Discover the benefits of achieving “Real Estate Professional” status per the IRS. This is how many billionaires pay so little in income taxes, legally!
The 3 Taxpayer Categories
US taxpayers can be organized into 3 categories as it pertains to real estate:
- Full Time Job No Real Estate: This includes the majority of income earners in America. They are working a full time jobs and own no real estate. This person has the standard write-offs that the average American worker gets and that’s it. These people pay the highest tax rates relative to their income and get no tax loopholes.
- Full Time Job Part Time Real Estate: A person who has a full time job and owns some real estate on the side has some tax advantages. If the income is $100,000 or less per year, you can take a real estate loss like a paper loss of $25,000 per year against other income. This is an incredible thing, which basically allows you to wipe away $25,000 in income so you end up paying less in taxes. If you make between $100,000 and $150,000 you can take some loss, but as you approach the $150,000 mark that loss phases out. However, if you make over $150,000, you can’t take any real estate losses.
- Full Time Real Estate: This person works 750 hours per year in real estate and is designated as a “Real Estate Professional,” by the IRS. You do not have to be a licensed real estate agent nor do you have to go to school to achieve this designation but you do have to be full time in real estate. You can either be a full-time investor, a real estate agent, property manager, or other real estate job. As a designated real estate professional, you can take unlimited amount of real estate paper loss against your income no matter how much you make or how much your real estate loss is. Remember, you don’t have to be a millionaire or billionaire for this to work for you.
If you are currently a member of Category 1, working full time with no real estate ownership, your goal is to get to Category 2. If you are at Category 2, working a full time job and doing some real estate on the side, your goal is to get to Category 3, which is full time real estate investing, because this is the category where you get the most tax benefits and achieve financial freedom. And if you are already in Category 3, welcome to the Club!
Tax Benefits of Real Estate Professionals
As a real estate professional you can write off all of the following against your other income.
- Mortgage Interest
- Depreciation
- Repairs & Maintenance
- Trips/Travel to the Property
- Educational & Mentorship Costs
- Home Office, Car, etc, etc, etc
$17.1 Trillion in Tax Savings to Real Estate Investors
Our federal tax system collects $2.1 trillion every year from taxpayers. Basically the government takes in $2.1 trillion, but it gives out $17.1 trillion in tax savings to real estate investors and other business people.
Why is there such a huge difference between the two and what they’re taking in and giving out? It’s because there is a huge lack of education of our tax system of how real estate professionals work. Real estate investors, including commercial real estate investors and even some tax accountants don’t take full advantage of that designation. They prepare these tax returns for their clients but they’re not getting all of the deductions and tax benefits that they deserve.
If you are a real estate investor, are you claiming all of the benefits that you have rights to? Do you have the right CPA working for you, where you’re not just a number, and you’re not just receiving the basic benefits. You must be the type of person that is going to look at your file, your goals, and everything you are doing, and maximize your benefits.
Definition of a Real Estate Professional
To be a real estate professional, a taxpayer must provide more than one-half of his or her personal services in real estate in which he or she materially participates in and performs more than 750 hours of services during that tax year. That’s the best definition I can find.
Example
I want to give you a practical example by sharing a real life person example and their tax situation and what they did to maximize their tax savings.
Dr. Rob is an engineering manager for a local tech firm here in the Bay area. He’s single and earns about $250,000 per year including his bonuses. He has a pretty good job and he has a PhD from Stanford, so he is also a pretty intelligent person. Over the years, Dr. Rob has also purchased a 12-unit apartment building near Silicon Valley in Santa Clara and a downtown strip center in Santa Clara. He owns those two properties and they cash flow about $82,000 per year.
When he does his tax returns, Dr.Rob’s returns show a paper loss of $90,000. He cash flows about $82,000 a year but he has paper losses on his tax returns of $90,000 a year but guess what, he can’t use those losses against his cash flow because he earns too much. If you recall, if you make over $150,000 and the job is not real estate related, you cannot deduct those pass up losses. What could Dr. Rob do to increase his tax benefits?
Here’s what he did. He got married. The good doctor marries Joan who ends up managing the apartments and strip mall full time while being a housewife. In fact, the housewife is probably a harder job knowing Dr. Rob. Anyway, she qualifies as a real estate professional and because she qualifies as a real estate professional and they’re filing a joint tax return, they both get to take advantage of her being a real estate professional.
Now they get to deduct that $90,000 loss on Dr. Rob’s properties, which are now their properties. They end up saving tens of thousands of dollars in income tax. To me what a great basis for a successful marriage.
What advice would you give this couple, Dr. Rob and Joan?
My advice would be to buy more cash-flowing commercial real estate. Enough so that they end up paying no taxes on their properties or on his income. Buy enough income-producing properties to accomplish earning as many tax benefits as possible.
Again, if Dr. Rob did not get married and he continued to be an engineering manager, he would pay taxes through the roof. But because he got married and his wife’s job is now a real estate professional, they qualify jointly as a real estate professional.
Today’s Three Takeaways
1. Learn Commercial Real Estate
I want you to learn how to invest in commercial real estate. After you learn, get help doing it. Do not try to do it by yourself, it’s putting too much at risk. For most people, investing in commercial real estate will be the biggest investment you will ever make in your life. Next, I want you to become a real estate professional period. Learn about commercial real estate, get help doing it, and become a real estate professional.
2. Hire a CPA/tax planner who specializes in tax planning for real estate investors.
All CPAs are not created equal. You will want to find someone that is creative and will explore different ways to maximize all of the benefits and rights you have as a real estate investor. You want a CPA that wants to help you become a real estate professional.
3. “The greatest investment on earth is earth.”
There’s nothing like having tangible assets like a piece of commercial real estate I can touch and feel and look at and go, “Wow, that’s mine.” You have that so you can maximize your cash flow and your tax savings. There’s no other investment like it.
Hi Peter, You provided very good information. I want to learn how to become a real estate investor.
Another reason to invest in commercial property is high yields; as commercial tenants often take on many of the costs that landlords would be traditionally expected to cover in the residential market.
Peter, is it important to obtain an LLC taxed as an S-Corp when starting out wholesaling commercial real estate for liability protection, credibility and tax advantage strategies?
The LLC part is important for liability protection purposes. But the choice of whether to tax the LLC as an S-Corp or as a Sole Proprietorship is a good question for your CPA.
A major reason due to which you must invest in commercial property is triple net leases. Therefore, as the owner of the property you will not be required to pay the expenses over the property, the lessee will be the one responsible for handling all the expenses directly including the real estate taxes as well.
Peter,
How would Dr. Rob’s wife determine the number or hours worked per year, considering the fact that she works in a family owned business.
Peter, interesting article and I understand the concept of negative cash flow of owning property mainly due to depreciation which can be counted as expense, but I will check with a CPA to confirm if the loss of the $90k can be deducted from what, from his $250k salary? Passive vs active income.
I want to learn how to invest in commercial real-estate now.
You can start by enrolling in my free course: Commercial Real Estate Investing for Beginners
Thanks Peter Harris. How do I become your student as am about to step out investing on my first commercial property?
That’s great! You can click this link and begin the application process: Protege Program.
After owning 4 houses in the last 8 years im ooking to get start in commercial Real estate are there any mentors in the tampa area tp work with to help me get start on the next level. Thx
Great information Peter. Thank you
In terms of finding specific Commercial Properties that are cash flow positive with secure leases.
Do these properties still exist in today’s market. If so what region do you focus on?
I am interested in a region that is likely to grow in population over time. Should I wait until we have a market correction or can you think of specific opportunities available right now?
I reside in Australia but will consider overseas for the right investment.
There are always opportunities; including right now, but you really have to be well versed in finding the best off-market deals before anyone else.
So clear, so informative, so easily digestible. Simply put, I am now motivated to follow my Vision. So well done. Thank you Peter.
Hi Mr. Harris:
If my wife stops working and collects her pension can she become the real estate professional and benefit from the loopholes you mentioned in the above video.
We are in the second category.
Thanks, John
Great stuff.Peter could you kindly make a video on the pros and cons of investing in student hostels since it is also commercial?
Great article.
In the example you gave, the properties are cash flowing $82,000 so how would the have a $90,000 paper loss?
Hello Mr. Harris, Thank You for the awesome advise and informations. I enjoy reading everything you write about. You make it easy to understand and most of all, You’re not like others always trying to sell something at the end of every subjects. Thankyou again for sharing your knowledge. Godbless. T.M.
Question. What does paper loss on tax return mean? And what does it mean to use the losses against your cash flow?
Good video, when will the next session be on commercial property.
Peter, as always, very insightful. Thank you for all you do!
do these tax benefits also apply to owning/investing in residential (<5 unit) properties? or is this specifically for commercial?
Applies to residential investment real estate as well
Thank you for the great advice.
Great information.
Thanks for always posting quality content.
Very good information. Was just talking to friends about this same topic.
Peter,
I recently discovered you and your site. I have both of your books and starting to read them. This s some good stuff!