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  • Federal, State, and Virginia Beach Taxes
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If you have a question or comment, please drop me a line. Paul @ PIM Tax.

08 October 2017

real estate investing tax strategy virginia beachThere are several significant differences between investing in real estate and investing in stocks, bonds, or mutual funds. One of those differences is the amount of hands-on, direct involvement real estate investing requires. While I advocate passive investing in traditional securities (i.e. stocks, bonds, mutual funds, and etfs), it would be quite costly to be passive about your real estate portfolio; possibly even disastrous. Fortunately, this is not a problem for most of the real estate investors I meet. They seem to like the direct involvement in their real estate investments. I suspect having the ability to exert a high level of control over their portfolios is what drew them into real estate investing in the first place.

Taxes and the Real Estate Investor

Taxes is another area that differentiates real estate investing from securities investing. There are numerous ways in which the tax code gives preferential treatment to income from real estate over income from other sources. I'm not going to try to describe all those ways to you, but let me give you one example.

Dave is single and has a home business building furniture. After taking all his expenses and exemptions into consideration, Dave has $50,000 of taxable income. Using 2016 rates, Dave will owe the IRS $15,731 in taxes for that $50,000 of taxable income.

Debbie is single and owns residential rental properties. After taking all her expenses and exemptions into consideration, Debbie also has $50,000 of taxable income. Using 2016 rates, Debbie will owe the IRS $8,271 in taxes for her $50,000 of taxable income.

Same amount of taxable income, HUGE difference in the total tax bill. The reason for the big difference here is that Dave’s income is subject to self-employment taxes (Social Security and Medicare), but Debbie’s rental income is not. For that reason alone Debbie has $7,460 more dollars to save, invest, travel, whatever. It's hers to do with as she pleases.

The point of this article is not to illustrate all the tax advantages of real estate investing.There are entire books written on that topic.  The point I am hoping to make is there are many ways in which the tax code provides for preferential treatment of real estate investing, and taking full advantage of that preferential treatment can make a significant impact on your bottom line as a real estate investor.

Professional Tax Help is an Investment, Not an Expense.

I would also like to impress upon real estate investors the cost-effectiveness of having a professional help you with your taxes. I find it difficult to convince many real estate investors they can save money by spending money. They tend to be rugged individualists and hardcore do-it-yourselfers. One of the things they seem to like about real estate investing is their ability to control costs. They see paying a tax professional as a cost. They don’t see it as an investment – but it is.

I offer free reviews of prior year tax returns. Every year I have landlords bring me the tax returns they personally prepared for their own real estate investments. As of this writing I have found errors on 100% of those returns I have reviewed. All of them. Every single one. In all but one case I recommended filing an amended return that resulted in money being refunded to the taxpayer. We amended 3 years of returns for one landlord who received just under $10,000 back from the IRS. He was not unhappy to pay my fee, and did not see it as a burdensome expense.

Sadly, many professional tax preparers also make errors in the tax returns of real estate investors. I had a new client this year who recently moved to Virginia Beach from Florida. He had a CPA firm preparing his returns in past years, but he likes to sit across the table from his tax preparer, so he brought his 2016 return to me. He also brought me his 2015 return, and while reviewing it I noticed the previous preparer had not taken several large and legitimate expenses for his rental property in 2015. When I asked the taxpayer about it he said the CPA firm had told him not to worry about it because he made too much money from his day job to claim the losses anyway. Without going into the details of suspended losses for passive activities rules, this thinking by his former preparer is very wrong. This gross misunderstanding was going to cost this taxpayer north of $7,000 at some point in the future, so we amended his prior year return to make sure all his suspended losses were captured for future use.

Real estate investing is somewhat of a niche specialty within the tax preparation business. The rules for real estate don’t always fit the standard rules. As a result, many tax professionals are not familiar with them. This can lead to costly mistakes for the taxpayer who is a real estate investor.

Develop a Tax Strategy for Your Real Estate Investing

One last point to make about real estate investing and taxes - plan ahead. Once you’ve taken an action with an investment property – bought, sold, repaired, placed in service, flipped, refinanced, etc. – the tax consequences of that action are pretty much fixed. You can’t sell a property, find out what the tax consequences of the sale are, and then undo them because you don’t like them. It does not work that way. You need to plan. You need to have a tax strategy in place before you take action.

The easiest way to put a tax strategy in place is to work with a tax strategist. Someone who can help you integrate taxes into your overall investment strategy. Be particular about the tax professional you choose. Your tax strategist should have two primary qualities. 1) You want someone who is knowledgeable about the nuances of the tax code with respect to real estate investing. 2) You want someone who will sit down with you and discuss your investing goals. The more familiar someone is with you and your investment strategy, the better able they will be to help you create a tax strategy that leads to the fulfillment of your investing objectives.

A significant portion of the money to be made in real estate investing comes from the tax advantages built into the Internal Revenue Code. If you are a real estate investor, or thinking of becoming one, make sure you are taking full advantage of tax breaks available to you. If you would like to further discuss your real estate investments, schedule a free consultation.

 

 

Disclaimer

Information in the Tax Blog is current as of the day it was posted. Tax laws change frequently, and it is likely that as time passes acts of Government will make some of the older blog content out of date.

The information provided is for education purposes only. It is general in nature and may not pertain to the Reader's situation. Every taxpayer's circumstances are unique. Reader's are urged to do some research or talk to a tax professional before acting on any of the information posted in this blog.

Paul D. Allen is a proud member of the National Association of Enrolled Agents, the National Association of Tax Professionals the Financial Planning Association of Hampton Roads, the National Association of Personal Financial Advisors (NAPFA), and The Tidewater Real Estate Investors Group. You can read more about Paul's background here.

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Common Acronyms

ACTC - Additional Child Tax Credit

AGI - Adjusted Gross Income

AMT - Alternative Minimum Tax

APTC - Advanced Premium Tax Credit

AOC - American Opportunity Credit

CTC- Child Tax Credit

EIC - Earned Income Credit

HoH - Head of Household

LLC - Lifetime Learning Credit

MFJ - Married Filing Jointly

MFS - Married Filing Separately

MAGI - Modified Adjusted Gross Income

PIM - Plan of Intended Movement

PTC - Premium Tax Credit

QC - Qualifying Child

QHEE - Qualifying Higher Education Expenses

QR - Qualifying Relative

QW - Qualifying Widow(er)

 

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