How do I show income while minimizing taxes?

Question

I own a retail business that is doing well. I want to diversify into real estate as a tax shelter and for money. My primary question is how do I show income after taking advantage of all the deductions? I can take deductions now but that brings my income down. If I don't use the deductions by tax bill goes thru the roof. If I don't show income I can't buy real estate.

My goal is to show as high of income as possible to buy real estate without paying excessive taxes.

Every deduction now takes away from my income, and income increases my taxes.

Does real estate depreciation solve this problem?

Does anything else solve this problem?

Michael Plaks · Answer

@Arthur Kineard

How do eat my cake and have it, too? :)

First, I would not go into real estate as "a tax shelter." If you do it, you do it "for money" - your second objective. For money means for cash flow, for appreciation, or both. Tax benefits is only icing on the cake, not the cake itself. (Yes, I always think a lot about cakes in the middle of the night, don't you?)

Second, let's be clear about creating losses from real estate. With one exception - depreciation - all other expenses you claim come from the money you actually spent. So the only way you can lose money on tax return while actually making money is with depreciation. Otherwise, you have not only tax losses, but real losses - hardly a worthwhile pursuit, in most cases.

Third, you cannot present different pictures to your lender and to the IRS. Not only it is mortgage fraud, it is impossible to pull off because these days lenders compare your application with the IRS transcripts.

I also urge you to pay attention to a crucial point made by @Linda Weygant: you cannot just forego available deductions to create higher income. It breaks the IRS rules and constitutes mortgage fraud.

So, the tax-reduction game is to have rental properties that cash flow and then have enough depreciation deduction to erase all the cash flow and create deductible losses. It's not that easy to accomplish and usually involves advanced strategies such as bonus depreciation mentioned by @Logan Allec and asset segregation.

The good part is that investor-friendly lenders will add back depreciation, not counting it against your income for underwriting purposes. The bad part is that your ability to deduct rental losses may be limited due to your successful retail business. This is something to discuss case-by-case.

Basically, you're left with three alternatives:

A. Minimize your deductions and maximize your income (and, of course, taxes) for two years. For example, you could capitalize certain costs instead of deducting them.

B. Use asset-based funding, such as private lenders and commercial lenders - those who loan money based on the value of your properties, their profitability and your credit but not your income.

C. Acquire properties with owner financing or subject-to financing. Then you do not need to apply for loans.

Logan Allec · Answer

@Arthur Kineard, get on the phone with your CPA and lender to discuss strategy.  I welcome these conversations when my client is seeking a mortgage.

I am not in the mortgage business, but I have learned over the years that lenders may add back certain deductions to arrive at the mortgage-qualifying income that he or she will use.  Examples include depreciation, amortization, and business use of home.

And here's a cool thing, thanks to tax reform: 100% bonus depreciation.  It all goes on your Schedule C, Line 13.  So it's essentially a good-as-gold full expense for tax purposes, but it doesn't hurt you on your mortgage application.

So make sure your CPA is aware of these things and is not afraid of the home office deduction.

Also, if you have a large non-recurring expense this year, this is worth talking through with your lender.

Someone like @Chris Mason could probably elaborate.

John Acheson · Answer

Generally you want higher income two years before you apply for financing, so you could change your tax strategies depending on which years you need a loan.

The most interesting real estate tax tactics to me are the 1031 and cost-segregation depreciation.

Also, as a retail business owner, you can qualify for some SBA financing that will allow you to owner-operate commercial real estate to where you could run your store in a building while renting out some of it at the same time to generate that income.

And for commercial you can use the income from the target property to help your income.

Linda Weygant · Answer

This is the conundrum that every investor is in and the answer is that it's an issue.

The way to work around it is to prepare your taxes for a couple of years without the "optional" items that you can declare.  These would be things like business mileage on your personal vehicle, a home office, maybe your cell phone and internet, etc.  Pay the taxes.  It's the price of getting into real estate, unfortunately.  Or figure out how to boost sales in your business such that your income is high enough even with all those optional deductions.What you may not do is opt not to declare expenses that are usual and ordinary in the course of your business and which you actually incurred and paid, such as advertising, supplies, labor, rent, etc.  "Deciding" to artificially lower these amounts in order to qualify for a mortgage is otherwise known as mortgage fraud.

Arthur Kineard · Answer

That is something I am considering and looking into. The 51% occupancy requirement is not ideal. In my mind small 20,000 square foot shopping centers would be ideal as far as investment goes but my retail stores need no more than 2000 Sq/Ft. If nothing else this is all very interesting. Dozens of forked roads most ending in dead ends. Just have to find the road that is not a dead end.

Arthur Kineard · Answer

Thanks everyone; not exactly what I wanted to hear. Getting loans for my retail business is much easier but more expensive. Yes I would like to have my cake and eat too.

How do I show income while minimizing taxes?

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