Looking for advice on a plausible tax saving strategy

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Looking for advice on a plausible tax saving strategy

Sara Batool
Member since 2018 · 6 posts · 2 votes

Some background that I hope provides cover for naive questions. 

My husband has a regular W2 job in the bay area. I used to work as a hospital/pharmacy admin, but took up work at my local elementary school to be close to my kids. Now with them on middle school autopilot, I want to get more involved in finances and figure out how real-estate can help with saving on our California/Federal taxes. So, in other words, am very early in my learning and excuse my naivete.

Regarding our tax strategy, we talked to our regular CPA who advised us to setup a LLC (in cali) in my name, loan money to this LLC and purchase rental property. Since I'd be self-managing the rental property, the downpayment, expenses and depreciation on the property would be tax deductible against our W2 income.

Now, this sounds too simple to me. Also, he couldn't confirm if this required having a Real Estate Professional status (which I've read is very tough and litiguous). Can someone with more experience (tax professional or otherwise) please give their take on this? Sounds simple enough but not sure why everyone doesn't do that.

Thank you

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Basit SiddiqiBusiness Member
Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
3y

Having a property within an LLC does not change the characteristics of the income.

Normally, rental income is considered passive.
You may need to claim real estate professional status to change it from passive to active.

It is concerning that your CPA is offering a strategy but unable to confirm your concern of whether or not you need real estate professional status.

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  • Basit SiddiqiBusiness Member
    Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
    3y

    Having a property within an LLC does not change the characteristics of the income.

    Normally, rental income is considered passive.
    You may need to claim real estate professional status to change it from passive to active.

    It is concerning that your CPA is offering a strategy but unable to confirm your concern of whether or not you need real estate professional status.

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  • Joseph PalmieroBusiness Member
    CPA · PA · Member since 2023 · 151 posts · 115 votes
    3y

    The downpayment would not be deductible in the year of purchase. It would be part of the total purchase price of the property and depreciated. 

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  • Jeff Nash
    Accountant · McKinney, TX · Member since 2023 · 394 posts · 580 votes
    3y

    You would have to have a STR and have a net loss unless you can qualify as a REP and again have a loss to offset active W-2 income. The entity structure is not relevant (except for additional LLC fees in California). I would dig into your situation more to see what can be done for tax planning and determine the best course of action.

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  • Katie Balatbat
    CPA and Attorney · San Diego, attorney · Member since 2022 · 302 posts · 219 votes
    3y

    @Sara Batool

    You may also want to research something called a "mom and pop exception" with regard to passive losses to see if any losses that you generate from your rental would in fact be deductible, and also look into whether you may qualify for real estate professional status.  Additionally, you may want to look into the requirements to meet the safe harbor for a Section 199A deduction, which may help you as well.  There's also a SALT cap workaround in CA if your husband is a high earner that you may want to look into a partnership structure of sorts to see if the pass-through SALT deduction could assist you in deducting more than $10k in SALT.  If these are things your CPA is unfamiliar with, I would echo some of the sentiments that you may want to find a different CPA or one that is more focused on real estate investments.  I have referrals in the San Diego area if you're willing to work remotely.

    Also - this is unrelated to your question, but your description of your situation made me think about it - since you have young children, you'll also want to be sure that you have a proper estate plan in place, too.

    *This post does not create an attorney-client or CPA-client relationship.  Readers are advised to seek professional assistance.  The information contained in this post is not to be relied upon.

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  • Twana RasoulBusiness Member
    Real Estate Agent · San Diego, CA · Member since 2017 · 1k+ posts · 1k+ votes
    3y

    @Sara Batool It would definitely be worth while for you to look into a CPA in your area in San Francisco or I can recommend someone in San Diego.

    This is not tax or financial advice but having LLCs set up seems to be way overrated on this site and not enough discussion of setting up a Trust. For what it is worth, anecdotal evidence that I've been exposed to the past few years....wealthier investors that own residential real estate (not commercial) are more likely to have their assets held in some sort of Trust vs beginner investors with 1 property tend to have that property in an LLC.

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  • Jeffrey Fung
    Member since 2019 · 29 posts · 15 votes
    3y

    From my understanding, you can deduct up to $20k of Schedule E losses as a non Real Estate Professional. I don't know what the LLC has to do with anything.

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  • Joseph Neri
    Investor · Houston, TX · Member since 2019 · 95 posts · 29 votes
    3y

    We have a similar way of doing this with an extra layer of protection using advance life insurance strategies. Lend your cash value to the LLC. I believe IRS will allow up to 10%. Check with you CPA. If your paying 50k or more in tax then there's other strategies we can look into. If this is something you want to learn more about just reach out.

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  • Eric Williams
    Accountant · Houston, TX · Member since 2023 · 148 posts · 41 votes
    3y

    The real estate license does not mean a damn thing when it comes to Federal tax law and the characterization of the activity as passive or nonpassive.

    The down payment is 100% not immediately deductible. It is capitalized and either recovered upon disposal if allocated to land, or recovered fully or partially via depreciation at 27.5 class life, straight-line, mid-month (presumably if residential rental or 39 if not). The down payment isn't a deduction during outflow because you didn't include it in income when received. You can't benefit twice.

    I'm going to tell you I disagree and simply because you are managing itself does not necessarily mean it will be deducted against your W-2. Expenses and depreciation are likely going to be net against income from the activity that produced both. If the deductions are greater than income amounts and nonpassive, then I can see them offsetting ordinary income.

    All rental activities are per se passive. There are more than a couple cases of real estate agents trying to use their accreditation as grounds for turning a passive activity into a nonpassive, and it never works.

    Ask your CPA about the real estate professional requirements, and the about meeting material participation requirements.

    I could be wrong but unless the rental is some exception to the per se rules, you might want to document if you want the benefits of a nonpassive activity.

    https://www.thetaxadviser.com/issues/2017/mar/navigating-rea...

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  • Natalie KolodijBusiness Member
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    Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
    2y

    This was not great advice on the part of your CPA. 

    I'd recommend working with someone who understands REI.

    An LLC doesn't change things, self rentals have specific implications as well.

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