-directed retirement account (such as a IRA, Roth IRA and the previously mentioned Solo 401(k)) to invest in real estate. Income and gains from these investments roll back into the retirement account. These are great ways to build wealth if you do not need the rental income right now to survive. Taxes are minimized or even deferred.

@Mark Nolan @Justin Windham @Ralph Hunter

Thanks again for your responses. I feel very welcomed in BP. I wish I would have known about this site 2 years ago. Everyone here is very helpful. Right now what I'm leaning towards is the self directed Solo 401(k) plan.  @Mark Nolan I like the link to IRS retirement income. @Justin Windham I used to be stationed in Denver at Buckley ANGB while I was in the Air Force 1989-91 I love Denver I have a sister and here family who lives in Loveland. @Ralph Hunter nice and very professional website. I'm working on my RE license here in Las Vegas. Let's connect and maybe make some business together. I wish you all the success in the world. 

@Luisito Espanola to "mention" someone. Type the @ symbol followed by the first three letters of their name. Below the reply box will appear a list of the names that match the first three characters. Select the one you want and their name will appear in your post highlighted in blue. 

@Luisito Espanola ,

To answer your question takes both tax and legal professionals. The REI education school I'm connected with has a two-day on-line tax and legal class which only breaks the surface - the tax code is many thousands of pages!

You'll want to find a tax attorney and tax accountant - preferably, the same person, I can recommend someone, if you need it - who can help you do it right from the start.

@Bill S. Thanks Bill, I didn't know that. You made my day. I was typing the whole name. 

@David Dachtera Thank you for your reply. Please send me more information about the school. 

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