RE tax questions from a noob

Tax, SDIRAs & Cost Segregation
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RE tax questions from a noob

Mark Stone
Investor · Palm Harbor, FL · Member since 2015 · 64 posts · 4 votes

Ok I have a few questions in regards to my taxes and am hoping someone could help answer them or point me in the right direction! Thanks in advance for any insight!

Due to my income falling between the $100-$150k, I am curious on how to increase the amount I can write off of the maximum $25k passive loss for active real estate investors (not sure if there is a term for this write off). 

Questions)

1.) If I contributed more money to my 401k would it lower my overall income that is viewed by this rule and therefore I could write more off?

2.) Currently if I work overtime I get paid 1.5x base pay, but I am wondering if someone can help me with the math of what I would roughly be making (1.4x, 1.3x etc.), since I would also be lowering how much I could write off the above rule (my OT wouldnt be extensive enough to have my income >$150k). This may not be feasible without more specifics on my taxes but perhaps a rough formula on how I could figure it out.

My basic thought process with the math would be the following:

For every extra $1.50 I make above $100k (but below $150k); I lose $0.75 I can write off.

So here is where my knowledge really breaks down (if it hasn't already unbeknownst to me).

So for every $0.75 I lose the ability to write off as a passive loss; will this cost me $0.75 or will it cost me $0.75 times my marginal tax bracket of 28%, which would be $0.75 x 0.28 = $0.21

And if it cost me $0.21 per $0.75 and therefore $0.41 per $1.5, that would basically bring my OT down from 1.5x base pay to roughly 1.1x base pay?

Thanks again for any insight!

Sincerely, 

Mark 

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John Woodrich
Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes
10y

I don't have time to answer all you questions but here is some help.

1.  Yes - if you make 401(k) contributions it will lower your Modified Adjusted Gross Income (MAGI) which is used to calculate the phaseout.

2.  I don't understand what you are asking here.  It sounds like you get overtime pay, and you are trying to figure out how much your are actually receiving if you are losing RE deductions??  I don't understand the purpose, if you only made 1.4 times instead of 1.5 times would that stop you from working OT???

3.  Your rental income will definitely count.  You will have to calculate your gross rents, less your expenses, etc.  Then if you end up negative you can potentially use this towards the $25,000 write off.

I am giving you general advice as I don't know your tax situation.

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  • Mark Stone
    OP
    Investor · Palm Harbor, FL · Member since 2015 · 64 posts · 4 votes
    10y

    Thought of one more question which could make a huge difference on my income for the passive loss rule. 

    I am living in an owner occupied triplex, with rents of $800/month and other tenant pays $975/month.

    Would this therefor add an additional $975 + $800 x 12 = $21,300 to my "income" for calculating this write off?

    Thanks again!

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  • John Woodrich
    Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes
    10y

    I don't have time to answer all you questions but here is some help.

    1.  Yes - if you make 401(k) contributions it will lower your Modified Adjusted Gross Income (MAGI) which is used to calculate the phaseout.

    2.  I don't understand what you are asking here.  It sounds like you get overtime pay, and you are trying to figure out how much your are actually receiving if you are losing RE deductions??  I don't understand the purpose, if you only made 1.4 times instead of 1.5 times would that stop you from working OT???

    3.  Your rental income will definitely count.  You will have to calculate your gross rents, less your expenses, etc.  Then if you end up negative you can potentially use this towards the $25,000 write off.

    I am giving you general advice as I don't know your tax situation.

    1Reply
  • John Woodrich
    Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes
    10y

    Here is the definition of MAGI:

    https://www.irs.gov/publications/p925/ar02.html#en...

    Here is a quick table to calculate MAGI:

    https://www.irs.gov/businesses/small-businesses-se...

    1Reply
  • Brandon Hall
    CPA · Raleigh, NC · Member since 2013 · 1k+ posts · 2k+ votes
    10y

    @Mark Stone are you asking this question because you already have $25k of passive losses or because you are theorizing?

    Instead of putting money into a retirement account and losing general control of it, why not look for alternative methods to reduce current year passive losses and tap into prior year suspended passive losses? 

    I wrote an article on this a few weeks ago for BP. Basically, you'll want to look for Passive Income Generators (PIGs). These are investments where you are the money partner or silent investor and they generate passive income for you which is offset by your passive losses. This is much better than realizing any temporary tax savings like contributing to a traditional IRA or 401(k).

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  • John Woodrich
    Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes
    10y

    @Brandon Hall I think he is asking the question because he wants to try and figure out how he can deduct the full $25k.  

    Increasing passive income will offset passive losses however I think his motives are to reduce his overall tax liability with what he currently has going on.  

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  • Brandon Hall
    CPA · Raleigh, NC · Member since 2013 · 1k+ posts · 2k+ votes
    10y

    @John Woodrich I understand, however I'm providing a different perspective. Instead of maxing out a 401(k) and losing access to that money, he can look at alternative investments that produce passive income. In this way, he's generating more income which soaks up his passive losses and therefore decreasing his overall effective tax rate.

    You maintain control over your money, you're earning more tax-free income, and you're investing in (theoretically) higher ROI assets than what would be available through a 401(k). Not to mention you also have much more flexibility with the tax code.

    Other options would be to buy better cash-flowing rentals (tough in this market), qualify your spouse as a real estate professional, or sell the property.

    You can contribute more to your 401(k) and it's certainly the easy route to take, but the easy route doesn't always lead to the best long-term results.

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  • John Woodrich
    Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes
    10y

    Yes, there are many options available - if he has a side pot of money he can definitely invest in passive income items.  As he mentioned, any additional take home pay will limit his ability to claim real estate losses he already has coming so that would offset part of the investment benefits. 

    Another option would be to throw it in his 401(k) and take a loan against his 401(k) to purchase investments to offset the passive income.  Would limit his MAGI which would help deduct more RE losses and he could generate income which would offset more.

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  • Mark Stone
    OP
    Investor · Palm Harbor, FL · Member since 2015 · 64 posts · 4 votes
    10y

    Hey @John Woodrich and @Brandon Hall,

    Thanks so much to both you for taking the time to answer my questions. You guys have definitely cleared up some of the issues I had, but have also given me a lot more to think about as well.

    I was obv thinking of a 401(k) to lower apparently was is my MAGI, but apparently there are other options that may be better, so I will def take a look at the article you mentioned Brandon. My current employer does offer some matching though so thought it was always best to at least capture this, not to mention my employer only lets me contribute up to about $8k towards my 401k.

    And yes John it seems kind of silly of me, but I work enough as it is at my current job, so when I pick up extra shifts I don't want to do so unless I am getting a decent amount more than base pay as opposed to my calculation of 1.1x base, otherwise I rather spend that time doing different stuff I enjoy like learning about real estate lol (which if it isn't apparent I have much to learn).

    Thanks again!

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  • John Woodrich
    Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes
    10y

    I have never heard anything about an employer limiting your contributions into a 401k....  I would be surprised if they actually could limit your contributions. If I had to guess I would say they are only matching up to $8,000 of contributions, I believe the 401K Max is $18,500.

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  • Mark Stone
    OP
    Investor · Palm Harbor, FL · Member since 2015 · 64 posts · 4 votes
    10y

    I believe there is a designation for "Highly Compensated Employees" (HCE) which allows my company to limit how much I can contribute in order for my company to meet certain rules set by the IRS that are necessary for the company to even offer a 401k. And apparently if those no-HCEs contribute more it allows the HCEs to do so then. Idk I read about it a while back and didn't seem fair at all.

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  • Mark Stone
    OP
    Investor · Palm Harbor, FL · Member since 2015 · 64 posts · 4 votes
    10y

    Apparently linking people doesn't work from my phone so figured I would still do so. @John Woodrich

    But I was brainstorming more about what you guys were saying and I may have actually completely misunderstood how the passive loss rule works. For sake of making things simple if I made like $50k a year and was able to utilize all $25k write off. Would I only be able to use this write off against passive gains, such as RE, and not towards my active income from working?

    If so I don't think at this point with only 1 triplex (with me living in one of the units) I would have enough passive gains to need the full $25k of passive loss.

    And would I be able to save some of these passive losses for future years as it sounded like @Brandon Hall you alluded to?

    Also, Brandon I wasn't able to find your article, if you don't mind PM me a link or posting here even that would be very much appreciated. 

    Thanks again guys!

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  • Dave Toelkes
    Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes
    10y

    Apparently, you are still confused about the net passive loss.   A rental property activity is a passive activity that generates passive income or passive losses.  

    Normally, passive losses can only be used to offset passive income from other passive income activities.  There is a special exception for a residential rental property operation with active participation that allows you to use net passive losses from your rental activity to offset your non-passive income (W2 income, or, ordinary income).  This special exception is called the "net passive loss allowance" and is limited to a maximum of $25K.  If your total rental income, expenses and depreciation is a net negative number (a net loss), then you can use up to $25K of that amount to offset your non-passive income.  This $25K net passive loss allowance is reduced for incomes above $100K and phased out completely at $150K and above.   

    if your net passive losses are greater than the net passive loss allowance, then you "suspend" the amount of passive losses you can't use and carry them forward to the next tax year.  

    Just to make sure you have a complete understanding of the net passive loss allowance:  the amount you are allowed to deduct is your actual net passive residential rental loss for the year up to a maximum of $25K.  You do not automatically get to deduct $25K as a net passive loss allowance if you don't have at least $25K in net passive losses.  If your net passive loss is $12K, then your maximum net passive loss allowance is $12K subject to the income limitations.  In this instance, you could take the full $12K in net passive rental losses as a net passive loss allowance against your other ordinary income provided your income does not exceed $126K.  

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  • John Woodrich
    Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes
    10y

    Good explanation @Dave Toelkes.

    To tie it all together - @Brandon Hall's advice was that if you have suspended passive losses that you aren't able to use, you can invest in passive income assets which will offset the suspended losses.  Thus your new passive income will not be taxed.  

    Hope everything makes more sense.  

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  • Mark Stone
    OP
    Investor · Palm Harbor, FL · Member since 2015 · 64 posts · 4 votes
    10y

    @Dave Toelkes @John Woodrich @Brandon Hall

    I truly appreciate all of your patience with me and thorough explanations! It is definitely making sense now, sadly I was thinking you were automatically given $25k to write off against your normal income (which was then adjusted based on income). I have read about this "net passive loss allowance" in numerous articles and it has never made sense until now. So thank you!!!!

    Out of curiosity is there a limit a limit to how long you can "suspend" these passive losses.

    Thanks!

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  • John Woodrich
    Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes
    10y

    @Mark Stone No, they are suspended until you have passive income to offset them or you can deduct them when you dispose of the property. 

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  • Mark Stone
    OP
    Investor · Palm Harbor, FL · Member since 2015 · 64 posts · 4 votes
    10y

    Thanks @John Woodrich

    0Reply
  • Mike Barry
    Plainfield, IL · Member since 2015 · 111 posts · 17 votes
    8y

    Forgive me if this answer was already given I have read thru these posts twice looking for it.

    Mine is a similar question but I believe can be answered with a quick yes or no. Here it goes...

    Will contributing to a traditional 401k to reduce my taxable income now reduce my W2 income essentially limiting my buying power for acquiring more RE?

    Thanks everyone!

    0Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    8y

    @Mike Barry

    Yes, your income will be lower both for tax purposes and for loan underwriting purposes.

    Lenders look at your ability to pay back the loan, and stashing money into your retirement account does limit the money available for repaying the loan.

    That said, declining to fund your 401k just to qualify for a loan may be short-sighted. Worth a case-by-case analysis of your goals and means.

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