5 Ways to Save on Real Estate Investment Taxes

 

Real_Estate_Investment_TaxesThere are many different ways to save on real estate investment taxes. Rather than bog you down with the minutiae of tax savings tips such as keeping track of gas mileage for every trip to see a property, you're going get the most powerful, most effective 5 ways for real estate investors to reduce their tax liabilities. And sorry, you're not going to be given any creative deductions like writing off cruises to the Caribbean or setting up offshore accounts in tax sheltering countries. The following 5 tips are tried and true methods that allow investors to pay the least amount in real estate investment taxes year after year. Are you ready? Disclaimer: This is not accounting advice nor is the author a licensed tax professional. Consult a licensed tax adviser for any tax or accounting related advice.

 

1. Hire a CPA that Invests in Real Estate

 

First and foremost, you should hire a Certified Public Accountant (CPA), preferably in your local area, although not completely necessary, who also invests in real estate on the side. Ideally, this person both earns passive income with rental property and creates earned income from buying and selling, or flipping, real estate. Not hiring the right CPA will cost you more in taxes than anything else. When you are making good money, a solid CPA will pay for themselves many times over.

Finding the right CPA can be as simple as asking other real estate investors in your area who they use. However, sometimes your competitors aren't interested in telling you who they use. In which case, you can also try asking other people on your team, such as closing attorneys, real estate agents, mortgage brokers, and the like, if they know of any CPAs that also invest in real estate. Local real estate investor clubs could even have a CPA as an advertiser in their newsletter. It may take some time to find this person, but it is well worth the search effort. Try not to get discouraged if not a single CPA you talk to owns their own real estate. These types of CPAs do exist out there, you just may need to be persistent.

 

2. Separate Short Term & Long Term Investing Activities

 

The first piece of advice my CPA shared with me was to separate earned income activities, such as my flips, wholesales, assignments and rehabs, from my passive income rental properties. He didn't want my rental income to get taxed as earned income. This is critically important for those just starting out because if you own a rental property in your personal name, and then start doing some flips in your personal name too, that could cost you a lot in taxes. Therefore, if you own a rental property in your personal name, set up another entity to do your flips and wholesales.

What type of entity should you set up? There isn't a one-size-fits-all answer to such a question. For example, I've seen trainings on "the power of the LLC", which may have some valuable insight. But try telling that to Mr. Barrett in Nashville, TN, who owns over 300 single family homes free and clear in his personal name. Do you think a man that wealthy is missing the boat and should own his properties in an LLC? Nope. It turns out, in Tennessee, if you own real estate in an LLC, you are charged an extra 2.5% franchise and excise tax per year on the total value of the assets owned by the entity. That’s $2,500 per $100,000 property you own per year, even if you have a loan on it for $100,000! The State of Tennessee F&E tax alone can eat up all of a real estate investor's cashflow. However, sole proprietorships and general partnerships are exempt from that F&E tax. Mr. Barrett isn't quite so dumb now is he? (In case you were wondering how Mr. Barrett protects his real estate portfolio from potential lawsuits of those 300 tenants, he uses a general liability insurance policy.) Meanwhile, for short term investing activities, you may, indeed, opt for an LLC or perhaps an S-Corp. Who should you ask for clarity on which entity to set up for your short term as well as your long term investing activities? You guessed it...your CPA.

 

3. Get Organized

 

The IRS severely punishes disorganized business owners. The list of unorganized entrepreneurs who are either in prison or are no longer rich is both long and distinguished. There are several skills required to be successful in real estate; from finding good deals, to structuring deals so that everyone wins, to executing the most profitable exit strategies. In addition to those skills, you also need to have your books in order. Welcome to the wonderful world of being rich. You have to account for your riches 🙂

 

Quickbooks

 

Every expense and income needs to be organized into a system. Quickbooks is the standard in small business bookkeeping management. There is now even an online version of Quickbooks that is very inexpensive. If you don’t want to learn how to use Quickbooks yourself, hire a bookkeeper. There are plenty of bookkeeping services out there and many charge a very reasonable fee.

When your books are organized into Quickbooks, you also activate the true power of a CPA. Investors that bring a shoebox full of receipts to their accountant once a year miss out on all the creative ideas a tax professional can unleash when you have everything in an easily accessible digital format. In essence, you are allowing your CPA to do his/her job the best way that they can when you organize your books digitally. You wouldn't provide a painter with a toothbrush to paint your house, would you? That's effectively what you are doing when you don't use a system like Quickbooks.

When you begin to get your books in order, you may discover that you are co-mingling personal and business transactions in the same accounts. That's a big no-no. Every business deposit and every business bill should be transacted through bank accounts and credit cards specifically set up for the business. There is a huge shortcut whereby certain banks like Bank of America and certain credit card companies like American Express integrate with Quickbooks so you can click one button and automatically import all of the transactions. So if you don't already have a separate bank account or credit card set up for your real estate business, when you go to get these, make sure the bank or credit card integrates with Quickbooks. It saves hours and hours of time each month on bookkeeping duties, which even if you hire a bookkeeper, will still save you money on the costs of their services.

When your books are organized, you can also see clearly what is going on in your business. I learned a whole lot about where the real profits are made in real estate after studying my Quickbooks P&L reports. Your biggest and easiest profits don't always originate from where you think. For example, I discovered the secret to flipping houses was, in most cases, to wholesale the deal to a contractor investor buyer rather than rehab it myself. I also realized just how potent retail wholesaling was. These were breakthroughs that have earned me a fortune since then...all because I took the time to get organized.

 

4. Own Some Rentals

 

Rental income is extremely tax advantaged money. It stems from this wonderful deduction the IRS allows you to take called Depreciation. For a single family rental property, the IRS allows you depreciate the tax basis amount of the property (the amount you purchased the property for minus the value of the land) over 27 1/2 years. For example, let's say you buy a $100,000 rental home that has a land value of $10,000. Your tax basis would be $90,000 ($100,000 sales price - $10,000 land value). When you divide by 27 1/2 years, you get a tax deduction of $3,272.73 each year. That's a significant "expense" to have on your tax return! Then, let's estimate that after all normal rental property bills, including maintenance, you’re left with a positive cash flow of $270 per month. The $3,273.73 in depreciation each year would completely offset all of your positive cash flow. So essentially, you wouldn't be paying any income taxes on your rental income! It’s incredible. Plus, as your property increases in value, you’re not paying any tax on the appreciation (so long as you don't sell it). Rental property is one of the most tax advantaged ways to earn money in the United States.

 

5. Earn Money Like the Ultra Rich

 

Have you heard folks like Warren Buffett (one of the world's wealthiest people) share that percentage-wise, he pays less in taxes than his secretary? Or perhaps you remember during the presidential election the big stink that was made over how little Mitt Romney paid in taxes? Technically, the majority of richest people in this country pay a very large total sum in taxes. In fact, the wealthiest 20% in America pay for nearly 70% of the total tax revenue. However, on a percentage basis, the rich pay far, far less than the middle class. Why? Because the wealthy earn some (or all) of their income through investments as opposed to W2s and 1099s created by working for other people. Rental property is one such investment that allows the wealthy to earn great money but not incur a heavy tax liability. Another example is when you sell your investment property after more than one year of ownership. You may incur a long term capital gains tax (15%...soon to be 20%) as opposed to ordinary income tax (15% - 35%+). One example of how this is applied in the real world is when you buy a property, fix it up, and then sell it on a 13 month Rent to Own so that the tenant buys the property in little over one year. The net profit can then potentially be considered a long term capital gain. Not only is your tax liability potentially much less, but you also can usually sell a property on a Rent to Own for top dollar and you typically don't have to pay real estate commissions. That’s a winning combination!

Another creative way to earn money like the ultra rich is with a 1031 exchange. When you sell a rental property, you can defer your profits from being taxed by doing a 1031 exchange. In simple terms, this is the real world example of what you do in the game of Monopoly when you exchange 4 green houses for 1 red hotel.

How can the richest people in this country pay the least percentage-wise in taxes? They earn their income from investments as opposed to jobs. Shouldn’t you be earning more of your income from investments?

Those are the top 5 ways to save on real estate investment taxes. Do you recommend any other ways to save on real estate investing taxes?

 

Comments

  1. Anthony R. says

    Another great video Phil. If you are financing a buy and hold strategy, can mortgage payments be considered deductible expenses for tax purposes? When I start REI, I want to reinvest every penny of cashflow back into a single property at a time in a snowball manner if it reduces the income on my taxes. I appreciate your opinion on this and I realize you are not a tax person; but I am asking from your unique perspective.
    Thank you,
    Anthony

    • Phil Pustejovsky says

      If you own a rental property and you have to pay a mortgage payment then that mortgage payment is expense against your rental income.

      • Jeffrey Smith says

        I am not a CPA. As I understand it, only the interest portion is tax deductible as a business expense. The principal portion is tax deductible according to the depreciable tax basis of the improved property. There are different kinds of depreciation that you can select when you acquire ownership, but once selected for a particular property you cannot change it. There are income limits imposed, so consult with a CPA (who owns rental real estate) for all of the gory details.

  2. The information you give is very helpful i am reading all the info i can get and becoming a new investor.Thank you looking forward to learning more.

  3. Hey Phil~

    Thank you so much for doing the presentations! I really enjoy them.

  4. Rob Arnold says

    If you are not sure where to find a good CPA, join a local real estate club. Lots of good networking can be done there.

    Also I was in a seminar on 2013 Florida land trust revisions. Apparently recent changes allow both the trustee and the beneficiaries to be relieved from liability from the property now. Makes the trust virtually bulletproof.

    Great video Phil.

  5. dolorosa hortelano says

    Thank you for such helpful articles.

  6. Linda Chea says

    I like this Phil. I had put my properties in LLC also. It is hard at the beginning, but hope the next year will be better. LLC is the best asset protection and it can file with individual tax or separate. It is up to us the way we wanted to form it.

  7. Thanks for doing this presentations I have watched them all. I never heard of a 1031 does this only exsist in the United States.

  8. Josef Nemirivsky says

    3000/12= 250 per month instead 275
    A small detail

  9. Phil,

    This is very great video. Thanks for the info.
    Radim

  10. nice information, well presented in a clear and concise way. thank you BZ

  11. Great video. Thanks

  12. keith jordan says

    Great info.

  13. Hi Phil – I want to know if it is possible to do a 1031 exchange and take out the original investment on a house without paying taxes on it – I think you mentioned it in your video

    Here is the situation- I bought a townhouse for 111,000 in 1985 moved into a 4 bedroom colonial in 1997 and have been renting the townhouse out since then. I would like to exchange the townhouse for another house at 260,000 the townhouse is worth 370000. Is it possible to do a 1031 exchange and get the original 110,000 out without paying taxes on it and defer the gain on the 260,000 (or so)

    thanks for your help

    • Phil Pustejovsky says

      Talk to qualified 1031 intermediary, but you shouldn’t have to pay capital gains taxes on anything within the cost basis ($110,000), but instead, any amount ABOVE $110,000.

  14. Gerald Gaddy says

    Thanks for the insight Phil. I just implemented one of your strategies when flipping house regarding having the buyer get pre approve by my preferred lender. I also included extra language stating that the buyer must also submit all their financial documents to the lender. Take care!

  15. That passive income of owning rental and tax treatments is VERY INTERESTING!

  16. Hi Phil love your videos the question I have is can I sell a like kind property to a friend roll that sell into an exchange and then buy back the property after I close on the new property ? Thank you Jim

  17. I always wanted to have someone put together a list that will prepare me when tax time comes (in order) like you did here. Thank you

  18. Your 5 Tax Savings Tips I just listen to reenforced my knowledge in investing real estate I did 1031 exchange back in 1987 when I sold my 10 acre land and with the advice of my CPA we did 1031 Ex. And have done 3 more times over the years and it works. Thank you and please continue educating us in investing in Real Estate . Marie N.

  19. Good day , i wanted to open a l.l.c in los Vegas Nevada
    There is a 150,000 .00 tax waver for l.l.c. licences can you or do you know any thing about this . I read about it and wanted to open my l.l.c. there can you verify this …..

  20. Marlene Garcia says

    Thank you so much for the information very helful.

  21. Great vid, Phil! I have a quick question. On depreciation, is that from the year it was built or from when you actually bought it? Like if the house was built 50 years ago, but I only bought it 2 years ago do I still get to deduct the depreciation even though it is older than 27 years?

  22. Linda Hoffmann says

    Ilive in Reno nv i think there is a bubble in Reno .you cant buy a house under 330 thousand in south Reno. what do you think? LINDA

    • Freedom Mentor says

      Our systems and strategies work everywhere in the US and Canada no matter what real estate cycle you are in.

  23. Thank you Phil for all that you do for us real estate investors or people looking to be real estate investors. I find your video presentations very informative as well as quite enjoyable.

  24. Christina says

    Thanks for these great educational videos.

  25. Thank you Phil,
    Got an invite to a circle of excellence and met a CPA who is into wholesaling houses, I thought of you. I am working for myself right now getting my house up to speed. Sharing your lessons in these to the point video’s is awesome. thanks again.

  26. vicky L SOWERS says

    I ONLY WISH MY HUSBAND THAT PASSED12-25-17 HAD KNOWN ALL THIS STUFF AS IT IS THE PROPERTIES THAT HE BOUGHT14 YRS AGO . WELL NO LEASES NO PROPER ACCOUNTS NO TAXES PAID ALL PROPERTIES (6) WERE TRASHED BY RENTERS, NO $ TO TAKE THEM TO COURT. I WATCHED , ADVISED AND TRIED TO HELP. TO NO AVAIL , NOW TODAY THESE PROPERTIES ARE BEING SOLD AT A SHERRIF’S SALE, AS THERE WAS NO LIFE INSURANCE. TO MAKE A LONG STORY SHORT , WE WERE LOSING $, NOW HE HAD INHERITED 675 THOUSAND $ FROOM MOTHER’S ESTATE. TO SAVE OUR BACON HE STARTED SELLING CIGERETTES AS HE SMOKED AND I DIDN’T , HE THOUGHT IT WOULD MAKE HIM $ ,.. SO IN THE MIX OF PAPERWORK THAT WAS NOT FILED, THEY ASSESED 36 THOUSAND $ AT THE 2ND MONTH OF BUSINESS, SO HE STOPPED THAT . THE ASSESEMENT GREW TO 378 THOUSAND. LEINS ON PROPETIES NOW THEY WILL BE SOLD AS “JUNK ” TO SATISFY THE STATE AND THE COUNTY WHOM HE ALSO DIDN’T PAY. SO ANY $ MADE TODAY WILL GO TO THE STATE AND COUNTY.. AND I WILL BE FINDING A NEW PLACE TO LIVE. OHTHE STATE 6 YEARS LATER SAID THAT THEY MADE A MISTAKE, JIM ONLY SOLD 3000. $ WORTH OF PRODUCT.. THERE SHOULD NEVER HAVE BEEN THE 36THOUSAND AT THE 2ND MONTH THEY , WERE CORRECTING BUT NONE THE LESS THE AMOUNT IS NOW DOWN TO OH ABOUT 80THOUSAND$ . BY THE WAY I DO NOT FAULT MY HUSBAND I BELIEVE THAT HE WAS LIVING WITH THE CANCER ALL THOSE YEARS TAHAT FINALLILY TOOK HIM. HE WAS A PROUD MAN AND I LOVED HIM DEARLY. SO LET THIS BE A CAUTIONARY NOTE WHAT NOT TO DO. THERE IS MORE TO THE STORY. BUT I WILL SIGN OFF. I AM LOOKING AT GETTING MY TWO BABY ROTTIES AND MOVING TO THE SOUTH GETTING BACK TO WARM WEATHER THAT I LOVE . OHIO IS TOO COLD FOR ME. TAKE CARE. AND I DO LOVE YOUR INFORMATION VIDEOS. THANKS

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