Just heard back from my tax accountant and I was expecting some good news that we were getting a positive return from owning 6 different rental properties (bought 2 in 2019) but instead he tells me that we're just breaking even.
The reason being that we make too much from our W2 jobs to claim depreciation. The income we make from the properties is all written off from the expenses we claim, which is great. But I was hoping to get a return.
Any thoughts on this? Is he missing something? I know I'm probably being vague, but I'm tax illiterate.
Accountant · Vancouver, WA · Member since 2019 · 100 posts · 71 votes
6y
It sounds like you are running into the passive activity rules. If you make over $150k in other income you cannot have a net loss for your rental activity. Any losses you have will be carried forward to future years.
You are able to take a maximum of $25k to offset your W2 income if your income is below $100k. Once you are in the $100k - $150k range, your losses are limited. If you are above $150k, you cannot take any rental losses against your W2 income.
Accountant · Vancouver, WA · Member since 2019 · 100 posts · 71 votes
6y
It sounds like you are running into the passive activity rules. If you make over $150k in other income you cannot have a net loss for your rental activity. Any losses you have will be carried forward to future years.
You are able to take a maximum of $25k to offset your W2 income if your income is below $100k. Once you are in the $100k - $150k range, your losses are limited. If you are above $150k, you cannot take any rental losses against your W2 income.
@Adam Rasmussen that's exactly what he said - so thank you for confirming! Just wanted to make sure this was really the case since this is a new guy I'm using. You just always hear on the Bigger Pockets podcast about how awesome of a tax benefit owning property is...it's ok, but nothing that's going to blow you away is what I'm finding out.
Accountant · Vancouver, WA · Member since 2019 · 100 posts · 71 votes
6y
It honestly depends. I believe to fully realize the tax benefits of real estate you need to qualify as a real estate professional. For everyone else (especially those with higher W2 wages) real estate professional is only somewhat beneficial from a tax standpoint.
Investor · New York City, NY · Member since 2012 · 332 posts · 385 votes
6y
@Joe Delgrosso, one important point to remember is that cashflow is expensive based on how it’s taxed, much better to focus on wealth via creating equity. Wealth creation is taxed much more favorably than cashflow.
Investor · brentwood, CA · Member since 2016 · 1k+ posts · 730 votes
6y
You should focus on making money not losing money, the taxes will take care of themselves. All my rental properties make money AFTER depreciation so I get:
1) Great Cash Flow about half of which is sheltered by depreciation (since I make money none of my deductions are ever limited).
2) 199A tax benefits on my net rental income.
3) Since I bought at fire sale prices during the housing crises I have huge appreciation none of which is currently taxed and for me very likely never will be (including the depreciation recapture).
You make money by making money, not by losing money and hoping for tax benefits to bail you out.
Developer · Cary, NC · Member since 2016 · 98 posts · 53 votes
6y
@Adam Rasmussen @Joe Delgrosso
If you ever go part time from your W2, and can show you spend 51% of your time you can be an ACTIVE real estate professional and realize all of the deductions.
If you ever go part time from your W2, and can show you spend 51% of your time you can be an ACTIVE real estate professional and realize all of the deductions.
Definitely a common question that I hear a bunch from my clients. For good reason too! You essentially need to dedicate a majority of your year to real estate related activities. In addition to that you need at least 750 hours of related work to qualify.
With my clients who have W2 wages but legitimately qualify as a RE pro I strongly advise them to document their hours during the year just in case. Better to have it and not need it than to need it and not have it!
As a W2 employee you are not likely seeing the benefits because the P/L will pass through as passive and not active. You need to be self employed to see the impact. Talk with your CPA about this. There is a test that the IRS uses to determine if you are active or passive.
So far I fall well within the <100,000K to reap those loses up to 25K, which are great.
My question is looking forward 5-10 years, when I *might* sell a few rentals. Say if I have 50K of W-2 or K-1 income from my day job, and I sell a rental and have a capital gain of 200K. Does that mean I can not take up to that 25K of losses that year?
So far I fall well within the <100,000K to reap those loses up to 25K, which are great.
My question is looking forward 5-10 years, when I *might* sell a few rentals. Say if I have 50K of W-2 or K-1 income from my day job, and I sell a rental and have a capital gain of 200K. Does that mean I can not take up to that 25K of losses that year?
Thanks, Dan Dietz
That is correct. Capital gains are included in your calculation for MAGI and any losses from rentals are carried forward to the next year. However, if you have operating losses for the rentals that are sold, those can be taken in the year of sale.
Rental Property Investor · MI · Member since 2019 · 192 posts · 205 votes
6y
@Adam Rasmussen
Exactly! My tax preparer was very helpful when she told me to keep a notebook with me at all times and document EVERYTHING I do pertaining to my properties....trips to Home Depot, phone calls to her, lawyer, tenants, etc. I just started doing this the end of 2019 so I didn’t reach the minimum hours needed for the year but I’m on top of it for 2020. Plus I use MileIQ to keep track of my business miles.
Exactly! My tax preparer was very helpful when she told me to keep a notebook with me at all times and document EVERYTHING I do pertaining to my properties....trips to Home Depot, phone calls to her, lawyer, tenants, etc. I just started doing this the end of 2019 so I didn’t reach the minimum hours needed for the year but I’m on top of it for 2020. Plus I use MileIQ to keep track of my business miles.
Soooooooo smart! You have a great preparer lol
With technology nowadays there is not much of an excuse to not document. It will be more than worth it if Uncle Sam ever comes knocking and wants proof!
Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
6y
Thanks for the response @Adam Rasmussen. That is what I suspected.
IF I sold doing a "Seller Financed Note" of say 175K after a down payment of say just 25K, and then payments that kept my AGI under 100K, I assume the "value of the note" would not count in the current years income, since it has not "been collected" yet?
Thanks again, and I hope others might get a few ideas from this too.
Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
6y
@E.S. Burrell we (two partners, two handymen and office manager) use Toggl App to track time. It works great and after getting things set up right we can keep track by; task, entity, and property.
Meaning if we want to see all time put in on property A, including turns, housecalls, lease writing and lawn care we can do that. All time on lawn care for ALL properties we can do that. All time on office tasks NOT related to a particlular property we can do that, etc....
Exactly! My tax preparer was very helpful when she told me to keep a notebook with me at all times and document EVERYTHING I do pertaining to my properties....trips to Home Depot, phone calls to her, lawyer, tenants, etc. I just started doing this the end of 2019 so I didn’t reach the minimum hours needed for the year but I’m on top of it for 2020. Plus I use MileIQ to keep track of my business miles.
Soooooooo smart! You have a great preparer lol
With technology nowadays there is not much of an excuse to not document. It will be more than worth it if Uncle Sam ever comes knocking and wants proof!
Thank you!! ......and they will come a knocking when you least expect it!! LOL
@E.S. Burrell we (two partners, two handymen and office manager) use Toggl App to track time. It works great and after getting things set up right we can keep track by; task, entity, and property.
Meaning if we want to see all time put in on property A, including turns, housecalls, lease writing and lawn care we can do that. All time on lawn care for ALL properties we can do that. All time on office tasks NOT related to a particlular property we can do that, etc....
Thank you! Awesome! I’m going to check that app out!
@Adam Rasmussen hello- my husband is retired and he does not have W2, can he get some tax benefit on our rental property ( married filing separately)? Showing that he has spent 750 hours to our rental? Thank you
@Christopher Smith who said I’m not focused on the money making side of it? My properties have appreciated nicely and I average a 14% cash on cash return. I was simply asking a tax question. Ease up on the agro responses.
@Christopher Smith who said I’m not focused on the money making side of it? My properties have appreciated nicely and I average a 14% cash on cash return. I was simply asking a tax question. Ease up on the agro responses.
The reason the code limits losses in a whole number of areas is to not incentivize activities with limited economic substance. If you select activities with robust economics (i.e., ones that make money after depreciation) you won't have any limitation issues as you clearly have now. This is better for the investor and for the country as whole as valuable resources are allocated to highly productive investments not marginal ones. No need to ease up on that comment, not even one little bit.
Thanks for the response @Adam Rasmussen. That is what I suspected.
IF I sold doing a "Seller Financed Note" of say 175K after a down payment of say just 25K, and then payments that kept my AGI under 100K, I assume the "value of the note" would not count in the current years income, since it has not "been collected" yet?
Thanks again, and I hope others might get a few ideas from this too.
Dan Dietz
That's creative thinking there! Sounds like you're talking about an installment sale where you are spreading any gain over a number of years. You would only recognize the portion of gain equal to the percentage of payments received on the note.
Keep in mind that your payments won't be your recognized income either. Hypothetically you could receive $30k in payments towards the note during the year but only have to recognize $20k in income. The other $10k would be a return of your basis (similar to how you can't deduct principle payments on your mortgage, you don't have to recognize principle payments as income when you're on the receiving end of things).
@Adam Rasmussen can you elaborate on it being more beneficial if you’re considered a real estate professional?
Absolutely. If you are a high income earner, the IRS does not allow you to take a "net rental loss." Any losses are carried forward to future years. But if you qualify as a real estate professional, the IRS sees your rental activity as active instead of passive and allows you to take losses to offset other income, like your wages. This is really the main draw to being a real estate pro.