What are the tax benefits of commercial real estate? I recently received two very intriguing questions from my YouTube channel comments. The first question was, "Peter, how does Donald Trump and other billionaires make a billion dollars in a year and not pay income taxes? How is that possible?" The second question was, "And with Donald Trump and other billionaires, how can their tax returns show a paper loss of $975 million in one year and that be a good thing? How can that be?" Well, the short answer to both questions in both situations is "commercial real estate ownership advantages."
Commercial Real Estate Advantages
I am going to lump every US taxpayer into three categories.
- A person who has a full-time job and owns no real estate
Can you relate to this person? They are working a full-time job and own no real estate.
2. A person who has a full-time job and owns some real estate.
3. A person who works in real estate as their full-time job and owns real estate.
This person is what's known as a "Real Estate Professional." It's actually an official IRS designation. You do not have to be licensed or go to school to be a part of this category.
Which Category Do You Fit Into?
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, working a full time job and own some real estate, your goal is to get to Category 3, which is full-time real estate investing, because this is the category where true financial freedom begins.
If there is anyone out there reading this that is already at Category 3, I say, "Welcome to the Club".
I am not a CPA. I'm not a tax attorney or a tax expert. I am a commercial real estate investor and mentor. My taxes are done by professionals and their companies. My advice is to always get the advice of a tax expert when you make any types of personal financial decisions.
Finding Your Category
Next, I want to review all three persons' situations and see if you can relate to them and put yourself in their shoes. Then I will share how to get out of their shoes and into the next level.
Before I start, all three people I'm referring to have the following tax status; they are married filing jointly. It's important to make that designation of their tax status, for the purpose of these examples.
If you recall, person number one has a full-time job but they do not own any real estate. Do your best to not stay here too long if this is you. This person has the standard write-offs that the average American worker gets. That's about it. You're going to pay the most in taxes and basically get to take advantage of zero of the tax loopholes.
This person has a full-time job and owns some investment real estate. This person has some restrictions that the IRS sets forth. They are as follows: As long as your 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. However, if you make over $150,000, you can't take any real estate loss.
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, person 2 is able to take more advantages then person 1. If you make over $150,000 a year, your advantages are basically phased out. What do you do if this happens? You have a really good job, you're buying real estate, but you have losses on paper that you are unable to claim.
Your best option would be to become Person 3. Become a full-time real estate professional. You can either be a full-time investor, a real estate agent, property manager, or other real estate job. Under IRS rules, this is defined as a real estate professional. You must basically work in real estate more than any other job and you must work at least 750 hours per year in that real estate job. Got it?
Now, 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.
This is exactly what Donald Trump did to avoid paying taxes. In some cases you can carry forward losses to future years to wipe out those taxes too. This is what Donald Trump did when he reported a $975 million loss. He carried it forward to a future year, which means he paid no taxes for several years. I heard he didn't pay taxes for around 18 years because of his losses. This is completely legal and in my opinion a smart thing to do. It's all legal.
Tax Benefits and Write Offs as a Real Estate Professional
As a real estate professional you can write off all of the following.
- You can write off property mortgage interest.
- You can write off directly against the income.
- You can write off property depreciation.
- Property mortgage interest and property depreciation, those are your two biggest deductions. They can be hundreds of thousands of dollars if you have enough property.
- You can also write off property repairs, trips to the property
- Educational seminars, Mentorship costs
- Your home office, your car, and the list goes on and on and on and on.
Two Interesting Facts
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.
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.