She's a high wage earner, I'm an investor. Tax issues?

26 Replies

Hello all. I have a question my fiancé and I have been mulling for a few months. We want to get married but neither of us are so enamored with the idea that we're willing to take a huge tax hit over it. But we just aren't too clear what the tax penalties would be. She earns enough in her W2 job that if we file jointly it will severely limit (or eliminate completely) what I'm able to expense on my rental properties. I also have a W2 job so our combined W2 income and my passive income also make the AMT a factor. Real problem to have right? I know. I'm not complaining but I would like to hear what the BP community has to offer by way of your own personal experience or even professional advice.

@Clarke Wegener I am not a tax professional but feel somewhat well versed in this issue. My understanding is that if you make under $100,000 a year you can deduct depreciation against your ordinary income up to $25,000. Once you exceed $100,000 that offset declines by $1 for every $2 you exceed $100k. $100,002 you can deduct $24,999. $120,000 you can deduct $15,000, etc.

If you are currently deducting depreciation against your ordinary income you will no longer to do that. You can however, deduct the depreciation against rental income from other properties. If you have enough other rental income to offset your good.

AMT changes how fast you can depreciate stuff but not the overall amount you can deduct overtime.

Advice from my tax attorney. Told me to get a divorce. Crazy world we live in that marriage results in a tax penalty.

@Clarke Wegener It is my understanding that everything you were able to write off in the past (taxes, interest, insurance, depreciation, etc.) can still be written off no matter how high your income is. However, these expenses can only be used to offset other passive income (I believe including stocks, bonds, rental income, etc.). So as long as you are creating enough passive income to be offset with these expenses nothing really changes. You can still carry losses forward as well. These loss carry forwards can still only offset future passive income. Basically the only thing you loose it the ability to offset ordinary income and of course your tax rate changes.

Offsetting ordinary income with depreciation from investments is an awesome perk but the tax advantages of real estate remain pretty amazing no matter how rich you become. This Link does a pretty good job of explaining the topic. That being said I have had my taxes done by an actual accountant the majority of my life and have found the extra expense is generally worth it for anyone without straight w-2 income. 

AMT will impact your schedule A deductions such as real estate taxes on your primary residence. It will not impact your Schedule E deductions. Higher income will remove your opportunity to take the up to 25 k loss against ordinary income but if you aren't currently using that loss then your tax situation relative to your rental real estate will continue on. You will get pushed to a higher tax bracket overall when you combine incomes.

However, possible real world positive implications would be using your wife's name/income to qualify for some of your mortgages increasing the number you can have, or boost your buying power on a mortgage you both cosign. I feel like that would outweigh possible tax impacts.

Finally, AFTER April 17th, any CPA would be happy to run your 2016 tax numbers as though you were hypothetically married to show you the actual tax impact (consider their fee wealth & tax planning, which it is). Seriously though, don't ask anyone to do this for the next 3 weeks ;).

Hi Clerke, you aren't the first high income earner with a fiancé who's a high income earner. There are ways to deal with this situation. Check out a book by an Attorney and CPA authored by Mark Kohler. It's called the Tax and Legal Playbook. In this book Mark Kohler lays out the game plan for succeeding with setting up the right entity that you will use for your ordinary income side. He usually suggests setting up a S-Corp to save on state employment tax and Obama Care. In his book he gives diagrams on how you should position your structure. He talks about putting your rentals in a LLC for asset protection. The Information he gives is so powerful that I am working on applying all of his principles right now. You can also check him out on YouTube. The man knows his stuff! He'll set you straight if you talk to his firm. Tell them what you're trying to do. Tell them your goals and they can absolutely help you. I think that's the best path you should take in regards to getting advice. Get the the advice from a guy who helps people in your dilemma all over the world. I think his website is kkoslawyers.com

Such a huge decision (getting married not the tax implications - thats just numbers :-)

I would call and pay a tax professional that specializes in volume on income property investor taxes and get an professional answer as there is likely a strategy for you.

Example - Someone like Amanda Han and Mathew MacFarland - author of The Book on Tax Strategies for the Savvy Real Estate Investor. I have only read their book but they are professionally active in the space.

get you a good CPA

look at all variables on investments and what you can right off- office space-ect..

now look at a way to get the w-2 earner investing most of that income pre tax or post tax and live under the corp umbrella

there are a lot of scenarios to consider but I do here your pain no matter what theirs(the irs) will always get paid

HA!

its a challenge for all who work in American to keep that income and not be squashed by the tax bug

enjoy

oh man! All great advice! Thank you so much! I read about the C Corp structure on here before but lost the thread. I'm ordering that book today! Also, great news on still offsetting my passive income with passive losses no matter the level of my ordinary income. My rents are high enough now that I'm buying more property to rehab just so I can offset the rental income. Thanks again, BP really pulled through for me on this one!

I always thought you always had the option of filing together or separate. My wife and I just had our cpa run our taxes and we saved $500 filing jointly. It took 10 seconds after all our income and deductions were plugged in for her to run it both ways. (My rental income ate up her refund) but overall it was better.

I was told filing separately is only advantageous if one person earns way more than the other and maybe with all your RE deductions that is true at least on paper

Max out your 401ks now while you are making bank.  Put the money in cash so you don't lose money in the Wall Street casino.  Eventually you will change jobs.  Place your 401k money in a self directed ira.  If you can, get you MAGI (mod adj gross income) under 150k.  Get a great cpa.  Your future self will thank you.  😎

@Sean Walton We were wondering about filing separately. I just thought it would be a nightmare moving deductions and income back and forth on the individual returns to see where the largest benefit lies. @Alan Grobmeier I get the concept of deferring the taxes by maxing the 401k. It's the part about deferring the income also that's hard to take. I really like the idea of organizing a management company under a C Corp and piling all our W2 income into the corp. I'm going to do more research and consult a profession on that concept. I'll be sure to let the BP community know what I find out.

@Clarke Wegener , I'd be curious to learn about what strategy you employ. My wife and I have W2 income right now, making enough that we have to do carryover losses and can't invest in Roth IRA directly. And in a short time our incomes will increase 2x. Being the proactive guy that I am, I am looking into ways to structure our assets and income sources so that they are tax efficient. I have time before I consult with tax professionals as well as CPA, etc. In the mean time, I am learning from the BP community. :)

"...but in this world nothing can be said to be certain, except death and taxes"

Pay it and move on.  

**Edit** After doing everything you should do (401k, IRA, depreciate, write off expenses)

Well I read the tax and legal playbook. It's pretty elementary in its actual advice but from what I've gathered the C Corp route is just too much hassle for limited gain. I think the best route is is to establish enough passive income that your passive losses will never be greater. That's my current position and the strategy I'll keep in mind going forward with my investments. No matter your W2 income you can always use passive losses to offset your passive income. Any losses over your passive income cannot be used to offset W2 income once you reach the $150k W2 income level. I'd be interested to hear if what I've said hear is correct or not.

@Clarke Wegener , I saw your title, "She's a high wage earner, I'm an investor," and I immediately thought, "Yes! Time for real estate professional planning!" But you mentioned that you have a W-2...it's tough to meet the R.E. professional requirements with a full-time job...

@Logan Allec I definitely actively manage my 7 properties but the 750 hour requirement is hard to hit. I'm recording my hours this year so we'll see. Does being a professional help my tax situation in regard to being over the $150k earned income threshold we're discussing here?

@Clarke Wegener , if a taxpayer is a real estate professional for tax purposes, rental real estate losses are no longer per se passive.  If the taxpayer materially participates in each rental real estate activity, his/her losses are fully deductible, and the $150k threshold no longer applies.

It sounds like you are familiar with the test, but I will restate it her for the sake of completion.

  1. At least 1/2 of personal services in all businesses for the year must be performed in a real property trade or business and rental real estate.
  2. The taxpayer must spend more than 750 hours in real property businesses and rentals in which he/she materially participates.

Both must be satisfied.  So even if someone spends 750 hours in real property businesses and rentals, if he/she spends 1,000 hours on other businesses, he/she would not qualify.

And then after this, the material participation test (must meet one of seven tests; will not go into here) is applied to each rental real estate activity to determine whether each activity is passive or non-passive.  The taxpayer may have made a one-time election to group all rentals as a single activity, in which case material participation is determined based on the grouped

So much great discussion here, but a little bit of misinformation here too, so I thought I would throw my .02 in.

First of all, just because you have a high wage earner in the family does not mean that things are suddenly not deductible any more.  You still fill out your Schedule E exactly the same way you always have.  All proper expenses, including depreciation, are reported and shown on the schedule.  Then, if you have a loss AND if your other income puts you up over the threshold where you can deduct those losses, then you have what is called a suspended passive loss.  You don't deduct the loss that year, but it does roll over to the next year.  Then the next year, if you've got passive income, those accumulated passive losses are written against that income.  OR, if your income has dipped down below the threshold, the passive losses are then written against your other income.  OR, if you sold the property that the passive losses accumulated on, then you get to write off the accumulated losses no matter how high your income is.

ALWAYS report all of your valid legal deductions every year.  The accumulated passive losses will not go away and if they accumulate long enough, can be a nice break against your other income later when you sell.

Note that if you are married, your choices for filing are Married Filing Joint and Married Filing Separate. In general, MFS is one of the worst situations you can be in. Lots of credits and deductions get lost with this status. The 10 second comparison your tax preparer does compares MFJ vs MFS. It does not throw Single or Head of Household into the mix as these options are unlikely to be available to you. If you or your partner do qualify for this, your tax preparer will have to calculate it manually. None of the common softwares out there do this automatically.

A C-Corp can be a good structure, but it does come with a lot of other headaches as well as the double taxation issue, so make sure this is really the best scenario for you before you head down that road.  It takes a very special scenario to make this worth while.  I am not sure what @Clarke Wegener means by "piling all our W2 income into the corp".  If you're working for another company, you can't do this.  What you can do is convert to a subcontractor with your employer (if they'll allow it) and then you'll get all kinds of tax advantages for being a small businessowner, but you can't just convert W2 income into a corporation.

The tax professional standard isn't met only by 750 hours.  You also have to do more real estate than any other venture or ventures.  So if you work 2080 hours for W2, you have to work 2081 in real estate in order to make the designation.

@Linda Weygant Thanks for the great input! You made some great points that haven't been discussed yet. I was headed down the C Corp road until I did a little more research. As you said, it's not as easy as just using your earned income from an employer as contributed capital. I miss read somewhere that you could deduct the contributed capital and just take a dividend payout low enough to not cause double taxation. Wouldn't that be great! Thanks for the bit about carrying the passive losses indefinitely! I was thinking I could only carry forward a few years. And being able to offset the gain from a sale is huge. That must be because the gain is still considered passive income? I'll definitely add that to my strategy. 

SOOOooo BP....I don't see any reason in my situation to not marry the love of my life! I don't ever see having more passive loss than passive income so I won't lose my deductions. Also, if my losses happen to be higher than my passive income I'll carry them forward which works very well for my exit strategy! The answer was much simpler than I had imagined. Amazing forum contributors! Thank you all very much!

Oh yeah, @Logan Allec and @Linda Weygant thank you for the real estate professionals refresher. I had an 18 month hiatus from the W2 job so I was able to claim RE professional. It really didn't help in my current situation. Maybe it would after I'm married but even that now has been overcome by other information. Thanks again.

Originally posted by @Logan Allec :

@Clarke Wegener , if a taxpayer is a real estate professional for tax purposes, rental real estate losses are no longer per se passive.  If the taxpayer materially participates in each rental real estate activity, his/her losses are fully deductible, and the $150k threshold no longer applies.

It sounds like you are familiar with the test, but I will restate it her for the sake of completion.

  1. At least 1/2 of personal services in all businesses for the year must be performed in a real property trade or business and rental real estate.
  2. The taxpayer must spend more than 750 hours in real property businesses and rentals in which he/she materially participates.

Both must be satisfied.  So even if someone spends 750 hours in real property businesses and rentals, if he/she spends 1,000 hours on other businesses, he/she would not qualify.

And then after this, the material participation test (must meet one of seven tests; will not go into here) is applied to each rental real estate activity to determine whether each activity is passive or non-passive.  The taxpayer may have made a one-time election to group all rentals as a single activity, in which case material participation is determined based on the grouped

This is really good advice! If you arrange things in this manner, then a wife that is a high W2 earner could be a financial match made in heaven for a "real estate professional"! One warning, though ... even though this strategy is 100% legitimate, take extra care to keep meticulous records, since checking the magic "real estate professional" box on your tax returns will dramatically increase your risk of getting audited, but this risk is worth it and if you keep good records and take only legitimate deductions, it should be no problemo.

Originally posted by @Clarke Wegener :

@Sean Walton   @Alan Grobmeier I get the concept of deferring the taxes by maxing the 401k. It's the part about deferring the income also that's hard to take. 

Deferring immediate gratification in exchange for future stability is what real estate investing (or any investing for that matter) is all about ... if you really want to be successful, you will need to get comfy with this and many more ways to defer as much as you possibly can.