Beating the tax man (or woman)

[Anthony R.]

So currently, I am 29 and for all intents and purposes, half of my income is from rentals. Also, the income from my rentals cover all expenses. This means that what I make working is mine for savings, other investments, etc. Currently I have been dumping 13% of my work income (10% from me and 3% from employer) into my 401k. 

As I am getting ready to do my 2015 taxes tomorrow, I was thinking about how I planned on writing off, most if not all, of my rental income.  Simultaneously I am still attempting to Beat the Multiple Rental Property Poison Pill and also Hold and Collect or 1031 Trade. 

Then it hit me....

Since my earned income is unencumbered, why not max my 401k and then take loans from myself. The interest paid back to myself would only benefit my retirement, I can stop giving money to those damn dirty banks, AND, most relevant to this post, I would lower my taxable income to an all time low. 

So my question is, does this sound feasible? 

1/2 of my income is rental income and between depreciation, taxes, interest, insurance, repairs etc. It's written off.

1/2 of my income is earned income. 

After I max my 401k though that would bring my taxable income down to 41% 

Add in standard deductions and I manage to get my taxable income down to 35.6% 

Does anyone else do this? Is this a pie in the sky dream? What are the potential pitfalls to this other than the obvious such as, I buy a lemon and waste a ton of my 401k money. 

(Yes I hire a rental property CPA, no I haven't discussed my delusions of grandeur with him yet) 

[Brian Eastman]

@Anthony R.

There is also a math/tax problem with this logic that most people overlook when they look at the 401k participant loan as cheap and easy money.

You put the money into the plan on a tax-deferred basis.

You borrow the money from the plan and pay the plan interest in the range of 4-5%.

So far, so good.

Your payments to the plan are made with after-tax dollars, thus eliminating the initial deferral benefit.  Ouch!

In your case, you would be better off just using money in your pocket today to invest.  There is no point putting it into the plan in the first place if your only intention is to pull it back out immediately in a loan.

For someone who has had a 401k for some time and contributed over many years, this "hidden cost" of losing the deferral basis of the 401k funds is acceptable if the use of the borrowed funds will be of real benefit such as getting them started in real estate investing.  Hard money is actually cheaper.