No CPA has a good answer for my situation. How can I reduce my income tax with real estate investment?

11 Replies

I am in a situation that traditional tax benefit of real estate investment is not applicable.

My wife and I want to buy a primary residence and rental properties within next 3 months and hoping to make this investment beneficial for my tax return as well. I have an earned income job which is at 33% tax bracket when married filing jointly and my wife cannot be a real estate investor since she is on H4 Visa status which dose not allow any income generating activity.

I have a strong passion in real estate. Gas and oil or agricultural investment might give me tax benefit but it looks risky. After speaking to CPAs who are very knowledgeable in real estate investment, only answer I now have is to maximize my 401K.

Owning rentals has tax benefits to the extent of your positive cash flow.  Your income is probably too high to claim passive loss.  So you buy rentals with high cash flow possibly through lower leverage or cash and write off that income against depreciation 

@Seolhyun Lee  

 You are certainly in an enviable position.  Certainly, combining the tool of using sec 121 to sell your primary residence and 1031 exchanges to sell and increase your rental portfolio will eliminate and completely defer all tax on profit from sales.  And this you can do outside your 401K.  Beyond that you may be asking the wrong question there are many standard deductions but ultimately, if you make profit you will pay tax.  Why not ask the question "how an i minimize additional tax."  i think you'll find that over time a strategy where you maximize income, minimize taxes, and accept some tax as the consequence of success your net worth will enjoy leaps and bounds.  

Dave

I am a CPA, but I could not speculate on your tax situation without the nitty gritty details. However, I have a good paying accounting position in the insurance industry and there are always ways to improve or lower your taxable income. The first thing you should research is setting up and "S" Corporation to run your real estate investing activities through. No double taxation and income and losses flow through to your individual tax return. Thus, there is ALOT more expenses to offset income from real estate taxation. Guess what, use that cute baby in advertising your "S" Corp and she gets a paycheck up to a certain amount TAX FREE and a write off for the business. You can pay yourself a "Reasonable" salary from the "S" Corp and take the rest as a shareholder distribution (again not taxed at full tax rates). Of course, for rental properties you can take depreciation against the rental income thus reducing taxable active income and deferring it as a future investment gain that is not taxed on a graduated scale, but has historically been a flat 15% - 20%, as apposed to you current 33%. But you can do this individually and through an "S" Corp and get the same result. I am not familiar with the Visa status of your wife, but perhaps she can form Property Management LLC or Cleaning business. You pay the cleaning business to clean your rental properties, take the deduction for the "S" corp, and if she is not an active officer, maybe she gets passive income through ownership and pays family to do the work. OK, I have gotten carried away. As I do not know your full situation, please do not take any of this accounting or legal advise. I would recommend continuing your search for the right CPA that is very familiar with structuring businesses and NOT just real estate. CPA's are like doctors, we all have specialties. Just because I am well versed in insurance accounting and taxation, does not make me an individual or general business expert which is why I have my own CPA to do my real estate business and taxes. I can't tell you how many people approach me when they see CPA after my name and start asking individual tax questions. I know enough to make me dangerous, but fully acknowledge this is NOT my expertise. I would also seek out a good business and real estate lawyer for the same reason. I would hope you would not go after an ambulance chaser to seek this advise ;-)

I hope this helps you and anyone else reading this post.

I am NOT a CPA. This is speculation based on MY PERSONAL situation. We are in a similar situation in the fact that we are duel income no kids and earned good starting incomes. The houses help you when you can produce a BOOK LOSS AND you are below the threshold of counting it. The thing that Real Estate does for ANYONE is it hides your gains. So as long as you are coming at neutral you don't have to pay taxes on your passive investments. If you are coming out positive than you will have to pay gains. If you are coming out negative and above the threshold to count it. Than you can save the "loss" for later through roll over. 

Basically depending on your "situation" it may or may not help your existing income. It "should" at least hiding your passive investments. 

First ,  the CPA is right that in your situation maximizing the 401k is a first step. so far that is what we found in our situation.  A personal residence will help decrease your tax obligations but you will need to get used to the idea that if you make money you will pay taxes and lots of them.   Legally minimizing them is the best you can do.  Real estate investing in your situation will help you only to hide appreciation gains until you decide to realize them. The biggest plus is deducting expenses and depreciation.  I have to look at the corporation related comments more in depth, interesting bu that hasn't been suggested to us.

I will caution  you  that while paying a CPA a reasonable amount to do your taxes is worth it be careful of the tax strategy CPA.  We were really taken for a ride by one CPA who basically billed himself this way and our taxes were no better by him then then other while he cost thousands. He had us thinking we would at least make his fee back and for our wage earning and "passive" RE investments that wasn't true.  You are a wage earner at the moment and you are going to pay the rate the current administration is asking plus pay for any income you show on rentals. The key is what income you show. 

Your wife's visa may not bar her from positioning herself through training now  to have a primary real estate occupation should she ever have a working visa down the road. That would move you out of the "Passive" investor category and open more tax deductions but that would be long term planning. 

I am a CPA that specializes in real estate and have run into this situation plenty of times before. 

When reading your post Lee, I had the same thoughts Colleen did. Although your wife may not be able to find a wage or compensation paying type position due to her VISA, what is stopping her from managing your own portfolio of rental properties? If you accumulate enough of them with leverage, you could create a real estate rental loss that could be offset against your income through the Real Estate Professional designation should your wife show 750 hours of management activity without external help. 

As for a few ideas that Chandler puts up, I have some comments to add:

S-Corporation as holding company / management company 

-I would not see any value in doing this, given your situation. S-Corporations have much more restrictive rules for allowing you to pass losses through to your personal return. Unlike a standard unincorporated LLC, you CANNOT use company debt to take losses against for basis purposes. Thus, you can only take losses up to the amount of any personal contributions to the corporation and/or the use of any PERSONAL debt to finance company transactions.

Taking Reasonable Salary

-Why? You are creating a payroll tax for doing this with very little potential for benefit. While you do allow the possibility for the wife to contribute to her own retirement account, the "entrance fee" of a 15.4% employment tax is an incredibly steep investment just to get her foot in the door. 

Advertising with Baby

While I preach to my clients to get their kids on payroll as soon as it becomes REASONABLE, I do not advocate that any of my clients use infants or toddlers for similar reasons. IRS audits zero in on payments to kids and expect a taxpayer to show the amounts paid to kids are for arm's length type work. In other words, market value. If you are paying your child a couple thousand for a marketing fee (i.e. taking a few pictures for your ads), be ready to prove to the IRS the rate you paid YOUR child is considered fair value and a market rate. What makes YOUR child worth more than the average child? This is a very slippery slope and has an incredibly high threshold of proof that must be met in an audit situation. 

Disclaimer: I know Chandler is not a CPA that does this for a living, just wanted to clarify a few points. 

All in all, I think the best strategy for Lee would be to find an accountant that is specialized and knowledgeable in the Real Estate Professional designation and help get his wife to meet that criteria. It allows for his rental losses to offset his wages, there's no creation of any taxes, there's no special tax returns that need prepared to do it, and he keeps his bill to his CPA and IRS at an absolute minimum while adhering to tax laws. 

@Nathaniel Busch  is spot on. It sounds as if you would like to drastically reduce your taxable income and the best way to do that (with real estate) would be to have your wife classify as an RE Professional. If she can do this, any RE loss can be deducted against your W-2 income. I would like to add two things to Nathaniel's post:

1) In addition to your wife working at least 750 hours, 51% of her time must be dedicated to real estate activities and she must meet an ownership test (must own at least 5% of the company if she is an employee).

2) You must file jointly. Even if your wife qualifies as an RE Professional, you will not be able to deduct the losses against your own income if you two are filing separately.

I had the same problem, I invest in a oil company that produces oil and natural gas, I can write off up to 80% of my active income in the first year and the rest over then next 5.  Then once the oil comes out of the ground we receive monthly payments for 20-30 years. 

Nathaniel just made my point. I was only throwing ideas out there and clearly Nathaniel is much more versed in this area of expertise as a CPA. I was thinking more long term, which I did not clarify and I appologize for that. Personally, I am trying to quit the day job and invest full time, which is always the angle I view everything from. In the current situation, Nathaniel is absolutely correct. Longer term, the baby will eventually be able to hold a paint brush, address and lick envelopes, clean rentals ;-) Just saying you can teach them the business early and they can get paid. Not sure how child labor laws apply to your own children, but I know I started helping out around the house at a young age like newspaper route in elementary school. LOL

I might also throw out there that you can max your 401K contributions with your employer for now and when and if you decide to invest full time and leave the day job, roll it to self directed and use those funds to invest in real estate. Also thinking longer term, I set up my investment company as an "S" corporation and established my own 401K in that corporation as self directed. I then rolled my SEP IRA from when I was self employed into my self directed 401K. I now use these fund for real estate investments and rental income and gains are tax deferred. I can also piggy back a Roth IRA onto this system to fund as well, which goes in after tax. However, any properties you buy in this Roth, all appreciation and rental income is TAX FREE when you retire from what I understand. Unfortunately, if you are employed and utilizing a 401K there, then you will not be able to fund your business 401K until you quit the day job. I am currently in this situation as well.

From my point of view, tax planning is ALWAYS long term and Proactive. I think alot of people get to caught up in thinking only in the present situation and end up being Reactive.

My advise stays the same, find the right CPA and Lawyer to set yourself up correctly going forward. I love classifying the wife as a real estate professional, which is where I was going in my tired stupper last night with the "Property Management" and/or "Cleaning Business".

Best of luck.

Originally posted by @Nathaniel Busch :

All in all, I think the best strategy for Lee would be to find an accountant that is specialized and knowledgeable in the Real Estate Professional designation and help get his wife to meet that criteria. It allows for his rental losses to offset his wages, there's no creation of any taxes, there's no special tax returns that need prepared to do it, and he keeps his bill to his CPA and IRS at an absolute minimum while adhering to tax laws. 

That was exactly what I wanted to do; make smart investment with 1/3 of my hard work using real estate investment as the tool. The dilemma is that I am not sure if my wife is allowed to be a Real Estate Professional under the immigration law. Maybe I should find an immigration law attorney? :) 

Originally posted by @Colleen F. :

I will caution  you  that while paying a CPA a reasonable amount to do your taxes is worth it be careful of the tax strategy CPA.  We were really taken for a ride by one CPA who basically billed himself this way and our taxes were no better by him then then other while he cost thousands. He had us thinking we would at least make his fee back and for our wage earning and "passive" RE investments that wasn't true.  You are a wage earner at the moment and you are going to pay the rate the current administration is asking plus pay for any income you show on rentals. The key is what income you show. 

Your wife's visa may not bar her from positioning herself through training now  to have a primary real estate occupation should she ever have a working visa down the road. That would move you out of the "Passive" investor category and open more tax deductions but that would be long term planning. 

I agree. It is very difficult to know their price will be worth in my situation beforehand. I certainly do not want someone recommends unlawful strategies. I will have to go with a CPA who does not charge top price but still specialize in real estate. 

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