Best Tax Advantages for REI with low 6 figure income?

14 Replies

Hello,

Wanted advice from BP.  I am a big reader over at various 'retire early' sites (Money Mustache, etc.), and have a decently high savings rate after tax.  I am trying to maximize my tax savings through real estate investing.  I know most folks are looking to retire early through passive income, and I wouldn't mind doing that (slowly), but I don't mind my current job.

I currently have a property with two doors (renting at 1,850 and 850), and may be adding a duplex where I house hack one side.  It's in a B+/A area and they are asking 375k (one side rents for 1,700, other for 1,500, but through forced appreciation I could raise it higher).

My focus is a little different than traditional BRRRR. What I'm really looking for are creative ways to reduce my taxes from my W2 job. For background:

1. I max out my 401k, Roth IRA, and HSA (triple tax advantaged) every year. I also do a lot of taxable investing in addition to my little RE ventures.

I'm stuck on what else can be done to maximize my REI for reduced tax gains. I've had numerous repairs done on my properties, and I'll be adding some appliances which should be able to be claimed on taxes this year. Another thought I had was forming an LLC property management company and visiting locations when I commute for my W2 job. Could potentially claim mileage there.

Not sure if others out there are in similar situations with strong W2 income that have found creative ways to maximize returns through taxes in REI? Would love to hear your feedback.

I'm in somewhat the same situation. 

I reduce my wage income through contributions to various retirement vehicles including a deductible Employer match (30K+ currently) and medical savings accounts (although that is only a modest tax savings), but I am not counting on too much more than that to directly reduce my wage income. I'm not really too big on generating economic losses just to get a tax deduction, too me that is frankly pretty stupid.

However, that's OK since I pay very little on my rental income from my various rental properties. Currently about 2/3 of my rental income is from property appreciation (bay area properties), which I pay nothing on currently (and perhaps ever). The other 1/3 is cash flow, and only about 1/2 of that amount is taxed (the other half is sheltered by depreciation, so not taxed currently, and again perhaps ever). With 199A (assuming I am confident I can qualify), that might even drop a bit more. 

Given I make about twice as much on my rentals as I do my W-2, and along with substantial tax deferred gains on stocks I pay a surprising small amount of tax on my total income even thought my I pay at a pretty high marginal rate on my last dollar of W-2 wages earned. That's OK I can live with that.

So its a very clean operation, and the tax bill is very manageable.

@Greg Tom

I was in the same situation years ago and found out about self directed real estate. Which is now tax free income for life. This method doesn’t help with your w2 now but as time goes on it doesn’t add to  the income  tax burden as income and equity increases. The bookkeeping is also easier. 

Other considerations are “conservation easements” and “bifurcation of depreciation” which may be helpful off setting income. Thus delaying or deferring taxes. I am in the process of understanding the new tax laws and how to modify what I’m doing going forward. Next year I will let know if and how the new strategies and tactical moves work. 

Originally posted by @Carl Fischer :

@Greg Tom

I was in the same situation years ago and found out about self directed real estate. Which is now tax free income for life. This method doesn’t help with your w2 now but as time goes on it doesn’t add to  the income  tax burden as income and equity increases. The bookkeeping is also easier. 

Other considerations are “conservation easements” and “bifurcation of depreciation” which may be helpful off setting income. Thus delaying or deferring taxes. I am in the process of understanding the new tax laws and how to modify what I’m doing going forward. Next year I will let know if and how the new strategies and tactical moves work. 

Thanks, Carl!  Insightful feedback.  When you say self directed real estate, do you mean investing through your traditional retirement vehicles (401k, Roth, etc.)?  I've been doing that to fund my deals with 401k loans, which have been pretty convenient.

Interested in what you find for the new tax laws - the 199A law sounded exciting (https://www.madfientist.com/section-199a/), but won't do much for me because I'm not a small business.  I had floated the idea of starting a management company for my properties, but believe the tax law requires you manage properties outside of your own, otherwise it is just seen as a pass through.

I hadn't heard of conservative easements, I'll research more.

@Greg Tom It’s great that you’re maxing out your accounts! Be sure you’re taking advantage of each fully to minimize your taxes. Roth accounts are wonderful to take advantage of provided you’re eligible. Don’t forget that there are deductions and sometimes even credits specific to retirement assets. The SoloK, for instance, allows you to use a Saver’s Credit up to $2,000 ($4,000 if married/filing jointly). Each account has the potential to lower your taxable income. Some investors have successfully dropped an entire tax bracket by exploiting their retirement savings’ tax status. Given you have three, if I were you, I’d have a professional give my financials a once over to be sure there’s nothing I’m missing or simply unaware of.

I’m sure you can get tons more feedback on this, but deduct, deduct, deduct...Knowing and taking advantage of deductions can save so much of your money from Uncle Sam. More tax pros will surely chime in, but it sure sounds like you’re on the right track.

@Greg Tom

Yes SDIRAs etc. I’m a very big Roth fan. Depreciation is great for deductions but payback/recapture is painful so get a strategy to minimize payback if possible. 

I feel the BP forum will be buzzing shortly as the CPAs have to start putting pen to paper and more direction is provided by the service and pundits. Most like

Originally posted by @Greg Tom :
Originally posted by @Carl Fischer:

@Greg Tom

I was in the same situation years ago and found out about self directed real estate. Which is now tax free income for life. This method doesn’t help with your w2 now but as time goes on it doesn’t add to  the income  tax burden as income and equity increases. The bookkeeping is also easier. 

Other considerations are “conservation easements” and “bifurcation of depreciation” which may be helpful off setting income. Thus delaying or deferring taxes. I am in the process of understanding the new tax laws and how to modify what I’m doing going forward. Next year I will let know if and how the new strategies and tactical moves work. 

Thanks, Carl!  Insightful feedback.  When you say self directed real estate, do you mean investing through your traditional retirement vehicles (401k, Roth, etc.)?  I've been doing that to fund my deals with 401k loans, which have been pretty convenient.

Interested in what you find for the new tax laws - the 199A law sounded exciting (https://www.madfientist.com/section-199a/), but won't do much for me because I'm not a small business.  I had floated the idea of starting a management company for my properties, but believe the tax law requires you manage properties outside of your own, otherwise it is just seen as a pass through.

I hadn't heard of conservative easements, I'll research more.

Greg, 

If planned carefully, your rentals might qualify for sec 199A deduction. 

Make sure you talk to your professional. 

@Greg Tom

The discussion predictably went away from your original question, because it's more fun to talk about self-directed retirement accounts. 

So let's go back to your original question. You have a high paying W2 job, let's say $150k (after subtracting 401k). Let's assume your taxes are $30k based on this salary. The question was: can you somehow reduce this $30k using real estate?

Let's be clear and not dance around the bushes. The answer is NO. 

(Note: if the amount was below $150k, you would have some limited room to save on taxes, using losses from rentals. Section 199A would not help you, though)

All other ideas discussed on this thread deal with a completely different question. Which is - can you make money in real estate without increasing this $30k? To that question, the answer is YES. Now we're talking about owning appreciating rental properties with cash flow and investing inside self-directed retirement accounts.

But let's not confuse the two questions: you cannot offset taxes created by high W2 via running a real estate business. Well, if you run your business into the ground and lose a pile of money - then yes, you will also reduce your taxes. Not a strategy I would recommend though.

@Greg Tom

About your specific idea to create a management company with losses. One of my pet peeves. :)

Technically, it is workable. Losses from any business other than rentals is usually fully deductible. So, if you have a business that loses $20k while you make $150k at your W2 job - then yes, you will pay taxes on only $130k. 

One little problem here: it's virtually impossible to run a profitable business (again, other than rentals) that shows losses on paper. And if your business is losing money in real life - what's the point of the related tax savings? Spend $1,000 to save $300? It only makes sense if you are in government.

Here comes the flimsy idea of a management company. 

Step 1. Let's create a management company that charges ourselves for managing our own rentals! Not breaking any rules so far.

Step 2. Let's deduct all expenses against that property management income. No problem, either.

The problem comes from the relative numbers. Our goal was to have losses, right? So we will need to have more expenses than income. So we're going to tell Uncle Sam that we're operating a business that consistently spends more than it makes. Uh-oh. I have not seen any legitimate property management company that can operate like this. Have you?

Once the IRS looks into it and realizes that we're managing our own properties - they will call this setup what it really is: a scam. 

Trying to cover it by pretending to also manage someone else's properties is a long shot. And if you do start managing other people's properties for real, then you better start showing profits. In real life and, consequently, on taxes.

Originally posted by @Michael Plaks :

@Greg Tom

The discussion predictably went away from your original question, because it's more fun to talk about self-directed retirement accounts. 

So let's go back to your original question. You have a high paying W2 job, let's say $150k (after subtracting 401k). Let's assume your taxes are $30k based on this salary. The question was: can you somehow reduce this $30k using real estate?

Let's be clear and not dance around the bushes. The answer is NO. 

(Note: if the amount was below $150k, you would have some limited room to save on taxes, using losses from rentals. Section 199A would not help you, though)

All other ideas discussed on this thread deal with a completely different question. Which is - can you make money in real estate without increasing this $30k? To that question, the answer is YES. Now we're talking about owning appreciating rental properties with cash flow and investing inside self-directed retirement accounts.

But let's not confuse the two questions: you cannot offset taxes created by high W2 via running a real estate business. Well, if you run your business into the ground and lose a pile of money - then yes, you will also reduce your taxes. Not a strategy I would recommend though.

Perfect!  Thanks so much for both your replies.  Direct and to the point.  We are aligned on not wanting to run failing businesses or investments in order to save a marginal % in taxes.

You can sometimes expense in one year a large section 179 deduction on certain RE expenses. This can sometimes save a bunch of taxes, but it also means you spent a bunch of money on the expenses. RE losses are there to make you hold ground and tread water tax wise and limit your income tax liability *from the RE business*, so you eventually pay capital gains (long term) at sale or even better, 1031 into something else without paying any capital gains then.

@James Miller As I understand it, the 179 deductions are available only for commercial properties, which would include apartment complexes but not single family rentals, correct? Also, I don't think you can carry forward losses from 179 deductions, correct? 

@Michael Plaks Under the new tax law, if you purchase a SFH rental that is a fixer and requires a big remodel, you should be able to expense many of those costs and 100% depreciate many of the rest, use some of that loss against your W2 income (I think up to $3k?, granted not much), and carry forward the rest of the loss for future years. Have I got this right? If so, it seems to me that under this new tax plan, it would be advantageous to buy fixers until the 100% depreciation expires in 2024 (or whenever), fix them up creating a big loss in year 1, deduct what's allowed in year 1 against your W2 income, and carry forward the rest of the loss for use against future earnings (both rental earnings and a little bit of W2 earnings)? Or, better yet, if a spouse can qualify as a "real estate professional" managing the remodel, all of the big loss from the rehab expenses and 100% depreciation could be used against the W2 earnings in the year the loss occurred? Thanks in advance for your thoughts and input!

Originally posted by @Kim F. :

@James Miller As I understand it, the 179 deductions are available only for commercial properties, which would include apartment complexes but not single family rentals, correct? Also, I don't think you can carry forward losses from 179 deductions, correct? 

@Michael Plaks Under the new tax law, if you purchase a SFH rental that is a fixer and requires a big remodel, you should be able to expense many of those costs and 100% depreciate many of the rest, use some of that loss against your W2 income (I think up to $3k?, granted not much), and carry forward the rest of the loss for future years. Have I got this right? If so, it seems to me that under this new tax plan, it would be advantageous to buy fixers until the 100% depreciation expires in 2024 (or whenever), fix them up creating a big loss in year 1, deduct what's allowed in year 1 against your W2 income, and carry forward the rest of the loss for use against future earnings (both rental earnings and a little bit of W2 earnings)? Or, better yet, if a spouse can qualify as a "real estate professional" managing the remodel, all of the big loss from the rehab expenses and 100% depreciation could be used against the W2 earnings in the year the loss occurred? Thanks in advance for your thoughts and input!

Maybe one of our kind CPAs can chime in on the applicability of 179. I thought the applicability turns on it being a trade or business under IRC 162, not whether the property is a SFH or an apartment complex. The TCJA also added certain RE categories that can now be 179'd like roof sales and HVAC equioment.

@Kim F.

Your interpretation is only partially correct, but all accountants, me included, are underwater these days due to Oct 15 IRS deadline. Ask me in a few days. :)