Major Tax Deductions

[Vikram C.]

I'd like this thread to be a place where we compile a list of the major tax deductions available to a real estate investor. Since I do flips, I do not get the benefit of depreciation, but here are a couple of good ones still available to me:

1. Defined benefit contributions. Looks like I can put $195,000 each year into this tax free. But can I self-direct this amount so that it is well-invested after I make my contribution?

2. Foreign earned income. Depending on the number of days spent abroad vs the U.S., I may be able to deduct up to $91,400 this year. This money can be invested any way I like, including in flips.

These two add up to about $280K in tax deductions. Any other good-sized deductions that you guys know about?

[Account Closed]

There are some that might be able to take advantage of the low income housing tax credit. This can amount to a lot of money and often times developers will sell the tax credit.

[Vikram C.]

Charles, LIHTC requires me to invest my money in some rent-controlled buy and hold properties. I would like tax deductions whereby I can do at least one of the following with the deducted money:

1. Invest it any way I want, including back into my RE business of flipping houses.
2. Invest it in stocks, ETFs, etc. based on my stock selection.

Do you know of any good-sized deductions that will allow me to do those things in addition to a defined benefit plan and the foreign earned income exclusion?

[Rich Weese]

Vikram- this next one is not a "quickie" but one that I used a few times.

Sell a residence you've lived in at least 2 of previous 5 years. Profit up to $500,000 may be gained with zero due in taxes. This may be used over and over again. No age requirements. Rich

[Vikram C.]

That's a big one, Rich. But I am trying to figure out the deductions available for rehabbers and flippers who tend to have short-term gains or income from a trade or business. The tax rules seem to be more favorable for long-term investors.

Are the short-term guys stuck with just the retirement fund options?

[Mark Updegraff]

Good Topic Vikram,
I'm unfamiliar with either of your tax strategies. I'll have to venture over to the IRS website for more details. We typically spend some time out of the country each year. This year we were out a total of about 1 month.

I'm guessing you're talking about IRA contribution limits for #1? Can you be more specific.

Rich,
Can you use that strategy to sell to a LLC that you control? The related expenses would then be deductible and you can get some tax free money to spend as income?
Seems too good to be true, am I missing something?

as always, thanks guys!!

[Vikram C.]

Mark, I was referring to a defined benefit plan, as opposed to the usual defined contribution plans. If you are the only employee of your business, it may be profitable to create a defined benefit plan that allows you to put away around $195,000 each year tax-free.

Regarding selling to your own LLC, the tax rules are usually pretty strict about related-party transactions so I suspect that would not work. I am sure our resident CPA, Charles, can confirm this.

The foreign earned income exclusion has a couple of tests to qualify for it. The physical presence test and the bona fide residence test. I do not think you will qualify for either one based on one month abroad on vacation. But you can check with your CPA on this.

I actually genuinely live in India although I am a U.S. citizen. Therefore the rules are different for me. My wife is not a U.S. citizen or resident and therefore I do not qualify for the married-filing-jointly limit, which is a nice $180K or so. It'll be nice to put away $370K each year tax free (defined benefit + fei) but I am unfortunately not eligible for that amount due to my wife not being a U.S. citizen or resident.

Which brings me to the subject of this thread - can other successful rehabbers (J Scott???) suggest some other big deductions?

[Jimmy H.]

Vikram, In reference to major tax deduction #1 you mentione din the OP -do you use a self directed IRA or a solo 401k? It seems from my research the solo 401k is easier, and does not require the formation of another LLC, nor the use of a trustee which could be a hassle. But it seems most people on BP use SD IRA's and not solo 401k's, why is this?

[Jimmy H.]

Also, I know using the funds of an IRA before reitrment is much easier than trying to do so out of a 401k, is this why people use the SD IRA, because they don't want to wait until retirement to get their lump sum?

[Account Closed]

Vikram the defined benefit plans were often used by large corporations. The administration and accounting for these plans became quite costly and so they have fell out of favor. They can still be done though.

How you structure your business is going to play into how many tax deductions are going to work.

If you have a number of employees you may be able to set up various benefit programs but you are going to want to watch how you favor any highly compensated individuals versus other employees.

Do you have an office in India and the US. You may have some great tax benefits from owning some prop in India and the US. More of your travel could be deducted.

[Vikram C.]

Charles, I already get a tax deduction for all my flights to the U.S. because I only fly there for my RE business.

I have an LLC in AZ and I am the only employee of it. So I will not have to worry about giving other employees the same benefits that I give myself.

Thanks for the tip about the defined benefit plans being more cumbersome and expensive. That's good to know in advance because I am meeting my attorney in a couple of weeks to discuss my options to reduce taxes. What I really love about the defined benefit plan is that I can deduct a nice $195K each year versus only a quarter of that for a defined contribution plan.

My concern, though, is about the flexibility of investing that money once it is in the plan. I would ideally like to invest it in the types of assets that I would normally invest in - stocks and my RE business. Would that be permissble or are these plans restricted in how you can invest them?

[Tod R.]

I don't think this available for a rehabber, but you are allowed energy tax credits for your residence if you make approved energy efficient improvements.

Charles, do you know if any of these are available for businesses?

Just thinking out loud...

[Vikram C.]

Jimmy, I do not yet know the details of how a defined benefit plan actually works. I should have more information in a couple of weeks. Charles or others may know more about it.

If not, I can post the summary of what I learn from my meeting with my tax attorney in a couple of weeks. I hope I get something useful out of the $400 per hour meeting!

[Don Konipol]

I have set up and been contributing to a defined benefit plan for the last 8 years. Here are some important points about these plans:

1- they can be used by a sole practitioner or one man business.

2- the amount the can be contributed to the plan in any one year is determined by the assumed income and profit on the plans capital, the age of the beneficiary, the retirement age of the beneficiary, the amount of assets in the plan, the number of years left to retirement, and the life expectancy tables published each year.

3- $195,000 is currently the maximum yearly benefit; however the max that can be contributed is determined by #2 above (can be more or less), the maximum deductible is currently $367,000 per year!

4- These plans are only good if you can fairly accurately predict that your earnings will continue for a minimum of 8 years or so because even if you earn no money you will be required to fund the plan. If you do not fund the plan the plan will self terminate, and you will owe all taxes that would have been paid plus an early withdrawl penalty of 15%!

5- To set up these plans you will need both a licensed actuary and an attorney specializing in defined benefit plans. the cost will be prox $3-4 K to set up, and prox $2K per year in fees to pay for the acturial work (which has to be recalculated every year) and the legal compliance issues (to ensure that the plan is in compliance with the ever changing government regulations).

6- you can be trustee for your plan as well as custodian, making all the investment decisions. There are rules in place about the plan providing a direct benefit to yourself thru the plans investments, but in most cases the investments would be passive (my plan invests in real estate notes and real estate limited partnership interests).

7- Under current law, the plan withdrawls are taxable as ordinary income. Hence the benefit of the plan is having the tax portion of your earnings working for you until withdrawl, and paying taxes in the future (in depreciated dollars).

Hope this is helpful.

[Account Closed]

Originally posted by Tod Radford:

I don't think this available for a rehabber, but you are allowed energy tax credits for your residence if you make approved energy efficient improvements.

Charles, do you know if any of these are available for businesses?

Just thinking out loud...

There are several energy tax credit currently available for both individuals and businesses. Some of them have no limit.

[Account Closed]

Don, sounds like you have found a very reasonable solution. Do you have employees in the plan? There are some extensive reporting requirements, but it sounds like you are managing them just surprised that you are getting it done that reasonably.

I may have to check into this again. Thanks for sharing your experience.

[Don Konipol]

No employees, I am a one person operation. The only other provision I forgot to mention was that the amount contributed to a pension plan can only be deducted from earned income (income subject to FICA and Medicare taxes), not dividends, rents or royalties or other investment or passive income.

[Vikram C.]

Don, thanks for the information. $367K per year is a very nice deduction and, from what you say, it can be almost $3 million over eight years. (I understand that all this becomes taxable when you start receiving the benefits.)

Are there any other good-sized deductions that you are aware of?