Investment Strategies on How to Save Money on Taxes

Taxes are one part of real estate investment operational costs. Although they shouldn't drive your investment decision, you need to thoughtfully evaluate your preferred asset classes and accounts to lower your tax bill. Read on to discover helpful investment strategies to save money on taxes.

Scott Royal Smith speaks on investment strategies to help you save tax funds

While tax rates and rules might change over time, nothing beats the value you'll get from factoring in taxes while making investment decisions. 

Taxes can reduce your return on investment yearly, potentially affecting your long-term goals. Before deciding on whether to go for real estate investment, cash instruments, bonds, or stock, it's best to understand how the Internal Revenue Service (IRS) treats income from such asset classes. 

You can also gain valuable insights from investment experts like Scott Royal Smith by listening to this Icons of Real Estate Podcast episode, where he gives out vital tips for lowering investment property tax returns. 

Scott Royal Smith is an astute real estate investor and founder of The Royal Legal Solutions, where he offers asset protection services to real estate investors. 

If you're an investor looking to protect yourself against paying high taxes on your investment return, this article explores vital investment strategies you can adopt. Read to the end!

How the IRS Tax Your Investments

The IRS taxes investment income separately from the way working wages are taxed. These differences include the tax rates and how and when investment income taxes are assessed. 

Broadly speaking, investment income comes in the following two ways, with each treated differently for tax purposes.

Capital Gains

Refer to the increment in an asset price. For instance, if a real estate property or stock goes up in value, the extra amount is the capital gain. 

The government taxes capital gains when the asset has been sold. 

Cash Income or Dividends

Cash income or dividends is money you receive during the year. This cash is often subject to taxes for the year it was received. 

Taxation is a crucial factor to consider before choosing an investment strategy
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7 Investment Strategies for Lowering Taxes

Now that you know how the IRS taxes investment income, the following are investment strategies you can adopt to lower your taxes:

#1 Opt for Long-term Capital Gains

Investment is a crucial wealth-generation tool, with the investor benefiting from favorable tax treatments for long-term capital gains. 

If you hold a capital asset for longer than a year, you'll enjoy a preferential tax rate depending on your income level. It could be 0%, 15%, or even 20% of the capital gain. 

Alternatively, the IRS will tax your capital gain at ordinary income rates if you hold the asset for less than a year before disposing of it. Therefore, it's best to understand short-term vs. long-term capital gains before starting your investment journey. 

#2 Max Out Retirement Accounts

Employees can enjoy reduced taxes from contributions up to $19,500 in a 403(b) plan and $20,500 in a 401(k) plan. Also, workers up to 50 years and more can add $6,500 to their retirement plan contribution. 

Alternatively, employees without a workplace retirement plan can contribute up to $6,000 or $7,000 for people above 50 in their traditional individual retirement account (IRA) and enjoy a tax break. 

Taxpayers with workplace retirement plans can deduct all of their traditional IRA contributions, depending on their income. 

Check the IRS rules for how much to deduct and if you're qualified for such deductions. 

The right investment strategies can save an investor from double taxation
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#3 Utilize a Health Savings Account

Consider using your health savings account to reduce taxes if you have a high-deductible health insurance plan. If you're lucky, your employer might match your health savings account (HSA) as with a 401(k). 

This contribution by payroll deduction is exempted from your taxable income and is completely tax-deductible from your income. Presently, the maximum deductible contribution for individuals is $3,650, while for families, it's $7,300. 

These funds can grow without you paying taxes on the earnings. Your withdrawals won't be taxed if you use your HSA to pay some medical expenses. 

#4 Lower Long-term Capital Gains Rates

The IRS fixes the wage and investment income differently, as reflected in the IRS capital gains treatment. Depending on your income level, the IRS taxes capital gains at 20%, 15%, and even 0%. However, you have to play by the rules. 

These taxes are often lower than short-term capital gains, taxed at the ordinary income rate. If you're a buy-and-hold investor and hold your investment for over a year, you can take advantage of lower long-term rates. 

For instance, if you earn less than $80,800 as a couple or $40,400 as an individual filer, you can be exempted from qualified dividends or capital gains up to a specific threshold. 

If you gain too much ordinary income, you'll be ineligible to qualify for the 0% rate and have to pay a higher investment tax. 

More so, if your income is less than average in a tax year, you can gain a 0% investment tax rate and increase your investment cost without any tax hit. 

#5 Employ Tax Loss Harvesting

Entails using your investment losses to offset the gains yearly, helping to reduce your income tax liability at the federal level. 

If your investment losses are more than the gain, you can use tax loss harvesting to offset about $3,000 of the annual federal taxable income. You can also carry additional losses over to future tax years. 

Tax loss harvesting can be valuable for high-earning investors with a long-term higher capital gain tax and a potential 3.8% additional net income tax. Note that if you hold off selling your asset till later in the year, the prices will depend on the year's final weeks of market downturns. 

Identical stocks bought within 30 days after or before the sale will also be regarded as a wash sale, which may render it ineligible for tax loss harvesting for that tax year. 

Consider consulting a tax advisor to understand how the wash sale rules work and if it prevents you from using the tax loss harvesting strategy. 

The right investment strategy can help you lower taxes on real estate investments
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#6 Use a 1031 Exchange

Real estate investors looking to sell a property that isn't their primary residence can take advantage of the 1031 exchange and reinvest the money into another building. 

1031 works by allowing you to sell your property, defer your capital gains, and invest the money into another like-kind investment property quickly. However, 1031 exchanges come with specific rules.

These rules can be complex, but you must follow them strictly to avoid losing your tax deferral. Like other asset types, you can hold your investment long-term and defer capital gains for up to decades. 

Most importantly, you get to avoid high real estate commissions. 

#7 Consider Asset Allocation

Generally, cash distributions and dividends are taxable in the year they're received. Therefore, if you use a taxable account, you can't avoid paying taxes as with capital gains. 

Getting low dividend taxes depends on where you keep your assets. For instance, you can opt for a tax-advantaged account, like a standard taxable brokerage account or an IRA. 

For investors with dividend stock, it's best to keep them within the tax-free confines of an IRA to avoid taxes on the distributions. Alternatively, you can hold stocks with possible capital gains in a regular taxable account. 

You can enjoy IRA's key benefits (tax deferral) in a taxable account until you're ready to sell your investment. However, consider whether packing your whole dividend payers into the IRA is the best financial decision.

Final Words 

Although paying taxes to the authorities is crucial, you don't have to pay more than is necessary. Taking your time to peruse the IRS website and other reputable financial information sites might lead to tax savings up to hundreds or even thousands of dollars.

Don't forget to get resources from successful investors. To gain more insight, you can listen to renowned serial real estate investors like Scott Royal Smith talk about asset protection and how to lower investment taxes on the Icons of Real Estate podcast. 

Whatever investment strategies you adopt, remember the goal is to make tax-efficient decisions. Also, consider how the investments will diversify your portfolio while pursuing your overall investment goals at your preferred risk tolerance level. 

Don't forget to consult a professional tax advisor before making investment decisions to avoid incurring more taxes instead of lowering them. 

However, if the technicalities involved in active real estate investing are too much for you, real estate companies like Holdfolio offer you the chance to become a passive real estate investor and earn returns without doing any work.

This article is sponsored by ArdorSEO, the leading online management company offering local real estate SEO services to help real estate agencies reach more prospective customers online. 

Conclusion

If you're tired of paying more taxes on your investment, you need to learn how to lower investment taxes through seasoned experts like Scott Royal Smith. Catch him speaking about how to reduce investment taxes at the Icons of Real Estate podcast and learn how to become a successful real estate investor like him. 

Tax Filing with Partners Using an LLC or Series LLC

While having a partner may make business sense, tax filing with partners can be complex and confusing. Paying taxes is painful. It’s tough to part ways with your hard-earned money when you have business expenses and maintenance to handle. 

This article doesn’t include every tax break or loophole available. But it provides helpful, clarifying information about tax filing with partners in an LLC or Series LLC. 

Tax Benefits Of An LLC Or Series LLC

There are several advantages of selecting a series LLC as your business structure. It provides you with asset protection and anonymity, but there are also tax implications. Let’s check out some things you need to know about how tax filing with partners works with an LLC. 

Remember, a series LLC is unique because it has a parent LLC and a series of children LLCs under it. Each entity in the structure provides its own layer of asset protection and anonymity and is protected against risk from other series. As a real estate investor, this allows you to segregate risk and hold several different properties without incurring the cost of setting up new business structures for them. 

First, the IRS treats a series LLC as a single entity. Since it’s a pass-through entity, you can choose how you want to be taxed by the federal government. You have the option to choose between being taxed as a: 

We will focus on the partnership or filing taxes with partners. 

What Options Do I Have For Filing Taxes With Partners?

Filing taxes with partners depends on a few factors. But first, let’s talk about what it means to be a partner. The IRS considers any individual who owns an asset with another individual to be partners.

In most cases, partners must file a Form 1065 to report their income, gains, losses, deductions, and credits. An exception to that is if you are married to your partner. In the case of marriage, you can file Form 1065 and then do your taxes as you normally would. 

There are some benefits of filing taxes with partners using Form 1065. 

Cash In On These Tax Tips 

Filing taxes with partners using Form 1065 can benefit you and your partner. Recall that if you’re in a partnership, you’ll have to file a Form 1065 (unless you’re married to your partner). The 1065 (and Schedule K1) may be beneficial. 

For instance, Form 1065 allows you to: 

Protect your assets

When you file Form 1065, you can move the tax liability of your business entity to the partners who have an interest in it. The form tracks your and your partner’s financial participation in the business on Schedule K1. 

The 1065 and K1 protect your assets because the total income and expenses are a single line item. There aren’t separate spaces for your properties, just for your overall income and expenses. 

Simplify your expenses

Through the ordinary course of business operations, you may encounter expenses that do not directly tie to one of your properties. When you file with Form 1065, it’s easier to specify those expenses and claim them on your taxes. 

Some examples of typical expenses you may claim on Form 1065 include the following:

Using Form 1065, you can enter the whole number as an expense, preventing messy records and bookkeeping. 

Secure loans

Banks sometimes favor Schedule K1 income over Schedule E income when you apply for a loan. The bank may look at your Schedule K1 income and accept the number of expenses you claim. 

On the other hand, if you supply your Schedule E income, banks will have predetermined vacancy credits, repairs, and maintenance that may lower your income. This may be especially harmful if you have new houses in your portfolio where you can get dinged for nonexistent expenses. 

There are some considerations when filing Form 1065. For instance, it takes a long time to get a K1, so your taxes are due on March 15. If you need to file for an extension, you must submit it by September 15. Another issue is that a 1065 and K1 can be complicated, so you may need a professional to help you prepare the forms. 

Key Takeaways

Filing taxes with partners through an LLC requires you to complete Form 1065 and Schedule K1. That rule applies to all partnerships unless you’re married to your partner. In that case, you can file a 1065 or in a different way. 

There are some benefits to filing using Form 1065, including, but not limited to, its ability to: 

It takes a long time, and it may be complicated to file taxes with partners using Form 1065, but we’re here to help. Take our TAX QUIZ to find out how we can best solve your tax needs.

Inflation Reduction Act Impact on Investors

Do you know much about President Biden's Inflation Reduction Act? If not, you're not alone. 

This bill, signed into law in August 2022, is new and pushes many real estate investors into murky waters. 

The IRS hasn't provided clear guidance on the Inflation Reduction Act, and many wonder what the new law means for the real estate industry. 

We'll show you the most relevant portions of the Act and how it might affect you as a real estate investor. This discussion won't be a comprehensive guide, but it will demystify some of the sections of the Act that influence your bottom line. 

What Is the Inflation Reduction Act?

The Inflation Reduction Act (IRA) was passed in the Senate and House of Representatives; President Bident signed the legislation into law on August 16, 2022. There is good news for real estate investors in the bill. 

In most cases, the IRA should not raise your taxes; instead, to combat inflation, the IRA created the following ways to increase tax revenue: 

The increase in enforcement might affect you as a real estate investor. An increase in enforcement probably means more audits due to more IRS agents, but you can protect yourself with good bookkeeping practices

Reducing Interest Rates, Probably

It's in the name–the bill aims to reduce inflation. With a reduction in inflation, the Federal Reserve can start easing back the interest rate hikes it's been implementing. This change takes time, but the end is–ostensibly–near, and Chairman Powell might be willing to ease up on the aggressive measure taken to date. 

That's good news for a real estate investor because lower interest rates should coincide with favorable mortgage rates; reasonable mortgage rates should result in more property deals.

One of the most relevant portions of the bill for real estate investors is the $369 billion earmarked for green energy and energy security. 

The Impetus To Go Green

The IRA provides $369 billion to tackle the climate crisis in the United States. The primary provision is tax incentives and credits for homeowners, businesses, and investors. 

Energy Costs For Real Estate Investors

The cost of energy increased to historic highs in 2022. As a real estate investor, you likely incurred increased utility bills in your properties, and that added cost significantly impacts your cash flow. 

An investment in green energy ideally will lower the cost of energy across all sectors, including for you. 

Another provision in the bill may help real investors mitigate the energy cost while also receiving tax credits by going green. 

Focus on Solar Energy

The relevant section for the solar panel tax credit is §13102 of the Inflation Reduction Act. This section extends the commercial tax credit for solar panels to 2034. 

Starting on January 1, 2022, your max tax deduction will be 30% of the solar panel's cost to your real estate property. The solar panel credit no longer has to go to your primary residence. 

Here is an example illustrating how that credit works for a real estate investor. 

Suppose you have a single property that you own and lease to tenants. You invest in a solar panel system that costs about $13,000. If you meet the requirements and earn the tax credit, the IRS will pay for 30% of the system, or $3,900. 

That's a good incentive, but additional benefits have to do with depreciation. You already have the 30% tax break, but you also have the provisions of 26 U.S. Code § 168, which gives energy property a 5-year life. That means you can depreciate the value of the panel over five years.

That matters for real estate investors because you get multiple benefits from installing solar panels: 

The federal government has stipulations for these credits and benefits: 

Exciting Electric Vehicle Rewards

These incentives apply to your real estate business' commercial vehicles. The IRA expands the 30d clean vehicle tax incentive through 2032. The incentive includes: 

Key Takeaways

The Inflation Reduction Act is probably a good thing for real estate investors, but we need further guidance from the IRS to understand its full impact. 

While there may be minor changes to the law and enforcement, a real estate investor should enjoy the benefits, including: 

Do you want to learn more about how to secure your financial freedom? Take our FREE Tax Quiz to learn how to handle the new law and your potential taxes.

Why Are 90% Of Real Estate Investors Overpaying Federal Income Taxes?

Death and taxes. These are two guarantees in life, but you shouldn't be stuck overpaying taxes. 

Paying the government doesn't always feel great, and overpaying taxes feels worse. Do you feel a pinch of pain when the government separates you from your hard-earned money? If so, you're in luck. 

This article doesn't list every tax-saving strategy available to you. 

What we'll show you instead is a handful of strategies that work. These strategies are easy to execute for your business and can potentially lessen your tax burden. 

Effective Entity Structures Reduce Overpaying Taxes

When you set up your business, you should make sure that you have an effective entity structure. Typically, your options are an LLC, sole proprietorship, an S-Corp, or C-Corp, depending on your financial situation. 

Limited Liability Company (LLC)

An LLC enables you to access a swath of tax benefits you might not otherwise have as a sole proprietor. Using an LLC as your business entity might save you from overpaying taxes. 

The primary strategy for tax savings via an LLC is pass-through. Pass-through is when an LLC's earnings are "passed through" to you, the owner. You do not have to pay corporate federal income tax on the income. 

Another thing is that the income from an LLC isn't subject to withholding tax. Instead, you'll file tax payments every quarter for federal income tax. 

You can choose how you'll be taxed as an LLC by filing an IRS Form 8832. But, there are some limitations. 

An LLC with more than one owner cannot choose to be taxed as a sole proprietorship. Typically, the government will tax your LLC as a partnership if you have multiple owners. 

Sole Proprietorship

The IRS views you and your business as a single entity. On the one hand, you have a level of freedom. On the other hand, you have additional tax responsibilities. 

You can avoid overpaying taxes by leveraging: 

The drawback to a sole proprietorship is that you have to pay the self-employment tax in addition to income tax. Self-employment taxes include Social Security and Medicare taxes.

S-Corporation  

An S-Corp is a small business entity. It'sIt's separate from the owners, which means that neither the owners nor shareholders are responsible for the business's finances. 

To form an S-Corp must have: 

An S-Corp provides tax benefits mainly on self-employment taxes (SS and Medicare). That means you can avoid overpaying taxes. Keep in mind that an S-Corp must pay any employee a reasonable salary.

The following is an illustration for educational purposes. 

Suppose you are self-employed and make $100,000. You would owe $15,300 in self-employment tax. 

In an S-Corp, you earn that same $100,000. In this example, you pay yourself a reasonable salary of $50,000. Only that $50,000 salary is taxable at 15.3% totaling $7,650. Compared to the self-employed taxes, you would be saving $7,650. 

The other $50,000 is a distribution reported on your income tax return.

Other tax savings might include: 

C-Corporation

A C-Corp is a business entity with room for growth and several tax benefits. It'sIt's a separate entity from its owners and offers a layer of protection to the owner's assets. 

A C-Corp tax structure differs from an S-Corp or an LLC. A C-Corp has to pay federal corporate taxes, also called double taxation. On the surface, that sounds terrible, but a C-Corp has benefits that may prevent you from overpaying taxes.  

A C-Corp is taxed as a corporation first, and then shareholders pay taxes on dividends personally. Here are the ways you offset that tax burden:

Retirement Funding Vs. Overpaying Taxes

Another way you can avoid overpaying taxes is through innovative retirement funding. You can deduct the funds you set aside for your Solo 401K from your taxable income. 

You use the power of Solo 401K to invest in real estate. Here is the process:

You are the trustee of the Solo 401K, but the purchaser of the real estate is the Solo 401K as an entity. That way, you avoid paying the UDFI tax when you purchase the property.

Stop Overpaying Taxes, Save Money As A Real Estate Pro

As a designated real estate professional, you aren't subject to the passive activity loss rule of IRS Sec. 469(c)(2).

As a real estate professional, you can avoid overpaying taxes because the passive activity loss rule doesn't apply to you. That means you can deduct losses from nonpassive income from your real estate business, including: 

To qualify as a real estate professional, you have to pass three tests: 

Key Takeaways

No one likes paying taxes. It's an even worse tragedy to overpay taxes when remedies are available to you. 

To avoid overpaying taxes, employ the following strategies: 

Are you ready to speak with an expert? Learn about our comprehensive solutions you can use to legally reduce your tax burden. Book a FREE discovery call now.

Tax Code Updates 2022: Unlock The Opportunities

It's been a few months since you had to pay taxes. Let's face it, paying taxes stinks. No one likes to think about next year's tax code updates already. You probably haven't thought about next year's taxes yet. 

Let me tell you why you should start planning. Failing to plan is planning to fail is a cliche, but it holds a nugget of wisdom. The truth of the matter is this. If you start planning now for the tax code updates, you'll be able to save more money when tax season rears its ugly head again. 

There were several tax code updates for 2022. Also, inflation has been a bugaboo and political football this past year. Because of the rule changes and inflation, the 2022 tax tweaks are here. It would be best if you prepared for them. 

Our Royal Tax Group Mentoring Session covered 2022's tax code updates with Pete Schindele, CPA.

To help you navigate the murky waters of tax season 2022, we compiled a list of the four most important tax code updates from that session. These changes are most likely to affect you as a real estate investor. Use this list to prepare for the future so you can keep more of your cash next year when it's time to file your taxes. 

#1 Tax Code Updates On Income Brackets

Tax rates didn't change, but tax brackets did. The changes occurred due to inflation from September 2020 to August 2021. See below for the updated tax brackets: 

Tax RateSingleTaxable IncomeMarried Filing JointlyTaxable IncomeHead of HouseholdTaxable Income
10%up to $10,725up to $20,550up to $14,650
12%$10,276 to $41,775$20,551 to $83,550$14,651 to $55,900
22%$41,776 to $89,075$83,551 to $178,150$55,901 to $89,050
24%$89,076 to $170,050$178,151 to $340,100$89,051 to $170,050
32%$170,051 to $215,950$340,101 to $431,900$170,051 to $215,950
35%$215,951 to $539,900$431,901 to $647,850$215,951 to $539,900
37%$539,900+$647,850$539,900+

2022 Tax Brackets for Single/Married Filing Jointly/Head of Household

#2 Standard Deductions Increase For Everyone

The standard deduction amounts increased for 2022. The increase in deduction amounts accounts for inflation. Here are the increases:

The standard deduction allows you to save money on taxes by reducing your taxable income. You do this by paying your children to work for you up to the standard deduction. 

Here are some general rules that you should follow if you have children who can work for you: 

Read our article Hiring Your Children Has Monumental Benefits: Decrease Taxes, Increase Profits. It gives you an in-depth look at how you can hire your children, claim an expense for your business, and keep your wealth within your family. 

#3 Safeguard Your Health And Money With HSA Contributions

You can reduce your taxable income by contributing to a health savings account. This account helps you pay for medical expenses. 

The deductible contribution increased to $3,650 from $3,600 for a single person. For families, the HSA deductible went to $7,200 from $7,300. 

#4 Tax Code Updates Means More Money For Your Family  

The lifetime estate and gift tax exemption surged from $11.07 to $12.06 million ($24.12 for couples). Also, the annual gift tax exclusion went up to $16,000 from $15,000. 

That means you can give your child $16,000 (or $32,000 for couples) to each child, grandchild, or person without filing taxes on the gift. You won't have to use your estate and gift tax exemption either. 

Key Takeaways

No one wants to think about paying taxes before taxes are due. But, you should plan to keep more money in your pocket and out of Uncle Sam's coffers. To hold onto your cash, you must stay abreast of the tax code updates that may affect you in 2022. 

Some critical updates that may affect you as a real estate investor include the changes to:

Please learn about the tax savings strategies you can implement as a real estate investor or entrepreneur by taking our Tax Discovery quiz. We'll use this information to prepare to have a productive conversation. At the end of the quiz, you'll have an opportunity to schedule your consultation. 

Hiring Your Children Has Monumental Benefits: Decrease Taxes, Increase Profits

Finding money-saving strategies for your real estate investment business isn't easy. It's hard. That's why the most successful investors are vigilant and proactive when finding powerful tax breaks. Have you considered hiring your children to decrease tax liability?

Does saving money on taxes sound attractive to you? You're definitely in the right place.

This article lists the remarkable tax benefits of hiring your children.

These benefits work to reduce your taxable income. These strategies are easy to use for your real estate investment business and save you money. You'll have more available cash to grow your business and secure your financial freedom.

The Truth About Hiring Your Children

The benefits of hiring your children are a massive advantage for running your own company. The type of business you have matters.

The IRS has guidelines for Family Help, but in general, the rules for your business are:

No matter what type of business structure you have, you will want to find ways to reduce your taxable income. Royal Legal Solutions can help. Be sure to check out our robust collection of Tax Strategies and Services. You will find expert advice about a myriad of tax strategies that you can leverage as a real estate investor.

Quick And Easy Tax Relief

The tax benefits of hiring your children are substantial. The standard deduction for 2022 is $12,950. Your child does not have to pay income tax on the money owed. It's tax-free!

Those wages matter to you as a business owner because you get to deduct your child's wages which lowers your business' taxable income. That's a win-win! There is an additional way to save $6,000 with the cunning use of a 401K or Roth IRA.

Suppose you pay your child $12,950. Additionally, you pay $6,000 into a tax-deductible IRA in which you are the custodian. A retirement account is an extraordinary exploit because you:

This strategy works for each of your children who you employ. That means if you have 2 children, you can potentially deduct a little more than $37,000 from your company’s taxable income.

IRS' Reliable and Direct Rules About Hiring Your Children

There are several benefits of hiring your children. The IRS is aware of the benefits of you hiring your children to work for you, and they keep close tabs on taxpayers who try to abuse the system.

To avoid running afoul of the IRS, here are some guidelines you need to keep in mind when you decide to hire your children:

Free Money: Defeating FICA

If you have an adult child who works for you or a corporation, you have to pay FICA. Don't fret, though; you have a few strategies at your disposal to enjoy the benefits of hiring your children.

The first strategy is to hire your adult child on an ad-hoc basis. That means you hire your child for single, one-of projects. For instance, perhaps your child is good at programming, and you pay them $7,000 to create a software program for you. In that instance, you would not have to pay FICA.

You have to be careful here, though, because you might have to pay FICA if you hire your child consistently. A consistent basis might be several projects in one year or a project every single year.

The rules are clear if you are an S-Corp. You have to withhold FICA taxes from your child's paycheck. In that case, you need to be innovative.

Here is how you can still avoid paying payroll taxes on your child's wages:

Key Takeaways

Exploit the powerful tax benefits of hiring your children for your real estate business. You will be able to save substantial money on taxes, up to $18,950 per child. When employing your children, follow the IRS rules and keep pristine records.

For more education about opportunities for real estate investors, join our Royal Investing Group Mentoring on Wednesdays at 12:30 p.m. EST. We meet weekly for an hour as a large group to learn, share, and collaborate on relevant topics in a fun and friendly format.

Keep more of your money with a Royal Tax Review

Find out about the tax savings strategies that you can implement as a real estate investor or entrepreneur by taking our Tax Discovery quiz. We'll use this information to prepare to have a productive conversation. At the end of the quiz, you'll have an opportunity to schedule your consultation.    TAKE THE TAX DISCOVERY QUIZ

First-Time Homebuyer Tax Credit: Can You Qualify?

Are you a first-time homebuyer? Good news, there are some excellent tax benefits for you!

You should know about a tax credit that puts more money in your pocket. The first-time homebuyer tax credit currently provides a refundable credit equal to 10% of the purchase price. The maximum tax credit is $8,000.

In 2021, President Biden and the 117th Congress submitted H.R. 2863-First-Time Homebuyer Act of 2021, which increases the tax credit to $15,000. Congress referred the bill to the House Ways and Means Committee, where it still sits. 

Read on to learn more about: 

First Time Homebuyer Rewards

According to the IRS, a first-time homebuyer is a person (with your spouse) who has not owned any other principal residence for three years prior to purchasing the new principal residence for which the credit is being claimed.

A principal residence is the dwelling where you and your spouse live most of the calendar year. You can only have one principal residence at any one time. 

You can either be a first-time homebuyer or a long-term resident and still qualify to get the tax credit. As a long-term resident, you are entitled to receive up to $6,500 in credit for purchasing a new principal residence.

First-time homebuyers are subject to gross income requirements.  

Income Tip And Secrets 

The income requirements to qualify are different for single and joint filers. The IRS looks at your modified adjusted income (MAGI) for this credit. Your MAGI is your adjusted gross income plus exempt or excluded income and certain deductions.   

MAGI limitations for the first-time homebuyer tax credit are:

How To Circumvent Challenges

Several situations can arise in which you are ineligible for the first-time homebuyer tax credit. First and foremost, if you exceed the MAGI limitations, you will not qualify for the tax credit. That’s not ideal, but you should know about the myriad of tax deductions available to you as a real estate investor. 

Check out our expert and informative articles on taxes to see what strategies you have available. 

Another reason the tax credit would not apply is if you purchased a home outside of the United States. In addition, you cannot sell the house or have the home stop being your principal residence in the year you bought it. That means you cannot use this tax credit to help you flip a house. 

If you received your home as a gift or inheritance, you cannot claim this tax credit. 

Shrewd Strategies To Stay Profitable as a First-Time Homebuyer

There are some situations where you will have to pay back this tax credit. For instance, suppose you decided to purchase a home and qualify for the credit. If you choose to sell the house within 36 months of the purchase date, you will have to pay back the credit. 

Perhaps you buy this home as your residence but decide to convert the home to a business or rental property. That means the house is no longer your principal residence. Since the home is no longer your principal residence, you will have to repay the credit. 

If you cannot keep up with the payments on the home and it goes into foreclosure, you will have to repay the credit.

You will have to include the credit amount as an additional tax on your tax return to repay the credit. 

If I Lose The Home, Do I Always Have To Pay The Credit? 

In some situations, when you lose the home, you will not have to pay back the tax credit.

For instance, suppose an act of God or some other disaster destroys your home. You do not have to pay back the credit if you purchase a new principal residence within two years of the home’s destruction.

Suppose the government finds your house unfit to be lived in and condemns it. No one is allowed to live on the property because of the safety hazards. In the instance of condemnation and your subsequent property abandonment, you don’t have to pay back the tax credit provided you purchase a new principal residence within two years of the condemnation. 

Maybe you get a divorce and lose the house to your now former spouse, the person who receives the home is on the hook for the tax credit.

Spotlight: The Bottom Line for a First-Time Homebuyer

As it currently stands, first-time homebuyers can earn up to an $8,000 credit to purchase their principal residence. Long-term residents can also qualify for a more minor $6,500 credit if they buy a new principal residence. 

The income limitations are $125,000 for single filers and $225,000 for joint filers. There are some situations where you will either not qualify or have to pay back the credit. Overwhelmingly those situations involve selling or losing the house. 

Taxes can be complicated, but they don’t have to be. To learn more about powerful tax savings strategies that you can use to keep more of your earnings, book a tax consultation by taking our tax quiz. The information you provide will enable us to have a productive discussion the first time we speak.

Self-Funded Pension Plan to Reduce Taxable Income

Are you interested in reducing your yearly taxable income? Like most keen real estate investors, you are looking for ways to save money and increase your cash flow. A self-funded pension plan might be right for you.

A self-funded pension plan, also called a defined benefit plan, is a powerful tax strategy for self-employed investors who have a steady income. The main idea behind setting up a self-funded pension plan is to lower your current year's taxes and provide you with options when you retire.

We recently chatted with Royal Legal Solutions' tax expert, Pete Schindele, CPA, and discussed this powerful tax strategy. Feel free to watch our discussion, "Self-Funded Pension Plans for Entrepreneurs," for more information.

If saving money on taxes and having an additional income is something that interests you, please read on.

What Is A Self-Funded Pension Plan?

Also called a defined benefit plan, a self-funded pension is a retirement tool. A pension is a retirement fund for employees paid by the employee, employer, and in some cases, both. When the employee retires, the fund pays out an annuity.

Now that you know what a pension is let's delve a little deeper into the self-funded part. Anyone can set up a retirement fund, even if they are self-employed. For instance, suppose you have an LLC or an S-Corp as your real estate business, and you are the only employee.

As an employee in your business, you can create your pension and fund it with the profits from your company. It would help if you considered some things before setting up a self-funded pension plan.

Who Should Set Up A Pension?

Anyone can set up a pension. Here are some things to consider before you make that decision–ideally, you:

If this sounds like your situation, a self-funded pension plan might be just the right tax savings vehicle for you. As with every business decision, you need to consult with your tax professional to ensure that a self-funded pension is a prudent business decision.

When Is The Right Time To Set Up A Self-Funded Pension?

There are no hard and fast rules for setting up a self-funded pension. It would be best if you talked to your financial advisors and tax professionals to determine the ideal time for you. Our tax expert, Pete Schindele, CPA, provides some general guidelines that might indicate that the time is right for you:

Is Setup And Maintenance Of A Pension a Hassle?

There are forms you will have to fill out with the help of a financial professional to get started. In addition, you will need to have at least three years of W-2s. The tax documents provide information to your tax professional about how much you will invest in the plan.

To maintain the pension, you must submit an additional tax document every year. Then, yearly, an actuary does a study to ensure that you funded your retirement plan appropriately. The actuary's fee ranges from $1,000 to $2,000 per year.

How Does A Self-Funded Pension Save Money In Taxes?

Suppose you have maxed out your other retirement plans, but you still have an additional income you want to protect from taxes.

Let's say that you have an additional $30,000. You would set up a pension and fund it with that extra $30,000. That money is tax-free, and you have saved about $9,000 in taxes, minus the actuary's fees.

That is not to say that a self-funded pension is without drawbacks. There are some things to keep in mind before you decide on making this decision.

What Are the Drawbacks to A Pension?

The self-funded pension is ideal for businesses or investors with a stable income. Wild swings in revenue are not going to work. Remember, you have to fund the plan every year–this is a fixed cost.

The actuary fee is steep. It ranges between $1,000 to $2,000 per year.

If you overfund the pension, you have to pay an excise tax.

Here is an illustration of how that would work. You have paid into your pension to the tune of $600,000. The IRS investigates your balance and determines that your fund should have $500,000. You have $100,000 too much in the pension. The IRS will force you to pay an excise tax on that additional $100,000.

A self-funded pension is not great for younger investors because it will be long before they can enjoy the funds. It's much better for more experienced (age-wise) investors.

How Does A Pension Work With Estate Planning?

You have the opportunity to name heirs, or you can get a lump sum payment from the pension when you retire.

Another thing you might consider is using the pension disbursements to pay for life insurance to earn even more money. Term life insurance premiums will be expensive when you retire because of your age. Instead of drawing the money from the pension, you can use it to pay for the life insurance premiums.

The life insurance will not be taxed when you die, and the income goes to your heirs. The payout from the life insurance will be more than from the pension.

FAQs: Self-Funded Pension

How does the pension differ from a Solo 401K?

With a Solo 401K, you are:

With a self-funded pension, you are:

When should I set up a pension?

First, you should invest in a solo 401K, an SDIRA; then, you should set up a self-funded pension with additional income.

Is there a baseline minimum income requirement?

It depends on the situation. There is a cost to implement, and you need to check your tax rate. Those variables make it impossible to determine a baseline requirement. Any advice requires you to do a cost-benefit analysis with your CPA or tax professional.

Key Takeaways

A self-directed pension plan requires you to have a history of good revenue for three to four years. It's also ideal if you have already maxed out your Solo 401K contributions—a couple of years.

In general, the pension is ideal for older investors. Be careful with the excise tax. Work with your tax professional to ensure you don't overfund the plan. The operational costs to set up and maintain your pension plan are not prohibitive. Finally, you can pass the funds on through the pension or clever use of a term life insurance policy.

To learn more about this powerful tax savings strategy and others that you can use to keep more of your earnings, book a tax consultation by taking our tax quiz. The information you provide will enable us to have a productive discussion the first time that we speak.

Augusta Rule: Homeowners Can Earn Tax-Free Income

Paying taxes isn’t fun. It’s a pain. The pain is why most real estate investors jump at opportunities to earn tax-free income using the Augusta Rule.

The Augusta Rule, or IRS Section 280A, applied to the residents of Augusta, Georgia, who would rent out their homes to attendees of the golf tournament.

Do you want to know more about how the savviest of real estate investors leverage this tax rule to their advantage? Read on to learn more about the Augusta Rule and its potential benefits to your real estate investing business. (This topic was also featured during our Royal Tax Group Mentoring; if you prefer to watch a video replay of the presentation follow this link and jump to 26:00 minutes in: Homeowners Can Earn Tax-Free Income with the Augusta Rule.)

What Is The Augusta Rule?

As mentioned, the Augusta rule originated with people renting out their homes. Subsection (g) of the code reads in part, “if a dwelling unit is used during the taxable year by the taxpayer as a residence and such dwelling unit is rented less than 15 days during the taxable year, then the … income derived from such use for the taxable year shall not be included in gross income.”

The rule applies to any taxpayer who owns a home in the U.S., provided that your home is not your primary place of business. One thing to note here is that the presence of a home office does not make your home your primary place of business.

The Augusta Rule IRS exemption applies to your (the owner):

That means you can rent out your residence for fourteen days and earn rental income but not have to report that income on your federal taxes.

How Does The Rule Work?

The Augusta rule works when you rent out a dwelling unit as a personal residence.

Here is a list of assets that are personal residences for Augusta Rule purposes:

You may qualify for the exclusion as long as you use that dwelling unit as a residence. While you can earn money through the rule, expenses related to your property rental are not deductible.

There is a 14-day limit on the number of days you can rent your property before claiming the rental income on your federal taxes.

What Is The 14-Day Rule In The Augusta Rule?

The rule has a provision that states you can only exempt 14 days of rental income from your taxes. On day 15 of rent, you have to report the entirety of the rental income to the government and get taxed accordingly.

The 14 days are cumulative, not consecutive. That matters because it gives you flexible options to generate rental income. For instance, at Super Bowl LVI in Los Angeles, a person who lived adjacent to Sofi Stadium rented their 2,500-square-foot home for $10,000 over the football weekend.

You may not see the same extreme prices, but there are plenty of ways you can maximize your rent for those 14 days. You might consider matching your rentals when an influx of visitors creates a spike in demand, including:

It would be best to charge a fair rental market price and avoid possible legal snags. To help you set the right rental market price:

An advantage of using rental websites is they track rent prices and rental rates that you can present to the IRS should they have questions.

Renting out while your market is hot is a good strategy. Another unique opportunity is having your real estate investing business rent the property from you.

Why Is Using The Augusta Rule Unique For Tax Planning?

The rule lets you shift income from your small business directly to you without paying taxes. For instance, you could rent your home to your small business to receive a tax deduction at the business level and exclusion from the rental income at the personal level.

Here is an illustrative example of how the August Rule could work for you. Suppose Jason is an owner of a small business.

Each quarter, the business rents Jason’s vacation home to hold meetings, strategize, and plan for the upcoming year. In total, the company rents the vacation home for fourteen days. The fair market rental rate for those fourteen days comes out to $10,000.

Jason’s business deducts the rental price as a legitimate business expense of $10,000. Since the company rented for only fourteen days, Jason does not need to report the $10,000 income.

What should Jason and the business do to ensure he does not get in trouble with the IRS?

In the preceding example, Jason potentially saved $3500 in federal taxes.

How Do I Determine The Right Rate?

Remember to call around hotels to get quotes and check out online rental sites like Airbnb, HomeAway, and Vrbo. Remember to look for similar properties to yours. For instance, suppose your house has amenities, like a pool and jacuzzi. It would be best if you found rates for similar spaces with extras, like a pool and jacuzzi.

Here is a list of things that you should consider when getting a quote:

It is critical to maximize the rent for these fourteen days. One way to do that is to remember the preceding list of invisible amenities your home provides.

Key Takeaways

The Augusta Rule is a way that homeowners can earn tax-free income from a residence.

Keep in mind these four fundamentals to maximize your income and minimize your entanglement with the IRS:

To learn more about this powerful tax savings strategy and others that you can use to keep more of your earnings, book a tax consultation by taking our tax quiz. The information you provide will enable us to have a productive discussion the first time that we speak.

Roth Conversions to a Solo 401K to Offset Losses

Are you a self-employed real estate investor? If so, the solo 401K may be the best option for you. The solo 401K is an IRS-approved retirement plan that enables you to minimize your tax burden. Read on to learn more about how this tax strategy works and how you can offset losses with a solo 401K and Roth conversions.

What is a Solo 401k?

As mentioned, a solo 401K is an IRS-approved retirement plan. Also, the solo 401K is ideal for self-employed business owners or business owners with one other employee, usually their spouse.

This retirement plan allows contributions of up to $60,000 each year.

If you want to learn more about the solo 401K and its many benefits, read our informative guide: Solo 401K vs. Self-Directed IRA: Which Is Better For You?

What is a Roth IRA conversion?

A conversion is a taxable movement of cash, real estate, or other assets from a Roth IRA to a Solo 401K.

When you convert from a Roth IRA to a solo 401K, there's a tradeoff. You will face a tax bill, possibly a big one, due to the conversion. If you decide to convert a portion of your Roth IRA conversions into a Solo 401K, you will pay taxes on the money you convert.

However, you'll be able to secure tax-free withdrawals as well as several other benefits, including no required minimum distributions, in the future. With proper tax planning, you may even be able to mitigate the tax bill from the conversion.

All in all, you pay taxes on the money you convert to secure tax-free withdrawals and several other benefits. One of the most significant benefits is that you will no longer have the required minimum distributions in the future.

Why are Roth conversions a popular tax strategy?

Roth conversions remain popular as many taxpayers fear that tax rates will only increase in the next few years. A Roth conversion enables you to convert now at lower tax rates, let your account grow, and let you make a tax-free withdrawal over the life of your retirement!

How is a solo 401K different from a traditional IRA or 401(k)?

Remember, if you have a traditional IRA or 401K, that money grows tax-deferred, but you pay tax on the distributions as you withdraw the funds at retirement.

The tax rate might be much higher when you retire. That means you would potentially lose more money to taxes each time you make a withdrawal.

Another thing to remember is that once you reach age 72, you must withdraw a certain amount of money each year, or the "required minimum distribution."

How can I offset losses with a Roth conversion?

One of the ways to mitigate the tax impact of the conversion is for a business owner to offset net operating losses (NOL). The income generated by a Roth conversion may offset the NOL, and the business owner may not incur any additional tax liability. Additionally, there is no limit to the amount of income that an NOL can offset.

What is a net operating loss?

Generally, a net operating loss (NOL) is an excess of deductions over income from the operation of a business. These deductions are expenses from the operation of a business.

For individuals, an NOL may also be attributable to casualty losses. A casualty loss occurs from the destruction or loss of your (taxpayer's) personal property. The casualty loss is a single, sudden event.

For instances of theft, you will need to prove that someone stole the property.

Example of how you would offset losses with a solo 401k

First, a disclaimer: these calculations can be complex, and investors should consult with a tax professional or financial advisor to decide the best strategy for them.

The following example illustrates the calculation.

INCOME

Spouse’s wages
$75,000

Interest and dividends
5,000

Total income
80,000

DEDUCTIONS

Net business losses
(itemized deduction and personal exemptions not allowed in net operating calculation)
(170,000)

NOL for tax year
(90,000)

Income from Roth IRA conversion
90,000

Net taxable income
0

This example is for illustrative purposes only.

In this case, the couple may decide to convert $90,000 from the IRA. Then they can use that $90,000 to offset the loss and possibly avoid generating any tax consequences.

If you want to learn more about how the solo 401K lowers your tax burden, read Self-Directed Solo 401K: How to Avoid Tax Penalties.

Here's The Bottom Line

The solo 401K is probably right for you if you are self-employed. You need to decide if it's the right time for you to convert money in your Roth IRA to a Solo 401K.

If you do decide on a conversion, remember the tax bill upfront secures your freedom from "required minimum distributions." Also, you may be able to offset your losses with a solo 401K.

To learn more about this powerful tax savings strategy and others that you can use to keep more of your earnings, book a tax consultation by taking our tax quiz. The information you provide will enable us to have a productive discussion the first time that we speak.

Tax Savings Strategy to Achieve Financial Freedom

Are you ready to grow your real estate business? To do that, you need a solid tax savings strategy.

You already know that there are considerable advantages to investing in real estate. The passive income, substantial tax savings, and long-term security most likely drew you to real estate investing.

Real estate investing is the first step in your plan for financial freedom. The first thing you need to focus on is finding good real estate deals.

The next step is to maximize how your money works for you. Read our list of six tax savings strategies to achieve financial freedom and build wealth.

#1: Start with the children, house, and vehicle

#2: Maximize your deductions

This tax strategy is primarily for single-family home investors and the available deductions.

You have a multitude of deductions available to you as a real estate investor.

Deductions that do not impact financing Deductions that do impact financing
- Amortization
- Auto
- Depreciation
- 529 Plan
- Home office
- HSA
- SDIRA
- SOLO 401K
- Business expenses
- Credit card processing fees
- Legal fees
- Office furniture
- Office supplies
- Repairs and maintenance
- Tax prep fees
- Travel expenses

As a sharp real estate investor, you need to know which deductions impact financing because it affects your ability to get loans, secure more properties, and generate wealth.

#3: Start a SOLO 401K

With a SOLO 401K, you can save $58,000 a year in taxes. If you're married, the tax savings increase to $116,000.

How a SOLO 401K works as a tax savings strategy:

Do you want to know more about this powerful tax vehicle? Visit our SOLO 401K Hub to learn more!

#4: Create a Self Directed IRA (SDIRA)

You can add a Self Directed IRA on top of your SOLO 401K.

This SDIRA enables you to manage everything as long as you set up an LLC owned by the IRA. Then, you can invest through the LLC and shelter about $7,000 more per year from taxes.

#5: Use the DB(K) Tax Savings Strategy

The official name of this plan is the Eligible Combined Plan which Congress created as part of the Pension Protection Act of 2006 under Section 414(x) of the Internal Revenue Code.

You can combine the SOLO 401K and SDIRA with the DB(K) strategy. You gain an additional shelter which allows you to grow your wealth with a deferred tax, more capital in play, and higher returns.

#6: Get a Real Estate Professional Designation

If real estate is the primary source of your income or you are a "stay at home" husband or wife, use this strategy.

You can use your depreciation and other losses from real estate to offset other income.

If you are a high self-employed or 1099 income earner, you should consider investing in commercial and multifamily investments. You can use cost segregation, accelerated, and bonus depreciation to avoid taxes.

Even if you are a W2 employee, you have to document your time thoroughly and may be able to secure the designation.

Learn more about the requirements it takes to earn a real estate professional designation.

Tax Savings Strategy Key Takeaways

We went over six tax strategies you need to take to grow your real estate business. These six strategies will help you achieve financial freedom and grow your wealth.

Remember to:

  1. Start with the children, house, and vehicle
  2. Maximize your deductions
  3. Start a SOLO 401K
  4. Create a Self Directed IRA (SDIRA)
  5. DB(K) strategy
  6. Get a Real Estate Professional Designation

We've covered a lot of information that may include concepts that are new to you. To hear this content presented by Scott Smith check out Royal Investing: Episode #1 Tax Savings Strategies on our Wistia channel.

To learn more about this powerful tax savings strategy and others that you can use to keep more of your earnings, book a tax consultation by taking our tax quiz. The information you provide will enable us to have a productive discussion the first time that we speak.

1031 Exchange Update for 2022

Are you fed up with paying taxes on your hard-earned real estate profit? Are excessive taxes preventing you from securing your financial freedom as a real estate investor? If so, you should read further to learn more about the 1031 Exchange update for 2022.

As a savvy real estate investor, you can use this little-known tax break to increase your wealth. Once you've mastered the 1031 Exchange, you'll see an increase in your purchasing power as you keep your money working for you and not filling the federal government's coffers.

What Is A 1031 Exchange? 

First, you have to know what we mean when talking about a 1031 Exchange. In general, a 1031 Exchange is a tax provision that lets you sell an investment property, take those gains from the property, and reinvest those gains into another property without paying taxes. 

When you sell real estate and earn gains, you have to pay tax. Appreciated property means more tax when you sell. The flip side of that is true too. If your property depreciates, you are subject to depreciation recapture taxes when you sell. Those taxes apply to you whether you claimed the depreciation deductions on your taxable income or not. 

Either way, the federal government will try to extract their pound of flesh from your gains. 

The beauty of the 1031 Exchange provision is that you get to defer the taxes on your gains. That means as a real estate investor you pay no taxes when you sell your property and exchange it for a new real estate investment. If you follow the rules, you may be able to defer the taxes indefinitely as you reinvest into bigger or better properties. 

If you want to learn more about the finer details of the 1031 Exchange, we recommend that you read Understanding 1031 Exchanges And Asset Protection Entities

What Is The 1031 Exchange Update? 

When President Biden won the election, one of his campaign promises was to eliminate the 1031 Exchange because of the perception that it gave an unfair advantage to the ultra-wealthy. 

The Biden administration had planned on either eliminating the 1031 Exchange program or modifying it somehow. One of the planned changes was the complete overhaul of the 1031 Exchange program, but that plan hasn't come to fruition. 

The other plan included a $500,000 limit on the amount of money exchanged per year. That plan has also failed to earn widespread support.

One of the reasons the government failed to eliminate the 1031 Exchange program is that it is not in their best interest to kill it. Here's why. 

If the government were to limit the 1031 Exchange successfully, it would mean less tax revenue in the long run. In the short term, the government would enjoy the taxes from the sale of the property.

However, a limit or drastic change to the 1031 Exchange would probably chill the real estate industry. That means that more people will hold onto property to avoid taxes. When people hold

onto their properties, all the ancillary sources of tax revenue dry up. 

That means the contractors, cleaners, attorneys, real estate agents, and title companies do not participate in those deals. When you eliminate those people from transactions, you eliminate the taxes they would have paid. On balance, the federal government earns less in tax by removing or reducing the effectiveness of the 1031 Exchange benefit. 

Fewer taxes and political gridlock have prevented any significant changes from the tax code yet. However, as a competent real estate investor, you should prepare for changes, just in case. That means you should look into all tools available to you right now and take advantage of them. 

You might wonder if the 1031 Exchange is the right investment strategy for you. Answer that question by checking out Is a 1031 Investment Strategy Right For Me? 

Key Takeaways

The 1031 Exchange update doesn't take away from the fact that it still might be the right vehicle for you to avoid paying capital gains taxes. Right now, there is talk in Washington D.C. about making policy changes, but nothing has emerged from those discussions yet. 

That's not to say that nothing will happen, but a lack of support and institutional gridlock are keeping policy changes at bay. As an intelligent real estate investor, you should plan, but don't worry too much about things out of your control. 

The best thing to do right now is to use all your tools. That means finding out which real estate investment strategy is suitable for your particular and unique circumstances. 

Do you have a plan for your financial freedom? If not, let us show you how to secure your financial independence and build generational wealth to pass on to your family. 

To learn more about this powerful tax savings strategy and others that you can use to keep more of your earnings, book a tax consultation by taking our tax quiz. The information you provide will enable us to have a productive discussion the first time that we speak.

Real Estate Professional Designation

As a real estate investor, you have to contend with mortgage payments, repair and maintenance, insurance, and other myriad fees. On top of all of those fees, you still have to pay tons of taxes—capital gains, net income investment, and income.

Sometimes, it’s hard to carve out profitability, and you want to have all the weapons in your arsenal to combat your tax burden.

Sound like you? You’re in the right place.

This article doesn’t list every tax break you have available to you as a real estate investor.

What is in this article is a tactic that works. Establishing a real estate professional designation for yourself reduces the amount of tax you owe, improves your cash flow, and acts as a step toward securing your financial freedom.

Why should I get a real estate professional designation?

The short answer is that it might save you money. It’s essential to determine whether your involvement in real estate activities makes you a real estate professional for tax purposes.

First, the real estate professional designation establishes if you can deduct losses from your real estate activities against ordinary income. Second, it determines if your income from real estate investing is subject to the net investment income tax.

What are the rules that determine the deductibility of real estate losses?

IRS Sec. 469(c)(2) states that rental activities are considered passive activities regardless of your level of participation.

That is important to you as a real estate investor because:

That means your passive losses from those activities are only deductible against your passive income activity income.

However, if you qualify as a real estate professional, the passive activity loss rule doesn’t apply to you.

That enables you to deduct losses from rental real estate against nonpassive income. Examples of nonpassive income include:

You have the potential to reduce your taxable income close to zero and increase your cash flow.

A net investment income tax of 3.8% applies to income over the threshold amount. The threshold amount is:

However, there is an exemption for gross rental income from being included in investment income for real estate professionals.

What constitutes a real estate professional?

You, as a taxpayer, qualify as a real estate professional for any year as long as you pass three tests with your real estate business:

Test 1: Material participation means that you participate through the year on a regular, continuous, and substantial basis. There are seven ways you can “materially participate,” so finding a way to qualify is surprisingly easy.

Test 2: You must spend at least 750 hours per year in real property trades or businesses in which you materially participate. Personal services performed as an employee do not count unless you (as the taxpayer) are at least a 5% owner of the trade or business.

Test 3: You must spend more than 50% of your working time on real estate activities in which you materially participate.

For the real estate professional designation, an actual property trade or business includes, but is not limited to:

If you meet the requirements of the three tests and have documented proof, when you file taxes, you will file an IRS Section 469(c)(7)(A) Election to Aggregate Rental Real Estate Activities. The election is a written statement sent with your return for the tax year of the election.

Why should you become a real estate professional for tax purposes?

The IRS recognizes three categories of real estate investors. The third category, “real estate professional,” enables you to deduct 100% of your real estate losses against ordinary income. You can even deduct your real estate losses against your spouse’s income!

You might have one rental property or several properties. As a property owner, when you take the real estate professional election, you can create thousands of dollars in tax deductions. Those tax deductions may result in no tax liability at the end of the year.

Key Takeaways

As you will quickly learn, real estate has incredible potential with the sheer number of tax breaks to create cash flow.

One of the top strategies that savvy investors use is qualifying as a real estate professional.

As a real estate professional, you can:

To learn more about this powerful tax savings strategy and others that you can use to keep more of your earnings, book a tax consultation by taking our tax quiz. The information you provide will enable us to have a productive discussion the first time that we speak.

Year-End Tax Preparation: What You Need to Know

Are you ready for year-end tax preparation?

It's hard to believe that there are only a few days left between you and 2023. As 2022 ends and you forge your path forward into 2023, you must undertake some housekeeping to close out 2022 and start 2023 in the best position possible as a real estate investor.

As a real estate investor, it might not seem that there is much to do. However, each year, you need to assess your plans, goals, and the state of your investments. Before the year closes out, make sure to go over this essential end-of-year checklist.

To prepare for tax season, we strongly suggest you:

Read below to find out the best ways to accomplish the preceding tasks.

#1 Organize Your Tax Documents for Year-End Tax Preparation

You want to make sure you prepare everything for filing. Tax day seems far off in the distance, but April 15th comes fast in reality. As a result, it's never too early to get your documents in order.

Right now is the optimal time for real estate investors to collect all documents related to filing taxes. Some things you can do to make this process easier include:

Ensuring that you have all your taxes settled ahead of time reduces stress and allows you to move past the financial commitments of 2022 and focus on growing your business in 2023.

Paper receipts can be burdensome, so it might be easier to pull out your bank records and highlight all your expenses. Some apps make tracking expenses more manageable. We like Expensify.

#2 Optimize End of Year Deductions for Year-End Tax Preparation

You plan on growing your business in 2023. One way to maximize your deductions is to purchase business vehicles and additional assets. Then you can schedule business meetings. Then, claim them as expenses on 2022's taxes.

As the year ends, you want to recheck your deductions to get your taxable income as close to zero as possible. One of the ways to lower your tax responsibility is to file deductions. You can file deductions on:

Being a real estate investor comes with plenty of tax deductions. The following list is not comprehensive but provides you with some ideas of what you can deduct in addition to the standard deduction:

It's hard to maximize your profit if it's getting eaten up by all the sales, properties, federal income, and state income taxes you must pay. As a savvy real estate investor, you need to finesse your documentation and deductions and realize the benefits of being a landlord.

An easy way to make sure that you are optimizing your end-of-year deduction is through Royal Legal Solutions' Peace of Mind Program. We hold all your tax accountability through the program, work with your account executive and CPA to maximize deductions, and shelter your assets.

Contact [email protected] to learn more about how the Peace of Mind Program will protect you and your assets.

#3 Prepare Your LLC for Tax Season

As a real estate investor, you know the importance of having your assets protected by an LLC. Depending on where you do business, having an LLC means paying a yearly franchise tax.

The franchise tax is a required fee that your LLC pays for the right to do business in any given state. This tax is separate from other federal or state income taxes required by government entities.

Franchise taxes are required:

In addition to franchise tax considerations, as an LLC owner, you will want to:

Key Takeaways

When you began your real estate investing journey, you had a set of goals in mind. Now is the time to revisit those goals, assess your performance, and make needed adjustments to accomplish your goals.

As you enter the new year, you should focus on growing your business. That means putting 2022 tax burdens behind you. Make sure you finish 2022 strong by having a clear and detailed plan where you:

A solid plan in place will allow you to earn more and grow your real estate portfolio.

To learn about powerful tax savings strategies that you can use to keep more of your earnings, book a tax consultation by taking our tax quiz. The information you provide will enable us to have a productive discussion the first time that we speak.

Are You Deducting All the Business Travel Expenses You Qualify To?

Business travel expenses add up quickly and negatively impact your cash flow. Losing money to taxes and other unforeseen circumstances makes being a real estate investor demanding sometimes. Safeguarding your venture has to be one of your top priorities. Do you want to make sure your real estate investing business is protected? Start with our investor quiz, and we'll help you find ways to protect your assets.

For a self-employed real estate investor, tax laws can be confusing. Some IRS tax codes are straightforward; others are a little quirky.

In this article, we'll look at some business travel expenses and allowable deductions.

Opportunities for Useful Travel Tax Deductions

If you are a self-employed taxpayer and meet specific criteria, you can deduct most of your travel costs.

For example, you can deduct business travel expenses away from your home if the trip's primary purpose is business or business-related. Those expenses include, but are not limited to:

Maybe you hate to fly; you can also deduct for travel occurring via:

Even if you mix business with pleasure, you can still deduct the trip's expenses, provided it passes the "primary purpose" criteria.

Shrewd Business Travel Reimbursement Secrets

The "primary purpose" criteria mean that your trip's primary purpose must be business--it cannot be an undercover vacation. To make your case that your trip was a business trip and not for pleasure, you must provide evidence that you spent more time on the business than leisure.

That makes the number of business days as opposed to personal days incredibly important. One of the things in your favor as a self-employed taxpayer is that the days you spend traveling count as business days.

Here is a brief illustration of the "primary purpose" point:

Mr. Johnson is a self-employed taxpayer. He leaves for a business trip on Monday. Johnson inspects properties, draws up contracts, and closes deals on Tuesday, Wednesday, and Thursday.

Mr. Johnson relaxes and enjoys the city on Friday, Saturday, and Sunday before flying back on Monday. In total, Mr. Johnson was on an eight-day business trip.

Based on the illustration, Johnson spent five days on business:

Easy Tax Deductions: Travel Expenses' Surprise Rewards

You can creatively leverage the tax code in your favor. For example, you decided to take a business trip, and your non-employee spouse wants to come along. You cannot deduct the expenses attached to your spouse, but you can subtract the total of what you would have paid alone.

Another thing that the IRS allows exemptions for is meals as long as they are:

The most important thing to consider when deducting meals is a precise documentation of the meals:

Your thorough documentation is the evidence you need to justify a tax deduction.

The Truth About IRS Commuting Rules

You should know about IRS Publication 15-B, Employer's Tax Guide to Fringe Benefits. In the guide, there is a section about working conditions fringe benefits. An applicable tax exemption is the business use of a company vehicle.

Mileage Deductions

You can deduct the total mileage driven in a tax year multiplied by the standard mileage rate of $0.56 (down 1.5 cents from 2020).

Another option is calculating an itemized list for vehicle expense which may include:

Just like for meals, your documentation must be thorough and accurate.

Commuting

Another IRS rule you should know is Topic No. 511 Business Travel Expenses, also called the "away-from-home rule."

Home for tax purposes is the tax home, not your actual home. The tax home for your business is the general area where you (the taxpayer) conducts business.

The IRS uses the term "away-from-home" to describe taxpayers who are not within commuting distance from home. If you work away from home for more than a typical workday and require sleep, the related costs are tax-deductible.

In contrast, if you work within commuting distance from home (and are away from home) but decide to sleep away from home--those costs will not be deductible.

However, if you do not follow the rules, everything is still deductible by you (the employer). The reimbursement will then be added to the employee's taxable wages and subjected to payroll withholdings and FICA.

Keep a Business Travel Expenses Log

An "accountable plan" requires the employee or business partner to provide justification and adequate proof of all expenses during job-related travel. This plan lets you (the employer) properly deduct these expenses (assuming you provided receipts!).

When reimbursements are made from the employer to the employee without an accountable plan, they are taxable. The employee will need to file a miscellaneous itemized deduction (Form 1040). These deductions will need to be made under Schedule A on the form and are subject to a 2% AGI nondeductible threshold.

As a result, the employee will not be able to deduct some or all of the expense. If the employee must file deductions for lodging and meals, they must be away from home for at least one night (per the away-from-home rule). Any travel that lasts longer than a year will likely be unable to be deducted.

As the employer, you can deduct business expenses that are "ordinary and necessary." These expenses include job-related travel and lodging expenses.

The Bottom Line, Simplified and Direct

  1. Keep thorough documentation.
  2. You can deduct business travel expenses from your tax responsibility.
  3. Mixing business and pleasure is fine, but only deduct business expenses.
  4. Traveling is a business expense.
  5. Business meals and staff appreciation meals are deductible
  6. Finally, make sure that you know the IRS rules for fringe benefits and business travel expenses.

Minimize Taxes through Cost Segregation

You want to protect your assets, and you want to protect your wealth. Cost segregation is a form of wealth protection, as discussed in the video below.

Cost segregation is a tax strategy available to the following:

This strategy creates an income tax benefit for you and generates increased cash flow.

In this article, we will answer the following questions you might have:

Like you want to protect your wealth, you want to protect your assets. Lawsuits can be catastrophic and painful, and insurance provides insufficient protection to you. Unfortunately, your equity in real estate is a lawsuit magnet--unless you're protected.

Do you want to make sure your real estate investing business is protected? Start with our investor quiz, and we'll help you find ways to protect your assets.

Your assets generate cash flow and are essential to your financial freedom. That's why understanding how to increase your income through cost segregation is so crucial. Continue reading more and learn about this effective tax strategy.

What is Cost Segregation?

You want to keep more of your money—cost segregation lets you do that. As Yonah Weiss says, "It's not about how much you make; it's about how much you keep."

Cost segregation benefits you by:

Real estate depreciates over time. As a result, the IRS enables owners of real estate investments to deduct an amount from their income every year before taxes are assessed. This deduction is called a depreciation expense.

You don't pay the depreciation expense out of pocket. Instead, you claim the fee and have less of a tax burden on your income. Cost segregation maximizes the amount of depreciation expense by accelerating the decline of your property's value.

How is Depreciation Calculated?

First, there are fundamental rules about calculating depreciation:

For example, you can calculate straight-line depreciation, which means you research and identify how long, in years, your asset will take to crumble completely. The number of years during which your property is in good enough condition to be used is called useful life.

Then, you take the amount you paid for your investment and divide it by the number of useful life years. Finally, you claim that amount ($ amount of investment # of useful life years) each year.

The IRS determines that the useful life for single and multifamily rentals is 27.5 years, and commercial properties last for 39 years.

Generally, when you buy a property, you purchase the building and the land underneath the building. Remember--land does not depreciate--so you can't just take the sales price of your property and divide it by the number of useful life years.

You have to separate your purchase price into two components:

Then you can divide the price of the building by the number of useful life years to determine your annual depreciation expense rate.

What is Accelerated Depreciation?

In general, the interior and exterior components of a building are classified as either commercial or residential. Commercial assets depreciate over 39 years, and residential properties depreciate over 27.5 years.

The IRS gives you different time frames for how long different things last. Just like you split the price of your building and land to calculate your depreciation expense, you can further split up the components of your building to take advantage of the tax code.

Remember that depreciation is calculated by (price useful life years). When the total lifetime of an item decreases, the annual depreciation rate increases. As you reclassify the IRS category in which your property belongs, you have the chance to claim a shorter useful life of the item.

Consequently, you accelerate the amount of expense in the early years of your ownership. In other words, your property is subject to accelerated depreciation. The higher the depreciation expense means that you have less taxable income and a smaller tax bill.

Here are the ways the IRS categorizes property and depreciation:

Key Takeaways about Cost Segregation

  1. Cost segregation saves you money on taxes by increasing the amount of depreciation expense you can claim.
  2. When you pay less to the IRS for taxes, you have an increased cash flow.
  3. That increased cash flow enables you to reinvest in your business and secure your financial future.

Determining which category your property falls into is not easy, and if you make a mistake, you may end up on the IRS' radar. That's why it's a good idea to get a cost segregation study from experienced professionals. Usually, it's a team of accountants, attorneys, and engineers who conduct the survey and determine where your property should be categorized.

Tax-Free Real Estate Investing: How To Get Started

Scott Smith, Royal Legal’s founder, and lead attorney, recently sat down with real estate investor J. Darrin Gross to discuss tax-free investing on Gross’s Commercial Real Estate Pro Network Podcast

The delightful discussion covered not only the possibilities of tax-free investing in real estate but also how real estate investors can protect their assets. You can click the link above to listen or read on to learn more. 

Tax-Free Investing vs. Tax-Deferred Investing

“Tax-free” investing is better thought of as “tax-deferred investing.” Whether you invest in a traditional 401(k) that taxes withdrawals or a Self-Directed Roth IRA, which taxes funds before use, the tax doesn’t just disappear. It’s a question of when the tax is paid.

You can accelerate the growth of your retirement account using either a Solo 401(k) or a Self-Directed IRA. In a nutshell, with tax-deferred real estate investing, you lend yourself money from your own Solo 401(k) that doesn’t have to be repaid until you retire.

How does this work in terms of W2 income?

Anyone with a W2 (employer) income can create their own 401(k) or IRA account. But with non-W2 income, one can take advantage of creating a Solo 401(k) that allows you to defer taxes.

What is a Solo 401(k)?

If you have non-W2 earnings and can demonstrate that you’re an “active” investor, you may qualify for a Solo 401(k). If you structure an entity properly and demonstrate that you are active in its operations, multiple advantages become available. You have to be able to deposit up to $50,000 annually and be in a position to borrow up to 50% of that balance without creating a taxable event. Royal Legal Solutions helps clients set up a Solo 401(k) to run themselves. 

What is the advantage of a Solo 401(k)?

The advantage is that you only have to pay it back by the time you retire. So, for example, you can take $50,000 and put it into your 401(k) tax-free and loan yourself $25,000 of that to invest in anything you want.

You still owe that money back to your 401(k), but you don’t need to pay it off until you retire. In the meantime, you’ve got $25,000 in tax-free money in your Solo 401(k) that you can invest immediately.

Does passive real estate qualify?

No, it’s not legal to set up a Solo 401(k) with passive income. But you can open up your own property management company. Doing this turns passive income into active income. 

Setting up a property management company for a Solo 401(k)

You can establish an S Corporation to be your property management company. As the sole employee of that S Corporation, you can then set up a Solo 401(k). There are a few inexpensive legal steps to this process, and Royal Legal Solutions can help set up a Solo 401(k) for you.  

Do I need to be a real estate professional to have a Solo 401(k)?

No, you just need to be earning active income. The income cannot be classified as passive. But passive income is easily converted into active income by setting up a real estate company, which can then be used to establish your Solo 401(k). The restrictions are light - you just have to be the sole employee of your own company to meet the conditions of a Solo 401(k).

Once you have set up the company, you can channel $50,000 per annum of non-W2 income into the company. That amount pays into the Solo 401(k) up to the $50,000 mark, and all of that is tax-free for now. 

The advantage of investing with pre-tax dollars instead of post-tax dollars can typically be a 20-30% bump, and that’s where the actual returns are. You get a pretty significant increase in your investment amount this way, without much risk.

Should I invest with a Self-Directed IRA?

Income from a Self-Directed IRA LLC is also tax-deferred, meaning real estate investments can be made tax-free. The tax is paid later instead of paying tax on the returns of a real estate investment. This allows investors to select the assets they want to invest in, except for “prohibited transactions,” such as collectibles and life insurance.

Tax-Deferred Investing: The Takeaway

Tax-deferred investing is important to real estate investors because it allows them the available funds to buy property from their own Solo 401(k) without paying back a loan to a bank or other financial institution. Essentially, you owe the money you’ve borrowed back to your retirement account, in effect turning yourself into your bank. The difference is that you are an active business, not a passive generator of income.

If you start with tax-deferred investing in your 30s and you don’t have to pay the loan you took from yourself back for another 35 years, your wealth curve will likely have been on an upper trajectory, making it easier to pay the loan back at retirement. Having money available makes a real difference to your ability to invest in real estate today for profit in the future. Unlike using a credit card, the debt here makes more money in the short term, which will pay down later debts more quickly.

Royal Legal Solutions: Helping You Grow Investments Tax-Free

Royal Legal Solutions has tax-saving strategies for everyday real estate investors. Royal Legal Solutions can help you form a legitimate strategy to protect assets.  If you are a real estate investor anywhere in the United States and want to learn more about tax-free investing and tax-deferred investments, start with our investor quiz, and we'll help! We are the one-stop shop for tax, legal, and business advice for real estate investors everywhere.  

Using Your C Corporation’s Tax Brackets To Reduce Your Tax Burden

Every real estate investor or business owner knows that taxes take up a big chunk of profit and earnings from investment income and capital gains. Understanding how the tax system and tax brackets work may help you reduce your tax burden and liabilities.

As a real estate investor, you may be able to minimize income taxes either by hiring family members or your C corporation. This article focuses on the possible tax benefits of outsourcing business contracts to a C corporation owned by you.

Interested in learning more? Check out our article, Using Your Family’s Tax Brackets To Reduce Your Tax Burden.

How the progressive tax brackets work

Progressive tax brackets start taxing the lowest amount of income at the lowest rate. The tax rate increases as income rises. Simply put, this means that you would fall in a higher tax rate bracket if you are a high earner; likewise, low-income earners pay at a lower rate.

Here’s a (hypothetical) example of how progressive tax brackets can work:

An annual income of $100,000 puts you in the 20% tax bracket. Note: The tax rates would be applied progressively—the first $15,000 will be taxed at 7.5%, the next $40,000 will be taxed at 15%, and the remaining $45,000 at 20%.

Using Your C Corp’s Tax Brackets

Similar to individual income taxes, C corporations have tax brackets. This is how it generally works:

  1. The first step is to set up two businesses. One would be set up either as a sole proprietorship, a partnership or an S corporation. This business would be your main real estate business, operating as a pass-through entity. The income you get from this business is taxed at your individual tax bracket. The second business you set up will be taxed as a C corporation.
  2. The next step is to hire your C corporation for tasks that can be justifiable and with payments that are reasonably within market rates. This can include things like property management, cleaning and maintenance or even digital marketing services.
  3. When you pay your C corporation for fulfilled and completed contracts, this counts as eligible expenses that can be deducted from your pass-through entity income. The goal is to transfer this income from your higher income tax bracket to a lower business tax rate. So if your individual tax bracket is at 40%, you can potentially transfer income from your pass-through entity real estate business to your C corporation, which can be taxed at a lower rate of say, 25% (for example).

Things to consider when using a C corporation to minimize taxes

Ordinarily, all of these money movements can be complicated, therefore it is important to keep constant records of all expenses, payments and transfer of income. All contracts and agreements should be documented appropriately. You may need an accountant to ensure this is done properly.

How to manage income from your C corporation

You are probably wondering how effective it would be to use a C corporation to manage and reduce your taxes and how to go about receiving your income from this business. Well, this is a valid concern and there are various ways to go about it, some more tax efficient than others.

In conclusion

If you're looking for ways to reduce taxes on your real estate business, you can explore the C corporation option. While this may require effort to execute, it could lead to potential savings for your business.

To learn more about this powerful tax savings strategy and others that you can use to keep more of your earnings, book a tax consultation by taking our tax quiz. The information you provide will enable us to have a productive discussion the first time that we speak.

Using Your Family’s Tax Brackets To Reduce Your Tax Burden

Effectively managing income taxes as a real estate investor shouldn’t leave you feeling overwhelmed. If you understand how the tax system works, you can find ways to reduce your tax burdens and liabilities. 

A basic feature of our tax system is its progressive nature, which places individuals into different tax brackets based on gross income. 

You can minimize your tax burden by hiring family members, and here I’m going to show you how. First, let’s review the applicable taxes that business owners should know about. 

Types of employment taxes for family members

Bear in mind that when you hire family members, they have to be treated the same way as other employees. The employment taxes that may be applicable to your family members can include:

As we’ll see, when the family members hired to work for the business are children, you can be exempted from some taxes such as the FUTA and FICA. Sometimes, the income paid to minors may be totally tax-exempt.

How progressive tax brackets work

Generally, the federal income tax system is progressive. Tax rates are usually layered and sectioned into tax brackets such that the tax rate increases as income rises. Simply put, this means that you would fall in a higher tax rate bracket if you are a high earner, likewise, low-income earners pay at a lower rate. 

Here’s a (hypothetical) example of how progressive tax brackets can work:

If a taxpayer’s income for the year is $100,000, he or she falls in the 20% tax bracket. However, the tax rates would be applied progressively—the first $15,000 will be taxed at 7.5%, the next $40,000 will be taxed at 15%, and the remaining $45,000 at 20%. 

Reduce your tax burden by hiring family members

Now, if you have children or grandchildren in lower tax brackets, there are legitimate ways to leverage their tax brackets to reduce your tax burden. The money you pay them will (because of their bracket) be taxed at the lower rate while bringing your own taxable income level down.

Using the family tax bracket strategy requires that you first identify where it would be appropriate for the family member to be employed. Document the responsibilities that the family member would take on. This does not have to be complex, especially if the family member is not an adult. The roles they fill could be anything from administrative to managerial; even “personal assistant” is fine so long as you document and define the duties.

Since you’ll be transferring income taxes to a child or relative with lower tax rates, there are things to consider:

You should use a payroll company. Don’t do the payroll yourself. As with other business processes and documentations, it is important to keep records for tax purposes. 

Your family member/employee will report the earnings on their tax return. If your family member is a minor, you’ll be filing a tax return on his or her behalf. Wages paid to a child are exempt from payroll taxes if your business is either taxed as a sole proprietorship or a partnership in which the only owners are the parents.

Here’s some more good news … You stand to save even more on taxes if your family member is not currently using their standard deduction!

Final thoughts

Hiring your family members to work for your business can indeed be a win-win situation if done right. This can provide an avenue to keep more income within the family and reduce tax liabilities for your real estate (or other) business ventures.

To learn more about this powerful tax savings strategy and others that you can use to keep more of your earnings, book a tax consultation by taking our tax quiz. The information you provide will enable us to have a productive discussion the first time that we speak.

When It Comes to Taxes, Is Managing Rental Properties a Business or an Investment?

Whether you are the landlord of a single-family rental or you own a share in a large apartment building, it’s essential to know how to classify this activity at tax time. 

Are you an investor or a business owner?

In this article, we’ll examine the distinction between the two and how qualifying as a business owner can save you money in deductions.

Rentals that qualify as a business

Your rental activity qualifies as a business under the law if you can prove your rentals are “for-profit” and that you work at this business “regularly and continuously.”  

Landlords can hire managers and contractors to do most of the work on their property, but they still must be engaged in running the rentals, according to the law. Also, if a rental unit is vacant, it doesn’t preclude you from qualifying as a business owner -- as long as you are marketing the space for rent.

Here are other factors the IRS uses to determine if your rental activity is a business:

Here are some other ways you can prove you are operating a business with your rental property:

The ‘three of five years’ test

If, as a landlord, you have earned a profit in three of the past five years, the IRS sees you as a business. If you cannot meet this requirement, you must pass the “behavior” test.

The behavior test

You can operate rentals at a loss every year and still qualify as a business owner if you meet the behavior test criteria. Here are the factors an IRS auditor will use in this case:

In order to pass the behavior test, you need to maintain excellent records, including a time log of all your real estate activities. You can establish your expertise through references, blogs, speeches, and podcasts.

Rentals that do not qualify as a business

Landlords often do not qualify as business owners when they do one or more of the following:

What you gain as a business owner versus an investor

For tax purposes, it’s always better for your rental activity to be a business rather than an investment. As a real estate business owner, you can deduct the following:

Landlords who meet the criteria of being business owners may qualify for the pass-through income tax deduction of up to 20% of their net rental income from 2018 through 2025.

This deduction—which is also called the Safe Harbor Rule—is part of the Tax Cuts and Jobs Act (TCJA), the tax reform package that became law in 2018. The deduction will end on January 1, 2026, unless Congress votes to extend it.

Use of the safe harbor rule is optional. To qualify for this deduction, a landlord must:

Landlords who use their rental property as their residence for more than 14 days during the year are not eligible for the Safe Harbor Rule. This requirement means that most short-term rental hosts may not apply for the deduction.

Finally, we cannot emphasize enough the importance of record-keeping as a landlord. Accurate, well-organized records will help you manage your rental property, prepare your financial statements, keep track of your expenses, prepare your tax returns, and support the items you report on your tax returns.

Keep more of your money with a Royal Tax Review

Find out about the tax savings strategies that you can implement as a real estate investor or entrepreneur by taking our Tax Discovery quiz. We'll use this information to prepare to have a productive conversation. At the end of the quiz, you'll have an opportunity to schedule your consultation.    TAKE THE TAX DISCOVERY QUIZ

How Are Canadians Taxed If They Invest Or Do Business in The United States?

A growing number of Canadians are getting into the U.S. real estate investment game.

According to the National Association of Realtors, Canadian buyers spent $9.5 billion on U.S. residential property purchases during the 12-month period between April 2019 and March 2020. This means that Canada only trails China in the worldwide rankings of foreign investments in U.S. real estate by country.

As more and more Canadians look to acquire U.S. properties, investors must keep in mind the tax implications of purchasing real estate in one country while living in another.

In this article, we’ll explain the ins and outs of how Canadians are taxed if they invest or do business in the States and how you can avoid double taxation. 

How Are Canadians Taxed If They Invest Or Do Business in The United States?

If You’re Canadian, Don’t Use A U.S. LLC

We usually recommend that our clients in the States use a Limited Liability Company (LLC) to manage their real estate investments. Not only do LLCs protect investors from personal liability, but they also offer tax advantages compared to a corporation, allowing owners to avoid double taxation on their business’ profits. 

Under U.S. law, corporations are taxed on their profits, and then employees and shareholders are taxed personally on the income they receive from the business. This means that every dollar the business makes is taxed twice. With LLCs, the business is not taxed separately. Instead, all of the business’s profits are reported as individual income of the LLC’s owners. This is known as pass-through or flow-through taxation.

Unfortunately, both single and multi-member U.S. LLCs are recognized as foreign corporations under Canadian tax law. So, if a Canadian invests through a U.S. LLC, the LLC distributions would be considered foreign income that is not subject to a Canadian dividend tax credit or a foreign tax credit. Rather, LLC income will be subjected to double taxation, eliminating the benefits of pass-through taxation that make LLCs ideal for investors in the states. 

U.S. LLLPs And LLPs Are No Longer The Go-To

For this reason, Canadian investors had traditionally relied on U.S. limited liability limited partnerships (LLLPs) and U.S. limited liability partnerships (LLPs) when investing in the States. Historically, these structures had been viewed as partnerships for Canadian tax purposes and therefore allowed investors to avoid double taxation.

However, in 2016, the Canada Revenue Agency (CRA) announced that going forward, U.S. LLLPs and LLPs would be classified as corporations rather than partnerships. This may mean double taxation for Canadian investors who manage their U.S. investments through LLLPs or LLPs. 

Limited Partnerships Are The Way To Go

Now that LLLPs and LLPs are treated as corporations, the ideal structure for Canadian investors is a U.S. Limited Partnership (LP) structure. Similar to how LLCs work for American investors, LP income is not taxed at the corporate level; it’s passed through and reported on its owners’ personal income tax returns.

Plus, LPs offer Canadian limited partners comparable personal liability protections to LLCs without the double taxation that comes with investing in a U.S. LLC. It’s a win-win!

Avoiding Double Taxation

As you can see, intercountry taxation issues can be messy and complicated. In order to enjoy the tax advantages available through U.S. LPs, Canadians must ensure that the required documentation is drafted and filed correctly. Mistakes could result in substantial tax penalties, forfeiting your liability protections, or even losing your right to do business in the U.S. 

For this reason, Canadians who are thinking about purchasing properties in the States should consult with a  U.S.-based business attorney with experience in real estate investments before making any purchases. A U.S. lawyer can help you minimize your taxes and maximize your profits.

 

 

 

 

 Image by Allange from Pixabay

4 Tax Benefits of Real Estate Investing

If you're a real estate investor, it's no secret that taxes are an essential part of your business. But did you know there are actually some tax benefits to owning property? That's right - not only is real estate investing an exciting and profitable way to cultivate wealth, but it can also help you pay less to the IRS.

Do we have your attention yet? Read on to discover four substantial tax benefits you can enjoy if you get into the real estate investing game!

Benefit #1 — You Can Deduct Your Expenses When You Invest In Real Estate

There are many benefits to investing in real estate, but one of the most well-known is the ability to deduct expenses you incur related to your investment properties. The IRS allows individuals to reduce their taxable income by certain expenses when they file their taxes for that year. This means if you own a rental property and have $10,000 worth of deductible expenses during the course of that year, you can use those deductions on your tax return and reduce your taxable income by $10,000!

Examples of some deductible expenses for investment properties include:

In some circumstances, you’ll be able to deduct additional expenses as long as they are related to your investment properties or your investment company, if you own one. Because everyone’s situation is different, it always helps to consult with a lawyer or tax professional before claiming any deductions.

Benefit #2 — You Can Deduct Depreciation When You Invest In Income-Producing Buildings

In addition to deducting expenses related to your real estate ventures, you can also deduct the depreciation in value that the building structures will inevitably suffer over time, as long as it is considered an income-producing property.

The first step in deducting depreciation is to calculate the value of the building itself without including the value of the land. You’ll then divide the value of the structure by its “useful life,” which, according to the IRS, is 27.5 years for residential buildings and 39 years for warehouses and other commercial properties. So, for example, if a commercial office building you own and rent out is worth $1 million, you can deduct 1/39th of the value (about $25k) in depreciation each year.

Generally, you can only use losses caused by depreciation to offset passive income and not your total income. So if you earned $200K in salary and have one investment property that lost $5K due to depreciation, you could not use that loss to reduce your taxable income from your salary. However, if you made $10K from another property, the $5K you lost can be deducted for a total of $5K in passive income.

There are three exceptions to this rule:

Benefit #3 — You Pay Capital Gains Taxes Rather Than Income Taxes When You Sell Real Estate

When you earn money by selling a property for more than you initially paid for it, the profits will be subject to capital gains tax rather than income tax. If you own the property for a year or less, the income will be considered a short-term capital gain, which means it will be taxed based on your income-based tax bracket.

Long-term capital gains are where the tax savings can start pouring in. If you owned the property for over a year before selling it, the profit you make would be considered a long-term capital gain. Long-term capital gains are subject to 0% to 20% taxes, with your rate of taxation being based on your income. This rate is lower than their income tax bracket for most people, which can save you thousands in tax dollars.

The long-term capital gains tax rates are as follows:

Benefit #4 — You Can Avoid Social Security and FICA Taxes When You Earn Rental Income

Because the IRS considers earnings from rental properties to be passive income rather than active income, you don’t have to pay social security or FICA taxes on your rental income. If you’re employed, you’ll have to hand over 7.65% of each paycheck to FICA, while your employer also pays 7.65%. If you’re self-employed, it’s even worse — FICA will take a whopping 15.3% of your self-employed active income since you’ll have to pay both the employee’s share and the employer’s part. This is called self-employment tax, and it sucks.

Fortunately, Uncle Sam actually cuts us a break for once and considers rental income to be passive. This means it isn’t subject to payroll or self-employment taxes. Paying less in taxes is always great, but on large real estate deals, avoiding that 15.3% self-employment tax can result in significant savings!

Wrapping Things Up

Investing in real estate is a great way to diversify your income and secure yourself some long-term security. We’ve outlined four substantial tax benefits you can enjoy if you get into the game, but there are many more!

If you want to get started in the real estate investment game, we recommend consulting with a business attorney who specializes in real estate investments to make sure you’re taking advantage of all the tax benefits that you can.

Taxes For An LLC: How the IRS Sees Your Limited Liability Company

If you're a real estate investor, you should be aware of how the tax code and the way you structure your business will affect how much money Uncle Sam takes from your bank account.

For example, the IRS has a lot to say about your Limited Liability Company (LLC) and how taxes for an LLC are handled.

If you don't already have one, it's time to create an LLC. Not only does owning your properties and other investments through an LLC protect you from liability, but it can also save you some serious tax dollars if you make the right elections for your business. 

Buckle up! It’s time to learn the basics of how the IRS sees your LLC and what the tax benefits of an LLC are.  

What Is An LLC?

An LLC is a business structure that offers its owners limited liability from the business’s debts. That means if you are the owner of an LLC, your personal assets are protected from any debts or obligations incurred by the company. You and your LLC are considered to be separate legal entities.

This type of legal structure is helpful for real estate investors because it's cheaper and easier to create than other entities like a corporation but still offers the all-so-crucial protection from personal liability.

The people or entities that own an LLC are called its “members.” There is no maximum number of members an LLC can have, and most states will allow single-member LLCs, which have only one member, to be formed.

LLC Tax Classifications

For the purposes of taxes, LLCs are considered “pass-through” entities. This means that LLCs do not pay taxes. Instead, the LLC’s profits are reported on its members’ income taxes. However, depending on the number of members in the LLC and the tax elections chosen for the business, the IRS will treat an LLC as a corporation, partnership, or a disregarded entity.

Disregarded Entities

If you own a single-member LLC, the default tax status for your business is called a “disregarded entity,” which means that the IRS ignores your LLC entirely and just considers its profits to be your personal income. This is the same way that the IRS taxes sole proprietorships. When you file your federal income tax return, you will also need to submit a Schedule C form, which details the profit or loss from a sole proprietorship. 

Many states also allow LLCs to be treated as a disregarded entity when the LLC is solely owned by a married couple. However, if you form a married-couple LLC in a community property state, it will be taxed like a multi-member LLC, so it’s crucial that you do your homework before making any decisions. 

Partnerships

The IRS will automatically tax multi-member LLCs like a partnership, which means that each member will receive a Schedule K-1 and include their portion of the LLC’s profits as taxable income on their personal income taxes. When LLCs are taxed as partnerships, each member must also include a completed Form 1065 for partnership taxation with their tax returns. 

Corporations

Although the default tax classification for an LLC is either a disregarded entity or a partnership, members of an LLC may choose to be taxed as a corporation by submitting Form 8832 (Entity Classification Election) to the IRS. For tax purposes, there are two varieties of corporations- S-Corporations and C-Corporations. 

Like LLCs, S-Corps are pass-through entities, where corporate income, losses, deductions, and credits are passed through to the business’s shareholders for federal tax purposes. With C-Corps, on the other hand, the business itself is taxed, and then each shareholder is taxed again on their earnings when they pay personal income taxes. 

C-Corps are generally not the best choice for an individual real estate investor, but, in some situations, an S-Corp can save you a significant amount of moolah on single-member LLC self-employment tax

While you must pay yourself a reasonable salary from the LLC’s profits, you can receive any income your business makes on top of your salary as a shareholder distribution instead of in a paycheck. Because the IRS considers distributions to be “passive” income, you don’t have to pay self-employment/ payroll taxes on the money you receive as a shareholder distribution.

However, this move only pays off if your LLC makes enough income to support a reasonable salary for yourself on top of shareholder distributions. Generally, this threshold is around $75K annually for a single-member LLC, but this can vary depending on your particular circumstances.

What Is The Best Tax Classification For My Business? 

Unfortunately, this is not a question that any blog or article can answer for you. Not even the all-mighty Google can give you advice on this issue. Because everyone’s circumstances are different, we strongly recommend that you meet with a business attorney or tax professional to discuss the tax classification that will save you the most money.

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