What tax benefits can high income earner get from real estate?

32 Replies

I have always been curious how how significant my tax benefits can be from the purchase of real estate. 

So a little background info on me so you understand why I ask the question.... I am a current multi-unit restauraunt owner who has been in business just under 3 years. I am very blessed my business have been successful which has allowed me a significant 6 figure income, however all my write- offs for depreciation and equipment purchases will not last much longer. This is especially true since I was only able to lease not purchase the buildings.

I have seen my father who is a physician working 100 hours a week pay 50% of his taxes his entire life. While he was very dedicated about investing in the stock market he never knew how to or had the inclination to invest in real estate. A decision which I believe cost him enormous amounts of money over the course of his career. 

Now that I am in his tax bracket(which I never thought would happen) and still in my 30s, I REALLY do not want to see half my income gone each year. I have seen FIRST HAND the amazing tax advantages I received (thanks to my accountant) throughout the first 3 years of my business from depreciation, equipment purchases, etc so I see how powerful it is . Since I do not plan to purchase restaurants for the rest of my life I believe rental income real estate is an excellent alternative. 

So now that you know about about me...Is there any high income earners out there in similar situation to me that can tell me how significant the tax advantages are for them to owning rental real estate? Are they immediate or do they take a while to see the benefits? Even if your not in my situation any professional advise about what types of properties to purchase to start, tax strategies, pitfalls, or ANY sage advice to minimized the dreaded tax bills would be greatly appreciated!! 

Thank you !

Jeff

Welcome to Bigger Pockets!

Any answer to your question that could be typed into a forum post would be incomplete. This is a huge topic! Many books are written about it. Here are a few suggestions/tidbits/points to ponder to guide your further research.

Avoiding taxes is a worthwhile goal, but pursuing an investment only for the tax benefits is usually a recipe for unhappiness. 

How did you plan to invest in real estate? Were you planning to buy residential or commercial property and rent it? Are you looking to buy property, rehab it, and then resell it for a profit? There are different tax implications for those different ways to invest.

You may want to consider reading the Bigger Pockets Book Tax Strategies for the Savvy Real Estate Investor for some ideas. Then go see a tax professional who is knowledgeable in real estate investing and talk about strategies you are considering to see how they fit into your specific situation. Everyone's situation is unique, insist on unique recommendations for yours.

Best of Luck with Your Real Estate Investing!

"Let's see @Paul Allen 's card.... Look at that subtle colouring. The tasteful thickness... Oh my God. It even has a watermark." I'm sorry.

Suggest you make an appointment with your CPA asking what it takes to be in a lower tax bracket. Feds & State.

Key word is passive loss.

Ha! @Dillon Lieder

I'd post a picture of my card, but I think that is probably a violation of forum rules.  :-)

Jeff,

I would suggest that you (as others have suggested) find a CPA that is familiar with real estate investing. You would also want to think about these two topics and mention them to the CPA as well:

1. Not sure if your wife works, but if not, then you would want to ask about forming an LLC taxed as a partnership with yourself and your wife as the sole members. If your wife can substantiate that she spends at least 750 hours of her time those real estate activities then she could qualify as a real estate professional. This is important because it will allow you to deduct the passive activity losses that the real estate activities would/could generate.

- A sidebar to the LLC formation - the rental activities are considered passive. Passive activities are not subject to self employment. This means the benefit of an SCorp is not important for self employment tax. Partnership tax treatment also avoids some issues that SCorps create when moving real estate in and out of the entity.

- One other planning for for discussion since you are starting from scratch is asset protection. Garrett Sutton recommends in his book that a Wyoming LLC owned by yourself and spouse that has subsidiary single member LLCs (with the Wyoming LLC as the single member) created in the state where the property is owned forms an excellent layer of protection. I can tell you that I am not an attorney but I set my structure up in this manner. If for any reason why not? At any rate, you might want to check out his book: Loopholes of Real Estate.

2. The other topic that would be of great benefit would be to discuss a self directed Roth IRA. High income earners are not allowed to contribute to a Roth IRA but you are allowed to roll funds from other retirement plans into a Roth IRA. Equity Trust would be a great company for being the custodian of the IRA but your CPA will be integral in your understanding of how to incorporate your existing retirement plans (if there are ones in place for your companies) into this strategy and also what a self directed Roth IRA could mean for your family. The gist of the Roth is that you get no tax benefit when contributing the funds but once the will not be subject to tax when withdrawn. The Roth does not have required minimum distributions for the creator of the account so you can literally never withdraw the funds (or properties if self directed) and pass them to your children where they can grow tax free for an even longer period.

Here’s the disclaimer: I am not a publicly practicing CPA but I have a high level of understanding of situations similar to yours. 

Chris

Congrats on your business success!  A good problem to have, taxes from high income.

I buy and hold RE long-term for depreciation and no SE tax on the passive income,  I buy property with low land value and have depreciation coming out my ears.  Don't forget about condos and townhomes.  No land value = all depreciation.  Good for high land value coastal areas and such.

Flipping and lending will only add to your tax burden.  I would avoid those in your shoes.

Crowdfunding , syndications and stuff give you a little tax benefit, but no say.

Broad strokes here, see a RE-focused tax professional of course @Jeff Lulek

Originally posted by @Chris B. :

Jeff,

I would suggest that you (as others have suggested) find a CPA that is familiar with real estate investing. You would also want to think about these two topics and mention them to the CPA as well:

1. Not sure if your wife works, but if not, then you would want to ask about forming an LLC taxed as a partnership with yourself and your wife as the sole members. If your wife can substantiate that she spends at least 750 hours of her time those real estate activities then she could qualify as a real estate professional. This is important because it will allow you to deduct the passive activity losses that the real estate activities would/could generate.

- A sidebar to the LLC formation - the rental activities are considered passive. Passive activities are not subject to self employment. This means the benefit of an SCorp is not important for self employment tax. Partnership tax treatment also avoids some issues that SCorps create when moving real estate in and out of the entity.

- One other planning for for discussion since you are starting from scratch is asset protection. Garrett Sutton recommends in his book that a Wyoming LLC owned by yourself and spouse that has subsidiary single member LLCs (with the Wyoming LLC as the single member) created in the state where the property is owned forms an excellent layer of protection. I can tell you that I am not an attorney but I set my structure up in this manner. If for any reason why not? At any rate, you might want to check out his book: Loopholes of Real Estate.

2. The other topic that would be of great benefit would be to discuss a self directed Roth IRA. High income earners are not allowed to contribute to a Roth IRA but you are allowed to roll funds from other retirement plans into a Roth IRA. Equity Trust would be a great company for being the custodian of the IRA but your CPA will be integral in your understanding of how to incorporate your existing retirement plans (if there are ones in place for your companies) into this strategy and also what a self directed Roth IRA could mean for your family. The gist of the Roth is that you get no tax benefit when contributing the funds but once the will not be subject to tax when withdrawn. The Roth does not have required minimum distributions for the creator of the account so you can literally never withdraw the funds (or properties if self directed) and pass them to your children where they can grow tax free for an even longer period.

Here’s the disclaimer: I am not a publicly practicing CPA but I have a high level of understanding of situations similar to yours. 

Chris

Hey Chris.  Nice comment on the real estate professional status.  Help me with the Roth...how does a Roth conversion benefit Jeff since he will have to pay tax on the conversion?

@Jeff Lulek

To answer the title of this thread: There are multiple. You can get depreciation and you can defer the capital gains for appreciation.

There are a lot of good suggestions above of what to consider. I would echo statements about passive losses (the limit you get now vs. the unlimited losses as a Realtor or RE professional), and how active or passive you want to be as an investor, which will determine your strategy.

One thing I didn't see mentioned was that there may be more you could do to maximize the tax advantages of your business. In fact, you may be able to get enough losses from your business alone that your limited passive losses as an individual may not matter as much. It sounds like your CPA has done a pretty good job so far, but I've found it really takes an expert in this particular area to really get you the most out of your business in regards to tax savings.

You may want to try connecting with my colleague Lex Byers, who is based outside of Detroit. He's an attorney and recognized expert in retirement planning, income tax mitigation and asset protection (among other things).

http://www.lexbyers.com/

I'd also suggest looking at other tax savings vehicles like others suggested including qualified plans (such as IRA's, 401K's, HSA's, etc) for your employees.

@Mike Dymski

The quick and dirty way to look at retirement plans (any of them) is that is the IRS expects you to pay income tax on the withdrawals from retirement in which hey gave you a deduction for your contribution. Traditional IRAs, SEP, SIMPLE, 401k, 403b, you name it. The Roth is the only only that allows you to pull your qualified distributions (when you reach 59 1/2) out without paying tax. There is a trade off for this wonderful benefit: you can't contribute once you exceed about 150k in adjusted gross income. If you are below the threshold and qualify to contribute then your contribution would be limited to 5-6k (depending on your age) which is the same as a Traditional IRA. It will take a long time of 5 or 6k contributions to have enough in the plan to purchase much property but it is very doable. You will never pay income tax on the withdrawals from the Roth IRA. Should you get wealthy enough that you never need the funds or property held in the Roth then you can heirs can inherit said Roth IRA and withdraw the funds tax free. Roth IRAs have no required minimum distributions during the lifetime of the person who started the IRA. They do have required minimum distributions if a person inherits such an IRA.

The real super charge on this strategy comes when you up the contribution amount. You can't directly contribute more than the IRA limit but you can roll funds into the Roth IRA without limit. The key then is to maximize the other qualified plan contributions and then roll them into the Roth IRA. Let's pretend that Jeff is married but his spouse is not an employee of the restaurant (the spouse can be an owner) and that Jeff has no other employees. If Jeff receives a paycheck from his restaurant and the restaurants are taxed as SCorps then Jeff can set up a solo 401k plan with a custodian. He will be able to get 56k per year (not 5-6) into that solo 401k per year. He gets a tax deduction for that contribution but he gives it up when he rolls it into the Roth. His family can then build a tax free real estate empire as well as one subject to tax.

Employees will complicate the scenario as any plan offered will have to include employees. They would not be involved in jeff's Roth IRA but they would be allowed to participate in the qualified plan that is tax deductible.

Nope, @Jeff Lulek , no one out here like you , sorry;) Welcome to BP.

Michigan, eh? Invest in a wind farm. Or better, develop a wind farm. Form 3468 Part III 12(o). No wind where I am so I use 12(b) ;)

Moderators:  I'm just answering the question, which at its root is all about real estate

See also Gratiot County, MI for an example or two. Talk to a CPA who knows 3486. Good luck.

Disclaimer: I am not a CPA. I am not a wind farm developer, but I am a part-time solar farm developer. I don't promote anything. I only see people in the swamp who use 3468 and pay no current tax (kind of like DT who pays no federal tax). Your mileage may vary, based on your CPA, your understanding of tax laws, and theirs

Chris,

thank you much for the tax form and the advise! Thank you for the warm welcome as well, IM glad to be a part of this!

@Paul Allen . Thank you for the warm welcome Paul! I understand there is no way to completely answer how to save on taxes in one reply, just looking for advise. I actually just started reading that book and love it so far!

I do not want to invest purely for the tax advantages but i won't lie those are a HUGE reason. I also love the potential for a third stream of income, passing down my properties someday, and learning a new business.

I thought I would start out with a single family home or duplex and see how that goes and work my way up slowly. I have a very close friend that's part of a property management company and he could manage them for me as well. I could possibly see myself buying an apartment building someday but that is a ways off i believe. I may consider doing some flips when I have a it more time after finishing building my last 2 restaurants in the next 2 years.

I like to do a good about of research and studying up on something before I just put my hard earned money into it and potentially make a bad investment. Do you think that starting slow getting one or two properties a year is a wise strategy?

thank you for taking the time to respond Paul!

@Sam Shueh ...Sam, 

I find that VERY interesting. Would you mind expanding on how I could explain to my CPA about how to be in a lower income bracket and what you mean by passive loss? are you referring to work 750 hours to get the passive loss write off? Cause I would not qualify for that as I don't have the time to devote that many hours. 

thank you!

@Dillon Leider . "I cant believe Brice prefers Van Patten's card to mine!" LOVE that movie 

Talk to your CPA that is what he is supposed to do. What deduction you are entitled and not used? How can you be like our president not paying income tax. Passive loss can be owning certain type of real estate.  

@Chris B. Given a choice of buying into a syndication with Roth IRA money or taxable acct money, I'd be inclined to think taxable was better for the better tax advantages of RE, even inside a syndication. Is that a correct assumption? Is that a good reason not to use funds in a Roth to invest in RE? Lastly, it sounds like heirs must take distributions (tax free) from a Roth IRA but when it's in RE, it can stay there and grow tax free?

You gave a great example of how to get $56k into a Roth IRA - wish I could get $ out of my 403b this way.

@Dave 

@Dave Van Horn . Dave,

I certainly appreciate the reference to Lex Byers. I have used the same CPA my father has for years and he is a good old school CPA but I am uncertain how familiar he is with tax regarding real estate. I do have a ROTH IRA which I maxed out of income-wise, also a ROTH 401K which i contribute$18k annually to, I will have to look into HSA.

I just don't understand why writing off the passive losses would be so valuable? As I understand it passive loss is when your expenses are exceeding you income from the property. I didn't get into rental properties with the expectation of having too many properties being unprofitable, not to mention I'm not sure how I would dedicate 750 a year to real estate. 

Am I missing something ? 

thanks for responding Dave!

@Jeff Lulek , you mentioned eventually buying an apartment building but that it is a ways off. Have you considered syndication and joining the team as a passive investor/limited partner? It sounds like you meet the SECs requirements to be classified as an accredited investor. Depending on how involved you want to be (this route is absolutely more passive), it's definitely something to consider. Check out my blog on why apartment syndication is an appealing investment vehicle. Number 7 touches on some tax benefits, although it is by no means all inclusive.

https://www.biggerpockets.com/blogs/10191/66365-8-...

Best of luck!

@Chris B. Chris,

wow thats a lot of valuable info and much apprecieted. I do have a ROTH IRA I maxed out of income-wise. So I contribute to my business ROTH 401K which I max out at 18k each year. I really want to learn more about this self-directed IRA and how i can rollover and even purchase property with them. If you have any more info I'd be happy to read it!

That is a great idea about the wife becoming a real estate professional since I suppose I am unable to qualify since my main source of income is my businesses and real estate is certainly not going to be more then 50% of my income for a while.

The thing I don't understand is why is being a real estate professional so valuable? Is writing off my passive losses really that advantageous? I mean I want to get into rental real state to make a positive cash flow(and tax advantages) not a negative then write it off. That seems like it defeats the purpose in have a rental property. 

Am I missing something?

thanks for the response Chris!

Hi Jeff, feel free to reach out to me. This is exactly why I started in real estate and now made it my full time job.

Best,
Troy

@Steve Vaughan . Steve,

That is a great little tip about condos and townhomes and I will keep in mind of the future! Can you tell me what were your first types of properties you bough? Any recommendation wether I should start with Single family, duplex, condo, etc? 

Also do you use a management company?

thanks for the advise!

@Jeff Lulek :

wow thats a lot of valuable info and much apprecieted. I do have a ROTH IRA I maxed out of income-wise. So I contribute to my business ROTH 401K which I max out at 18k each year. I really want to learn more about this self-directed IRA and how i can rollover and even purchase property with them. If you have any more info I'd be happy to read it!

No problem Jeff! I would recommend you reach out to a self directed IRA custodian. I am familiar with a company call "Equity Trust" (I can't post the link) and I believe they would be able to answer many of the questions you will have about how to use a self directed Roth and rolling your funds into a plan with them.

That is a great idea about the wife becoming a real estate professional since I suppose I am unable to qualify since my main source of income is my businesses and real estate is certainly not going to be more then 50% of my income for a while.

Generally speaking the IRS views a person who has W2 income from another job as someone who is not eligible to be a real estate professional. If a person has no W2 income but owns several companies than the IRS could still argue that the person does not meet all of the criteria for being a real estate profession. 

For instance, say a person has no other job or W2 but only owns 1 single family residence for rental and it is managed by a professional property management company. The owner of that single family residence will not qualify as a real estate professional. The same would apply for 1 apartment building. A person who owns multiple and is working with multiple management companies would have a much stronger argument that the day to day work on bookkeeping, correspondence with the management companies, pricing repairs with outside contractors (if they are large), looking for new deals, working with banks, etc takes at least 750 hours a year.

The thing I don't understand is why is being a real estate professional so valuable? Is writing off my passive losses really that advantageous? I mean I want to get into rental real state to make a positive cash flow(and tax advantages) not a negative then write it off. That seems like it defeats the purpose in have a rental property. 

Depreciation of the property while you hold it and the deferred income tax on appreciation of the underlying asset are probably the two main tax benefits that real estate provides. There are definitely syndication deals that involve low income housing tax credits or historic preservation credits (as well as other tax credits) that offer incentives besides appreciation and deprecation. They are not the types of investments that most people will seek.

Appreciation is the easy topic of the two. You buy an asset now and it should (as long as you did your due diligence up front) be worth more in the future than it is today. The difference, or profit, or gain is only dealt with at the time the property is sold. There are many ways to sell the property to minimize the tax impact but you don't have to pay income tax on the increased value each year.

Depreciation is a little more complex. I agree that it is very easy at first to dismiss the value of being able to deduct passive losses. What if you we able to not only purchase a property that generates positive cash flow (so it is "making money") but you are allowed to accelerate the depreciation of the building and thereby generate a "tax loss". In that situation the government is not only allowing you to have a tax free income but they are allowing you to offset those "tax losses" against the earnings of your other businesses. That is a win-win. The more properties you own, the more you can accelerate the depreciation, the bigger the benefit.

You really would need your CPA to look at your situation to help you better understand how many dollars this equals for you. They would be able to look at a hypothetical apartment building purchase, potential value of completing a "cost segregation study", and how much that would equate to in terms of dollars in your pocket. You can still receive tax free income and appreciation through real estate investment but being able to deduct passive activity losses against your other earned income is a real home run in the higher tax brackets.

@Nancy Bachety

Given a choice of buying into a syndication with Roth IRA money or taxable acct money, I'd be inclined to think taxable was better for the better tax advantages of RE, even inside a syndication. Is that a correct assumption? Is that a good reason not to use funds in a Roth to invest in RE? Lastly, it sounds like heirs must take distributions (tax free) from a Roth IRA but when it's in RE, it can stay there and grow tax free?

I would have to say that the answer depends on the kind of syndication deal and your specific facts and circumstances. Is the deal a straight up equity or debt position on some large real estate that will more than likely generate a tax profit from year to year at some point? This could be a good candidate for a Roth IRA.

On the other hand, if it is a syndication deal that has been specifically structured for tax advantages, then no. Putting a tax advantaged investment (a deal throwing off some kind of tax credits, buy-in based on tax losses, etc) then those would not be a good candidate for a Roth IRA. Basically the Roth would be negating the value of the investment because the tax advantages would be trapped inside of a tax exempt investment vehicle.


You gave a great example of how to get $56k into a Roth IRA - wish I could get $ out of my 403b this way.

Thank you! If you are ever lucky enough to retire from your 403b employer, or unfortunate enough to be terminated (or otherwise "separated from service"), then you would be eligible to roll those funds out of the 403b.

@Jeff Lulek  

The thing I don't understand is why is being a real estate professional so valuable? Is writing off my passive losses really that advantageous? I mean I want to get into rental real state to make a positive cash flow(and tax advantages) not a negative then write it off. That seems like it defeats the purpose in have a rental property. 

If I am reading your question correctly, I can see why you are confused about passive losses. You do no need to experience negative cash flow in your checkbook to be able to write off losses. You write off paper losses from depreciating your assets over time. Believe it or not, some people - even re investors - do not bother to do this or their family accountant isn't doing it for them. 

On top of that, if your are NOT being designated as a RE Professional (or your wife) you are limited from enjoying those losses sooner rather than deferring them until later if your have a high enough W2 income. You still do get passive losses though even if you are positively cash flowing.

@Chris B.

Thank you for clarifying. It is expected to generate a tax profit. 

And yes, I want to separate from service to be able to access those funds. When I do, if I understand this correctly, I would take income from my S corp (no employees) set up a Solo 401K plan, contribute $56K into it, then roll it into a Roth IRA (a pay taxes on that). Good stuff.

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