How to minimize income tax?

Question

Hello BiggerPockets.

I'm pretty new to the real estate investing business. I do not currently own any properties. My aim in to obtain 2 rental properties in the next 12 months, and scale up as I go alone.

The issue (a good problem to have, I suppose) is that I am in a pretty high paying profession. As far as I understand it, net rental income would be subject to income tax much like regular salary. While this will not be an issue for the next year or two, I would like to know/prepare for when rental income will become significant. What can I do to reduce my tax liabilities? I understand I can depreciate any improvements made, but what about turnkey properties?

Thanks in advance!

Josue Vargas · Answer

You should contact a local CPA preferably with knowledge in REI.  There are many legal ways to follow the law and take advantage of REI regardless of your professional income.  I'm sure you will find good advice here, but ultimately, I recommend to talk to your CPA.

Mike McCarthy · Answer

I'm far from a CPA, but in my limited experience, the way depreciation is set up, as long as you're paying off a mortgage on your properties, you'll see little if any income tax implications.

Unfortunately, if your full-time job is in another field, your RE taxes (or losses) don't affect your W2 income at all.  Which is good from the REI side, but you're still paying your normal taxes on your W2 income.

Alina Trigub · Answer

@Shuo Li

Welcome to BP!

I want to make a few points here:

1) If you're a f/t W-2 employee, it doesn't matter whether you buy properties yourself of invest via syndications. Your income will be treated as passive either way. Unless you have a wife who either doesn't work or works p/t or a realtor or somehow else in real estate profession and can claim "real estate professional" status, you're out of luck.

2) if you have a high paying job, then concentrate on continuing to make the money through it and invest passively. More on the topic here:

https://www.biggerpockets.com/member-blogs/10850/84064-what-type-of-investor-to-be-when-i-grow-up-active-or-passiv

3) if you want to invest in real estate, it is well worth the money to hire  RE-savvy CPA and work with them. Most of them work virtually these days. You can find plenty of accountants here on BP.

4) whatever feedback you receive on BP or anywhere else, always run it by your accountant.

Best of luck!

Allan C. · Answer

@Shuo Li as others have stated, free cash flow and net earnings are very different items from tax obligation perspective.

While Syndications are good passive income generators, you are still subject to capital gains and depreciation recapture upon disposition of the asset, so still not the best vehicle to minimise tax obligations.

The best approach to minimize income tax, is buy and hold, where depreciation reduces or eliminates any net income.  Therefore you can still have positive cash flow but minimal tax obligation. Ideally you hold assets until you die, and then allow your children to benefit from step-up basis to minimise capital gains if they decide to sell.

Basit Siddiqi · Answer

Rental income is not taxed like W-2 income.There is no social security or medicate taxes on Rental income. Furthermore, you mention cash-flow. Cash-flow is not necessarily the amount that is added to your income and then taxed. You are entitled to depreciation.

Daniel Hyman · Answer

As a high income earner, you may want to couple your rentals with investing passively in a real estate syndication (or other business) that will shoot off a passive gain.

Account Closed · Answer

I highly suggest this book on landlord tax write-offs:

https://store.nolo.com/products/every-landlords-tax-deduction-guide-dell.html

Allan C. · Answer

@Shuo Li  the property you have will have a Land basis and a Building basis. You can depreciate the Building basis to reduce your taxable income.

For example, you buy a $100k SFH.  You can say that the Building is worth $60k and the Land is worth $40k.

You can depreciate the $60k over 27.5 years, or $2k per year.  If your net passive earnings before depreciation is $5k, you are taxed on $3k instead of the full $5k.

Note - Building vs Land valuation is a separate topic you’ll need to understand. Depreciation rate is also a separate topic.

Shuo Li · Answer

Thanks. Will read more about the post.

Shuo Li · Answer

Thanks Allan.

I am indeed planning on buy and hold, or perhaps 1031 into bigger properties if it ever comes to that. By depreciation, do you mean depreciation of the renovation costs?

How to minimize income tax?

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