Moving highly taxed business profits into real estate?

Tax, SDIRAs & Cost Segregation
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Moving highly taxed business profits into real estate?

Jess O.
Member since 2018 · 7 posts · 2 votes

So I'm beginning my real estate journey, and I'm curious about something. I own a highly-profitable online business, and I often see people talking about "moving highly taxed business profits into real estate," and I'd like to start by learning more about this as I don't understand how it's possible. My business makes a lot of money, but if I just started buying real estate with the profits none of that is tax deductible to my business, so I don't understand how that would help. Can someone shed some light on this, or point in the right direction (articles, courses, books, etc.)? Thanks!

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Natalie KolodijBusiness Member
Moderator
Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
8y
Originally posted by @Jason Bott:

@Jess O. here's the way my CPA laid it out for, (I might have the terminology wrong, but you should get the idea).

If your online business is considered Active income, you need Active losses to offset you Active income taxes.

Real Estate that provides Passive income/losses can not offset the Active income.

For your Real Estate to be considered Active income, you need to work in the business 20 hours per week or more.

So the key to reducing taxes is to have both active or passive income.

Again, that's the general premise, a CPA could give you a refined answer that you could act on.

While REI pro i s a great option

There are several tests to meet along side the 700 hours annually. The big one is you need to spend more time doing real estate than any other activities.


So if you're spending 2500 hours a year running a profitable business- you would need to show that you spent > 2500 in real estate as well. 

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  • Carl FischerPro Member
    Rental Property Investor · Ambler, PA · Member since 2015 · 2k+ posts · 1k+ votes
    8y

    @Jess O.

    Real estate depreciation is one of the ways that people use to offset earned income. Get your cpa to help and see what buying real estate does for you. 

    [email protected]215-283-2868
    2Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    8y

    @Jess O.

    There're basically two roads that can be tentatively fit under the "moving highly taxed business profits into real estate" slogan.

    1. Buy rental properties that generate tax losses and use these losses to offset your other income. It may not work in your case at all, based on your vague mention of a highly profitable business - but the only way to tell is to discuss it with a competent tax accountant, one on one, as each situation is different.

    2. Channel your profits into a retirement account ("self-directed retirement account") and use this retirement account to buy real estate. Also needs a discussion with a tax professional.

    Before pursuing real estate for tax reasons, it's a good idea to explore ways to restructure your existing online business for tax savings. Maybe you need to incorporate it or change the type of corporation you're using if already incorporated. Again, sounding like a broken record, this is a strategic conversation with a tax expert. 

    Rules of thumbs are not reliable, and listening to random tips of "this is how I do it" can lead to disasters. People talk about a lot of things. This is what Internet is for.

    Also, taxes are not the right reason to go into real estate. The #1 reason is long-term wealth accumulation. Another topic to discuss with... you know what I'm going to say.

    2Reply
  • Jess O.
    OP
    Member since 2018 · 7 posts · 2 votes
    8y

    Thanks guys for the replies. Things like depreciation and a self-directed retirement account barely make a dent when you're making significant business profits. I believe the most you can contribute to an SEP is 55k a year, which is better than nothing but not terribly meaningful.

    This was just an isolated question in regards to a very specific statement I've seen repeated by several seemingly respected members here, but I think I must be misinterpreting what they're saying...

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  • Ryan Seib
    Attorney and Real Estate Broker · Madison, WI · Member since 2016 · 265 posts · 100 votes
    8y

    Depending on the business, you can also buy real estate with the business. That would allow you to avoid income tax on the business profits, and allow depreciation against future business profits. Accountant or business attorney should be able to help you figure this out. 

    1Reply
  • Jess O.
    OP
    Member since 2018 · 7 posts · 2 votes
    8y

    Ryan,

    I don't know of any type of business structure where purchasing real estate is tax deductible, that's the problem.

    I figured there are 10,000 people here who probably know the answer, so that's why I figured I'd ask here before spending money and hiring a CPA just to ask them one simple question.

    I'm not moving forward with anything any time soon so I have no need to hire a CPA or attorney now, I just need to know the answer to this one particular question before I can move to the next step in my research and planning.

    But if no one answers here then ya I'll have to hire a "professional" I guess...

    0Reply
  • Caleb Heimsoth
    Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
    8y
    Jess O. How much money per year are we talking? Millions? Hundreds of thousands? If it’s a lot you can use something called captive insurance company to shield profits. From my understanding you basically set up an insurance company you own, to insure against different stuff you then pay insurance premiums to your own insurance company and that’s a business write off for the other business, but you also own the company taking your money.. Anyways you’d need a good lawyer to set this up and I believe with fees and maintaining it you need around 2M to make it worth your while
    0Reply
  • Jess O.
    OP
    Member since 2018 · 7 posts · 2 votes
    8y

    Yup that can certainly be a good option @Caleb Heimsoth thanks for the reply.

    The issue is that it will only work with certain types of businesses, and it certainly won't fly with my 100% digital business. If my online biz netted 1M in profits and I just happen to buy close to 1M in insurance for things that could never be justified, well, I wouldn't be able to sleep at night.

    There's no way you'd get out alive if audited unless 1) the amount you're spending on the insurance is "reasonable" vs. your overall profits/expenses etc. (which it wouldn't be if you were making a lot of money and spending all the profits on insurance) and 2) you can actually somehow justify the need for the insurance.

    Seems like these are pretty tough to do with a 100% digital business, especially #2.

    1Reply
  • Caleb Heimsoth
    Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
    8y
    Jess O. Have you considered running this buy a tax person at all? I want to say it may be possible even if it’s all digital but I could be wrong. If you’re all digital, have you considered moving your tax domicile to a low tax area such as Puerto Rico? There are also ways to tax your income less such as taking it as a dividend vs income. No tax advice given
    0Reply
  • Jess O.
    OP
    Member since 2018 · 7 posts · 2 votes
    8y

    @Caleb Heimsoth like I said I assumed this was a relatively straightforward yes/no type question that lots of people here would know the answer to, which is why I posted here. If it turns out that's not the case I'll certainly hire a pro and ask them.

    I also investigated the whole Puerto Rico thing, and even went and spent some time there, but at the end of the day the big benefits require living there for a few years. And let's just say that after spending 10 days there my wife and I agreed that moving our family there for a few years was completely out of the question. For a single, adventurous guy or gal it's certainly an interesting option.

    As far as dividends go, they are not tax deductible to a corporation so that doesn't really work...

    0Reply
  • Caleb Heimsoth
    Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
    8y

    @Jess O. if you make a lot of money and could save tbousands On taxes, hiring a pro for a couple hundred bucks is worth it.

    The other thing is, changing states from one with high taxes to low.  That’s what @Jay Hinrichs just did I believe (at least was part of the reason).  

    Otherwise what I’ve mentioned are going to be the most common ways people reduce Tax liability.  

    0Reply
  • Jess O.
    OP
    Member since 2018 · 7 posts · 2 votes
    8y

    Thanks for your time and replies.

    I've spent at least 200k on attorneys over the past 20 years.

    My original post was just one very specific question that I assumed (maybe incorrectly) that tons of people here would know the answer to, that's the only reason I posted.

    1Reply
  • Jason BottPro Member
    Insurance Agent · Nationwide · Member since 2014 · 2k+ posts · 1k+ votes
    8y

    @Jess O. here's the way my CPA laid it out for, (I might have the terminology wrong, but you should get the idea).

    If your online business is considered Active income, you need Active losses to offset you Active income taxes.

    Real Estate that provides Passive income/losses can not offset the Active income.

    For your Real Estate to be considered Active income, you need to work in the business 20 hours per week or more.

    So the key to reducing taxes is to have both active or passive income.

    Again, that's the general premise, a CPA could give you a refined answer that you could act on.

    1Reply
  • Natalie KolodijBusiness Member
    Moderator
    Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
    8y
    Originally posted by @Jason Bott:

    @Jess O. here's the way my CPA laid it out for, (I might have the terminology wrong, but you should get the idea).

    If your online business is considered Active income, you need Active losses to offset you Active income taxes.

    Real Estate that provides Passive income/losses can not offset the Active income.

    For your Real Estate to be considered Active income, you need to work in the business 20 hours per week or more.

    So the key to reducing taxes is to have both active or passive income.

    Again, that's the general premise, a CPA could give you a refined answer that you could act on.

    While REI pro i s a great option

    There are several tests to meet along side the 700 hours annually. The big one is you need to spend more time doing real estate than any other activities.


    So if you're spending 2500 hours a year running a profitable business- you would need to show that you spent > 2500 in real estate as well. 

    Podcast Guest on Show Pay Less Tax to the IRS This Year With THESE Real Estate Tax Strategies
    Kolodij Tax & Consulting
    WebsiteView Page
    3Reply
  • Account Closed
    Tax CPA · Charlotte, NC · Member since 2014 · 215 posts · 186 votes
    8y

    Also, as @Natalie Kolodij pointed out that the 750 hour rule is a difficult to get over, you also have to prove material participation per rental activity. Very difficult test, even with a spouse involved.

    0Reply
  • Natalie KolodijBusiness Member
    Moderator
    Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
    8y
    Originally posted by @Account Closed:

    Also, as @Natalie Kolodij pointed out that the 750 hour rule is a difficult to get over, you also have to prove material participation per rental activity. Very difficult test, even with a spouse involved.

    It doesn't need to be per rental. You can elect to lump your rentals together and count aggregate hours in total toward the goal. 

    The down side then is all losses become trapped in that aggregate grouping- and they no longer free up upon disposal. 

    I try to avoid RE Pro status from rentals only  whenever possible, much prefer when one of the two spouses cultivates a side career as an agent or such. 

    Podcast Guest on Show Pay Less Tax to the IRS This Year With THESE Real Estate Tax Strategies
    Kolodij Tax & Consulting
    WebsiteView Page
    2Reply
  • Account Closed
    Tax CPA · Charlotte, NC · Member since 2014 · 215 posts · 186 votes
    8y

    @Natalie Kolodij Agreed!

    1Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    8y

    @Jess O.

    Trying to map a tax strategy for a $1 mil business by asking on a public forum?  

    Yeah, there're tons of millionaires here with the secret simple key to tax savings. Hopefully they will reveal it. I want to know, too. ;)

    1Reply
  • Jason Dillard
    Real Estate Broker · Greer, SC · Member since 2013 · 548 posts · 271 votes
    8y
    If you file jointly, your wife my become the "full time real estate professional" to get your active losses to offset. We have the same issue with our real estate only business. We meet qaurtly with CPA to get ideas about potential write offs. When to buy next company car and what size truck is best for tax benefits is discussed. How to balance leverage and need for more properties to depreciate comes into play. Anticipation of principal inside debt service over taking the interest can also bite you. Almost always 1031 when we dispose of property. Cost segs and Opportunity Zones are helping lower our tax most, recently.
    0Reply
  • Ryan Seib
    Attorney and Real Estate Broker · Madison, WI · Member since 2016 · 265 posts · 100 votes
    8y
    Originally posted by @Jess O.:

    Ryan,

    I don't know of any type of business structure where purchasing real estate is tax deductible, that's the problem.

    I figured there are 10,000 people here who probably know the answer, so that's why I figured I'd ask here before spending money and hiring a CPA just to ask them one simple question.

    I'm not moving forward with anything any time soon so I have no need to hire a CPA or attorney now, I just need to know the answer to this one particular question before I can move to the next step in my research and planning.

    But if no one answers here then ya I'll have to hire a "professional" I guess...

    My point was not about the structure but the activity of the business. If you are a digital business perhaps you could buy a warehouse or a principal office location. The business can be any structure you want when it buys real estate for use by the business and thus tax advantages. Ie if you funnel profits from the business into the purchase of an office building and the profits are not taxed. Then you end up with an office building at the end of the day. Perhaps as an exit strategy you sell the office building separately, or together with the going concern. Either way the assets of the business increase while no taxation on your profits for acquisition have been taking place. Let me know if you have any questions or comments about that.

    0Reply
  • Jess O.
    OP
    Member since 2018 · 7 posts · 2 votes
    8y

    Ryan, I'm not sure where the disconnect is but when you buy "a warehouse or a principal office location" that real estate purchase is NOT tax deductible to a corporation, and so those profits WOULD be taxed even though you spent them all.

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