Real estate investments are becoming more and more popular among medical and healthcare professionals – most of our clients own more than just their primary residence.
Very often we receive calls along the lines of: “How can I save on taxes with a rental real estate investment?”
The regulations concerning rental properties are not simple!
The answer is very complex. Here are a few things you should know. Investing in real estate is just that – an investment. We’ve seen clients make a LOT of money buying, renting, and selling properties – and we’ve seen clients who lost a lot of money as markets turned. This is because an ROI from an investment is never guaranteed – no matter what anyone tells you.
Rental income (unless you achieve professional real estate status), is considered PASSIVE income. If you have more expenses than revenue – this is called a PASSIVE LOSS. Many rental properties have passive losses, as a result of depreciation, rental expenses, maintenance, property management fees, real estate taxes, insurance, and other operating costs.
With various types of business or self-employment income, you can deduct losses on your annual income tax return. With passive losses this may not always be possible – as passive losses can usually only be offset by passive gains (i.e. if your rental property becomes profitable, your passive losses will offset your passive gains, but usually NOT your active (ordinary) income, like from a W-2 job or a business or a 1099).
Unless you have a passive gain OR sell the property, your passive losses will be carried forward indefinitely – with no benefit to you.
There are exceptions to the above, but our clients usually cannot meet the requirements.
Are you a real estate professional?
You may be able to deduct passive losses against your ordinary income if you obtain Real Estate Professional status. This is not easy to do – and you must spend at least 750 hours annually in the real estate business, and more than half of your working hours must be dedicated to real estate. You must also fulfill a series of other requirements. This is almost impossible if both spouses have a full-time job, though we have seen successful implementation if one or both spouses give up their job, obtain a real estate license and follow down this path.
You can deduct up to $25,000 in passive losses if your Modified Gross Income is under $150,000 annually for married couples filing jointly, and under $75,000 for single taxpayers or those who are married and filing separately. This is only if you can demonstrate active participation in your investment property.
In conclusion, passive income rules and stringent IRS regulations regarding real estate professional status make it difficult for taxpayers to offset tax liability from ordinary income.
You should do a lot of due diligence on a company promising to slash your taxes in half through a rental property investment (especially if the aforementioned company wants you to set up a convoluted legal entity structure or employ complicated measures or loopholes).
So… what can you do if you are eager to invest in rental real estate or already own a property?
Know it may or may not work out for you!
View your purchase as an investment – and not a tax reduction strategy (there are MUCH better tax reduction strategies out there, even if you receive only a W-2).
Understand that your rental property may not be profitable – and you may not see any of the passive income you strived to obtain with the investment.
There ARE various ways to increase your passive losses to help offset passive gains, or defer capital gains from the sale of your property (for example 1031 exchanges).
If your property is profitable, you may want to look into speeding up depreciation with a cost segregation study.
If you’re looking for tax savings, our tax reduction plans can take current or future real-estate investments under consideration. Each tax plan is researched for ONE client, and we are able to dive deep into the nuances of your finances and taxes.