Rental Income Tax - avoid?

Question

Hey all. I searched for an answer here but haven't found it. If I missed it,  please let me know.

I'm in the planning stages. What I would like to do is get a multi-family property and collect rent (gasp!)

But when the profits from the rent, i'd like to put them in a high interest savings account(1%) completely separate from my accounts. When the account is large enough, use it to purchase another property. So basically I don't want to take an income from the investment. Is there a way to avoid paying an income tax on the money since i plan to reinvest it 100%?

I understand that an LLC is just a passthrough. Is there a way to do this with an LLC? Or another corp? I do plan to talk to a paid CPA, but I just want to do some more research first.

Thanks in advance

Bill Gulley · Answer

Realize too, that if you show expenses to reduce the taxable income, you won't have the income necessary to finance new projects and may create a liability for refinacing the property you hold. I suggest you bite the bullet starting out as you'll usually need income to move forward. :)

Steve Babiak · Answer

To avoid income taxes, you could have your self-directed IRA or 401K be the purchaser of the asset in the first place; those are tax sheltered.

Then there is the notion of "trading" property using the 1031 exchange; the 1031 exchange allows for deferral of capital gains on property held as an investment.  But the rental income would still be taxed along the way.

Now you have a couple of ideas to read more about in the forums :)

Jean Bolger · Answer

I don't know your particular situation of course, but once you figure in the mortgage and expense deductions and the depreciation on the property you may be pleasantly surprised at how your taxes look. The laws are extremely favorable to real estate investors. You might find, as Chris mentioned, that you're making money while showing a loss- legally. This can create a tax shelter for your other income. It blew my mind at first. You could go over all of it with a tax attorney- I'm sure they could tell you exactly what your options are. But the income tax obligations on your first property shouldn't be enough to make or break the success of your plan. Some people will spend $10 to avoid $5 in tax; me, I'm one of the ones who thinks taxes are just the price of a (semi)-civilized society ;)

Bill Gulley · Answer

No, seems that the government has a thing about income taxes, they want them. In any entity you'll have tax on income, one way or another. You can avoid taking the income yourself throgh retained earnings but you still have taxes. There are ways to reduce the tax liability, but not to nothing unless you don't make enough to file, which should not be your goal. :)

David Krulac · Answer

@Steve Babiak

is right.  Each bank has different rules but many count rental income at 75%.  Their justification for that is that there will be vacancies and other expenses that reduce the income.

OTOH, I don't know many buildings with 25% vacancy rate, so they're being overly cautious.

Steve Babiak · Answer

That is partly true - you would get like $1500 credit out of $2000 rents, not just $500.

David Krulac · Answer

@CL Tumlin

Depends on whether the loss is pre-depreciation or after.  If the bottom line is positive before depreciation, you're to the good.  If your loss is due entirely to depreciation, line 18 on Schedule E, that means you were positive cash flow before subtracting the paper loss of depreciation.

If on the other hand you were negative before depreciation was factored in that is negative cash flow.   But you might still be able to explain away that to a lender by citing higher than normal expenditures due to remodeling or fix ups that were essentially one time events.

CL Ziegler · Answer

Thanks David! A follow up question:

I have heard that bankers only consider a percentage of rental income (ie $2000 in rent revenue monthly only counts as $500)

.....is this true? Thanks

CL Ziegler · Answer

Hi Charles,

That's great, and exactly what I aim to do. Another poster above said that losing on paper will hurt one's chances to get new financing. Have you found this to be true?

Thanks!

Charles Morgan · Answer

I'm one of those who is losing (on paper) even though my renters are buying my houses for me.  Deductions for Insurance, depreciation, repairs, taxes, etc. add up fast even though my equity is going up every year.

Rental Income Tax - avoid?

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