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If you want to save money on taxes, there is a way to do that with Real Estate.
Real estate finance for investment properties can be a complicated topic to understand.
What I am about to tell you could very well change your life and fast track your family on the road to building wealth.
There are many laws and rules when it comes to figuring out what your bottom line is for an investment property.
Yes, you have to do your homework and make sure that the investment property IS actually worth purchasing.
It is important that the property is not some type of HAZMAT property incubating mold that will cost tons of money to rehab.
Nobody wants that.
However there are also a lot of regulations and tax laws that pertain to investment properties aside from the physical characteristics of the properties. Income and expenses can be calculated in a lot of different ways depending on your situation in life because of these laws.
You can save money on taxes by marrying a Realtor.
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- 1 If you are looking to save money on taxes in your life, below are the reasons why everyone should marry a Realtor.
If you are looking to save money on taxes in your life, below are the reasons why everyone should marry a Realtor.
Before we go any further, I want to be sure to point out that you should run your particular situation with the appropriate legal or accountant advisor in your life. They are the ones to best handle your particular situation as they are licensed professionals who deal with these real estate finance issues on a day-to-day basis.
Determining real estate finance for investment properties and whether or not a particular property should be purchased has a lot of variables. To keep things as simple as possible to understand, I am referring to a 4-unit or less investment property throughout this article. Anything over 4-units, funding requirements change and so do some of the laws.
Some Realtors will utilize a spreadsheet for the real estate finance of the property that will quickly help a client analyze the property.
No, this is not the reason why you should marry a Realtor.
Unless the Realtor works specifically in this investment niche, most residential Realtors can’t do this. They may not be familiar with this type of real estate finance. Often times, a client is better off going with a commercial agent or residential agent that specifically deals with investment properties on a regular basis.
Real estate finance, cost recovery, or depreciation (common terminology in the investment world is depreciation), will play a huge role in how profit and loss of income is determined and the taxes you will pay.
Depreciation is an accounting term that often times will lead to a passive loss on your investment. In the world of real estate finance, It is very possible that you may have positive cash flow for the investment property, but because of depreciation you will show a passive loss on your investment.
It is passive loss that we are interested in.
Why is Passive Loss Important?
In order to understand IRS passive loss rules on an investment property is important, we first have to look at the different types of income there are and a little bit of background on the issue.
The Tax Reform Act of 1986 (which took effect in 1987) had a major impact on real estate finance and passive loss rules.
PRIOR to 1987, there was just one type of income by the IRS. A lot of high-wealth individuals were buying real estate and showing passive losses on their investment properties. They would use ridiculous paper losses as a way to offset their current income from taxes.
As a result, there were a lot of CEO’s just buying whatever type of property up in order to qualify for paper losses as a way to shield some or all of their income from these taxes.
Well Uncle Sam didn’t like that.
So In 1987, the IRS said your income has to be classified as one of the following sources:
Active or Earned Income: Wages, Salary, Main Job
Portfolio: Interest, Dividends, Income from Investment, Royalties
Passive: Rental Real Estate, Limited Partnerships.
IRS defines passive income as income from “trade or business activities in which you do not materially participate…”
The Government said your income now has to be classified in one of these three categories.
Rental real estate is considered passive income. As such, all of your losses are considered passive losses. In 1987, they could no longer be used to offset your salary and wages from your job or your active income. They could not be used against portfolio income either. The only place passive losses could be used was against passive income during this time. However, there is one exception.
The $25,000 Exclusion
However, the $25,000 exclusion is also part of the act. If you met certain rules and criteria, you are allowed to use up to $25,000 of passive losses against active (or earned income) and portfolio income.
Those two rules are:
1. You have to own at least 10% of the property
2. You have to be actively involved in the decision making
No, this is not the reason why you should marry a Realtor either.
Think about that for a minute…how many people lost major wealth as a result of this?
If they had bought investments JUST for the paper loss to be used against their active income to offset taxes, they could only use $25,000 of losses now and they had to meet the two rules above as well now.
A lot of people lost wealth and some even filed for bankruptcy because of these changes that took effect in 1987.
Remember all those CEO’s who were making $300,000-$400,000? Prior to 1987, these CEO’s would get a mortgage loan and own enough real estate where they could show $300,000 losses and end up not paying ANY tax.
They would buy property that had negative cash flow because they could make it up in income tax savings.
Even the $25,000 exclusion has variables once your AGI reaches $100,000. We don’t need to cover the details of that. Just know that the $25,000 exclusion becomes less effective with an AGI over $100,000. With an AGI at $150,000 or more, the $25,000 passive loss deduction is reduced to $0 based on some variables.
So even the CEO’s who were making $300,000 and $400,000 a year, since their AGI was over $150,000, they would not qualify for ANY of the $25,000 passive loss deduction applied to their active or portfolio income.
The HOLY GRAIL of Exceptions…The 1994 Exception
Then came along the Reconciliation Recovery Act of 1993 that basically said people who meet certain requirements can ignore the $25,000 passive loss deduction limit.
This exception is considered the golden goose in my opinion of deductions and is an excellent tool for a family to build wealth.
The requirements are as such:
1. Over half your work time is self-employed in a real estate related business. (brokerage, rental, management, or leasing).
2. That half must be more than 750 hours per year in those businesses.
If you meet those rules, you are not subject to the $25,000 passive loss deduction or the phase out. You can shelter all your income with no limits. That’s right.
However, it gets even better and I hope you are sitting down. What I am about to tell you could drastically alter your financial future and wealth building strategy for your entire family.
Only ONE SPOUSE has to meet the rules and the entire family qualifies for the exclusion.
That’s right so if one spouse works exclusively in a real estate related business (say rentals as a section 8 landlord for example) those losses can shelter the entire family income, provided you are holding enough real estate to generate enough passive losses.
THIS IS THE REASON YOU SHOULD MARRY A REALTOR.
Think about this, if you have one spouse who is a doctor or a surgeon that has a salary of $200,000, alone that individual would not qualify for any of the $25,000 passive loss deduction. However, IF that surgeon marries an individual who has over half their work time in a self-employed real estate business and that half is more than 750 hours in a year, then that high income surgeon WOULD qualify for the passive loss deductions with NO LIMITS.
I sold real estate for a decade and I never knew of these passive loss deductions; specifically the Holy Grail exclusion. A lot of Realtors do not even know of this exception.
Additionally, some accountants and CPA’s do not know about the 1994 exception so it’s vital that you mention this to them and seek their professional knowledge on how this would affect your family.
Real Estate is a great investment tool for building wealth, that you can’t afford to ignore this strategy.
If you fall into this situation and you want to go back and apply these passive loss deductions, you can use form 3115 to do so. I have used this form before to make adjustments on my rentals. The beauty of this form is that there is not a time limit and you can go back several years for the adjustments (you should verify all of this information with your tax accountant, CPA, or legal team that represents you).
The Benefits and Your Pathway
The underlying benefit that everyone needs to realize is that this also offers a way for people to transition into the real estate field. Maybe you are looking to retire or you want to push your cubicle walls down, take your red stapler, and ditch your 9 to 5. It’s a dream many of us have. However, you can’t quite piece it all together on having enough income.
By going into real estate, either in retirement or pre-retirement, your family may be able to theoretically not pay any tax on your spouse’s income. That’s real money back in your pocket.
Remember before 1987, just about every CEO and high earner was using this very strategy to reduce their taxes paid. Their focus was real estate.
You can also sell real estate should you decide to become licensed to do so. The real estate industry is one of the best industries for flexible work scheduling and does not have income limitations.
This is such a great pathway for wannabe FIRE’s to take control of their life. Not only can you manage rentals, but you can also work in other areas of real estate while you are doing that. It’s possible to make over $100,000 by working a combination of these real estate related jobs.
So there are many financial wealth building options such as:
- You can just focus on having enough rentals and showing passive losses in the event to reduce your spouse’s taxes paid.
- You can do the above strategy and focus on working more in the real estate field and make more income if you want
- You can do a combination of the strategies above and use income to continue to buy more real estate rentals. The advantage to this is that at some point your properties will grow and appreciate. That is something I have not even covered in this post.
However, you can see why having a tax manager is so essential in trying to formulate your wealth building plan through real estate finance and these strategies.
If this sounds like something your family wants to look into, I recommend you meet with a tax manager, not a planner because there is a difference. It’s vital that you speak with CPA and not just the tax preparer down at the corner at the place with the 15ft air dancer in front of the business. Remember, you get what you pay for.
And if you don’t want to get married…
Knowing the laws and rules of real estate finance is one of the best ways to save money on taxes for your family.
This strategy has been used throughout history for high income earners. Through passive loss deductions, it is possible to fast track the pathway to building wealth for your family.
Guys all you have to do is ask, and ladies, all you have to say is “I do!”
I am an advocate for marrying for love, but saving money on your taxes by marrying a Realtor, it’s like the icing on the cake.
Who doesn’t like cake?!
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