Tax benefits from RE investing in high income earners.

95 Replies

Hello everyone,

We recently started investing in real estate in 2020. We are buy and hold investors and currently have 2 doubles in the cleveland area. We got into investing for it's wealth building annd tax benefits. We also really enjoy it. We hold our properties in an LLC.

Anyhow we are considered by many high income earners, over $400k combined on W2s. Our CPA just completed our taxes for 2020 and our tax bill is quite sizeable and we are not seeing any benefit whatsoever from our real estate activity. He tells us that since we are high income earners, >150k per year, our real estate activity is considered passive and we cannot take any of those benefits .

"LLC is there just to title those properties and to provide you with liability protection. This activity is treated as passive, and you can deduct losses just if your income is under $150k... To get those losses deducted in the current year when income is above $150K, you need to qualify as Real Estate Professional. Based on what you are doing professionally and what you are doing for those properties you can not pass that test. Having or not having LLC has nothing to do with this because the rental activity is by default passive activity."

While I understand that having an LLC makes no difference for tax purposes. We do manage our own properties including driving to and from the properties for showings and have spent a good amount of capital on repairs and maintenance.

Has anyone on the forum had any experience with this? I would love to hear what everyone thinks about this.

Thanks!

Hello! Have you talked to your CPA about changing the business entity? Ask them if you could benefit from being an S-Corp and paying yourself as an employee from that business for investing. Is your $400K income for your main jobs? 

How much income/loss do you have per tax for your two rental properties? Also, S-Corp is not recommended typically for owning properties. 

Acquiring properties that generate profits after depreciation is the best solution to your problem. Your suspended loss issue magically goes away, providing you with huge tax free cash flow.

@Elizabeth Brown

In the case of Jose, if he establishes a S corp and pays salaries to him... and show a loss...

1. Will that reduce Jose’s W2 income tax? Even if he and wide are not deemed RE professionals?

2. How much salary would be deemed adequate?

Originally posted by @Jose Contreras :

Hello everyone,

We recently started investing in real estate in 2020. We are buy and hold investors and currently have 2 doubles in the cleveland area. We got into investing for it's wealth building annd tax benefits. We also really enjoy it. We hold our properties in an LLC.

Anyhow we are considered by many high income earners, over $400k combined on W2s. Our CPA just completed our taxes for 2020 and our tax bill is quite sizeable and we are not seeing any benefit whatsoever from our real estate activity. He tells us that since we are high income earners, >150k per year, our real estate activity is considered passive and we cannot take any of those benefits .

"LLC is there just to title those properties and to provide you with liability protection. This activity is treated as passive, and you can deduct losses just if your income is under $150k... To get those losses deducted in the current year when income is above $150K, you need to qualify as Real Estate Professional. Based on what you are doing professionally and what you are doing for those properties you can not pass that test. Having or not having LLC has nothing to do with this because the rental activity is by default passive activity."

While I understand that having an LLC makes no difference for tax purposes. We do manage our own properties including driving to and from the properties for showings and have spent a good amount of capital on repairs and maintenance.

Has anyone on the forum had any experience with this? I would love to hear what everyone thinks about this.

Thanks!

Yes, this is correct. We see this every day.  You will not see the short-term benefit from the losses generated via depreciation becuase you make so much money.  However, when you dispose of the property, the suspended losses will help you reduce your taxes then. You don't lose the deduction, it is just suspended now. I have seen many high earners plan the investments in such a way that they will periodically dispose of the properties to reduce taxes in the future. You have to sit with your advisor and plan that out. Remember, the taxes shouldn't be the sole driver of your disposal decisions.


There are ways to convert some of your expenses as active income via a property management company. This has to be planned out. 

 

If you want to benefit from the losses now, you or your spouse would have to be a real estate professional. 

 

Originally posted by @Sakib J. :

@Elizabeth Brown

In the case of Jose, if he establishes a S corp and pays salaries to him... and show a loss...

1. Will that reduce Jose’s W2 income tax? Even if he and wide are not deemed RE professionals?

2. How much salary would be deemed adequate?


 You dont need S-corp to do what you are trying to say. Getting S-corp is actually a very bad idea. Also, paying a salary from the activity that generates the passive income and subjecting it to the self-employment income/FICA is not a good idea. 

There as some ways to convert the passive losses from the rental into an active management company loss and offset the W-2 income but has to be planned with the CPA. With just two properties, it might not make a big enough dent to even go through this. Again needs to be discussed. 

Originally posted by @Elizabeth Brown :

Hello! Have you talked to your CPA about changing the business entity? Ask them if you could benefit from being an S-Corp and paying yourself as an employee from that business for investing. Is your $400K income for your main jobs? 

You dont need S-corp to do what you are trying to say. Getting S-corp is actually a very bad idea. Also, paying a salary from the activity that generates the passive income and subjecting it to the self-employment income/FICA is not a good idea.

There as some ways to convert the passive losses from the rental into an active management company loss and offset the W-2 income but has to be planned with the CPA. With just two properties, it might not make a big enough dent to even go through this. Again needs to be discussed.

Originally posted by @Jose Contreras :

Hello everyone,

We recently started investing in real estate in 2020. We are buy and hold investors and currently have 2 doubles in the cleveland area. We got into investing for it's wealth building annd tax benefits. We also really enjoy it. We hold our properties in an LLC.

Anyhow we are considered by many high income earners, over $400k combined on W2s. Our CPA just completed our taxes for 2020 and our tax bill is quite sizeable and we are not seeing any benefit whatsoever from our real estate activity. He tells us that since we are high income earners, >150k per year, our real estate activity is considered passive and we cannot take any of those benefits .

"LLC is there just to title those properties and to provide you with liability protection. This activity is treated as passive, and you can deduct losses just if your income is under $150k... To get those losses deducted in the current year when income is above $150K, you need to qualify as Real Estate Professional. Based on what you are doing professionally and what you are doing for those properties you can not pass that test. Having or not having LLC has nothing to do with this because the rental activity is by default passive activity."

While I understand that having an LLC makes no difference for tax purposes. We do manage our own properties including driving to and from the properties for showings and have spent a good amount of capital on repairs and maintenance.

Has anyone on the forum had any experience with this? I would love to hear what everyone thinks about this.

Thanks!

You may want to look for a new CPA. If you are managing the properties yourself, then it's ACTIVE income, not passive income.

 

The tax benefits of real estate are still enormous even if you can't offset W-2 income.  Many people pay near 50% marginal tax rate on their W-2 income but little to no taxes on their real estate income due to depreciation and other tax benefits.  If everyone (non-real estate professionals) could offset W-2 income with real estate losses, real estate demand and prices would skyrocket which would wipe out the benefit.

I am really considering this. I just want to making sure I am doing everything as legally as possible but taking fill advantage of the tax law.


Originally posted by @Mike Adams :

You may want to look for a new CPA. If you are managing the properties yourself, then it's ACTIVE income, not passive income.

 

 

Ashish,

so what you're saying is that even thought my wife and I managing the properties on our own including for showings, fixing stuff and managing contractors is of no benefit from a tax perspective unless I can show that one of is a true real estate professional?

i was always under the impressions that depreciation alone could offset income earned and if it's greater than income earned it could carry over to benefit me on W2 income?

thank you all for the useful information.


Originally posted by @Ashish Acharya :
Originally posted by @Sakib J.:

@Elizabeth Brown

In the case of Jose, if he establishes a S corp and pays salaries to him... and show a loss...

1. Will that reduce Jose’s W2 income tax? Even if he and wide are not deemed RE professionals?

2. How much salary would be deemed adequate?

 You dont need S-corp to do what you are trying to say. Getting S-corp is actually a very bad idea. Also, paying a salary from the activity that generates the passive income and subjecting it to the self-employment income/FICA is not a good idea. 

There as some ways to convert the passive losses from the rental into an active management company loss and offset the W-2 income but has to be planned with the CPA. With just two properties, it might not make a big enough dent to even go through this. Again needs to be discussed. 

 

@Mike Adams its passive. See IRC 469. The rules are black and white and often “marketed” incorrectly. You can certainly navigate them but there is quite a bit of confusion over the passive activity rules and “working on your rentals.” Simply work on your rentals does not escape 469.

@Jose Contreras

Well first of all congratulations you're doing better than the majority of Americans!

If you Oh and residential rentals that are approximately $600,000 or higher you make verify for a cost segregation study.

If you qualify don't just get a regular cost SAG study make sure it's an engineering based study, there is a massive disparity in benefits between the two.

I'll be happy to answer any questions you have about this!

@Jose Contreras

I’ve run into a similar issue.

I continue to invest in real estate for a passive cash flow and future benefits, however tax benefits should be looked at as a side benefit in my opinion, and that is not a primary reason to make any business decision.

Recently I purchased my own commercial building and I am renting it from myself which provides a nice tax deduction and you can take your income from a passive source instead of an active source which helps a lot.

Originally posted by @Sarah Waterman :

@Jose Contreras

Well first of all congratulations you're doing better than the majority of Americans!

If you Oh and residential rentals that are approximately $600,000 or higher you make verify for a cost segregation study.

If you qualify don't just get a regular cost SAG study make sure it's an engineering based study, there is a massive disparity in benefits between the two.

I'll be happy to answer any questions you have about this!

Cost seg is not beneficial here when their losses will be limited anyway. They are not RE pro.  

Originally posted by @Greg O'Brien :

@Mike Adams its passive. See IRC 469. The rules are black and white and often “marketed” incorrectly. You can certainly navigate them but there is quite a bit of confusion over the passive activity rules and “working on your rentals.” Simply work on your rentals does not escape 469.

Our CPA firm in White Plains, NY and this is how it has been filed.. active since we manage the property, handle the tenants issues, collect money, do repairs ourself, etc. Again, this is active income, not passive income such as investment income. One would think, a firm with over a dozen CPAs and lawyers would know how to file a tax return for their clients.  It would only be passive if a third party management company would be managing the day to day operations. We also have a few dozen units our own management; so I am not sure if that makes a difference or not. 

More over from https://www.sapling.com/875009...

Active Participation

In addition to owning at least 10 percent of the rental property to meet the active participation test, you must have actively participated in the property's management, specifically in management decisions. The Internal Revenue Service provides examples of active participation as advertising units, collecting rents and making or arranging for repairs. It clarifies, however, that the term "active participation" is a less stringent standard than "material participation" applicable to real estate professionals. To actively participate you do not have to handle every aspect of management. If you approve new tenants, determine rental terms and approve expenditures, you have met the test.

Originally posted by @Jose Contreras :

@Mike Adams

This is a distinction I tried to make to my CPA. However he goes on to say that since my income from W2 (outside of RE investing) is >$150K per year, I cannot take any deduction from my RE losses.

That I am not sure of. Since we, my partners and I, derive all of our income from the rental properties, perhaps that's the reasoning? If you created a separate legal property management business just for your properties, would that make a difference? Perhaps ask him that? 

@Mike Adams

Active participant rule: A taxpayer who is an “active participant” in rental real estate may use up to $25,000 of loss to offset non‑passive income. This exception is phased out for taxpayers with a modified adjusted gross income (MAGI) between $100,000 and $150,000 for the year.

@Jose Contreras

Your CPA is correct. You are not a "real estate professional" for tax purposes. That is a defined term in the tax code, not your every day jargon.

Don't try to use real estate to reduce your taxable income on paper. That's tax evasion. If you have a profit, pay the tax.

@Audrey X.

Not evading. I have paid plenty of tax and happy to keep doing so. It's only fair that I take full advantage of how the tax law is written. Please do not misunderstand the point of me asking.

At the end of the day, our RE investing activity generates economic activity for a lot of people not just ourselves. One would think that the government understands this and would pursue legislation that benefits investors in some way. I believe this is where the tax benefits of RE investing come from.

Again, thank you for bringing this up as it reassures me that my CPA is doing what is right.