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Are you about to lose all your RE tax deductions?

Diane Kennedy

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Aug 31, 2007
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Just when you think you’ve got the tax loopholes figured out…here comes another tax wrinkle. It’s called Alternative Minimum Tax (AMT for short) and it’s estimated that 10 million more Americans will fall prey to it this year.

AMT is the single biggest issue facing American taxpayer this year. It’s especially a problem if you’re a real estate investor, selling an asset and hoping for capital gains tax rate, make more than $75,000 per year or have a lot of itemized deductions.

AMT is basically an alternative form of calculating tax. You end up paying tax based on whichever is more: regular income tax or AMT.

The same tax formula you’ve always used applies:

Income
(Deduction)
= Taxable Income
* Tax Rate
= Tax

The difference is that the definitions are different for each step.

For example:

AMT Income = Income reported for regular income tax
+ Incentive Stock Options
+ Gain from sale of Qualified Small Stock
+ Private Activity Bond Interest

Note: Passive activity losses can not be used against other income. Losses are added back in for AMT Income calculation.

AMT Deductions = Deductions for regular income tax
Except for: Accelerated Depreciation
Long Term Contract calculation
Circulation, Research, Exploration Credits
Mining Exploration & Development
Pollution Control
Some Charitable Contributions
Percent. Depl.
Intangible Drilling Costs
Misc. Itemized Deductions
Some Medical Expenses
Some Mortgage Interest
Fuel Credit

AMT Rate = 26%/28%

So, how does this apply to you? AMT means that you might suddenly get hit with 28% federal tax rate on your long-term capital gains. It means that you may not get the depreciation deduction you thought you were going to. It also means that you can not take your real estate losses against your other income, with no exceptions. (In other words, the real estate professional loophole isn’t going to help you for AMT.)

Think it won’t happen to you? Think again. There are 10 million more American taxpayers that are going to be hit with this tax this year.

I am working on a new series of AMT Loopholes. I should have that written by the end of September.

Meanwhile, check with your CPA to see if AMT is an issue for you. Or you can go to the IRS website and download the AMT worksheet to go through yourself (plan on setting aside a day and have a bottle of aspirin handy if you try to do-it-yourself on this one).
 

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Russ H

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Every year AMT rears its ugly head.

And every year (so far), we've been able to avoid it.

Looking forward to your AMT series, Diane. :smxA:

-Russ H.
 
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Diane Kennedy

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Aug 31, 2007
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Every year AMT rears its ugly head.

And every year (so far), we've been able to avoid it.
Russ, just because I know a little bit about your tax situation, I also think I know the reason you've been able to duck it.

You actually are doing a brilliant job with an AMT loophole strategy!

Here's the secret not many people are aware of: If you're a real estate investor, you lose a lot of the loopholes under AMT (depreciation, passive loss against other income, capital gains treatment). BUT, if you're a business owner - you do not! That's one big reason why I'm not nearly as active on the real estate section of this forum like I used to be in the ol' RD days. I've moved my focus to businesses - both start-up and fix & flips! That's where the loopholes are these days.

The thing that is especially working in your favor is that you are doing fix and flip on your real estate. That means you are a real estate dealer. Used to be, that was a curse because it meant you lost real estate loopholes. NOW it's a blessing. That's because the real estate loopholes are lost if AMT kicks in. BUT if you're a real estate dealer, you have a BUSINESS - and so you get to take the loopholes (including business loss) without exception against your other income.

Next step will probably be a C corporation - because Congress has basically repealed AMT for corporations.

Funny isn't it? Business owners always make out. It's the guys who follow the crowd that get led to slaughter.
 

andviv

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I'm not that savvy about this topic, but if I am understanding this correctly, Mr. Andviv filing on his own will get hit, but Andviv Inc will just report a K-1 number back to Mr. Andviv, after using the deduction/loses in its favor?

I've always heard that being classified as a Real Estate Dealer was the worst thing that could happen to you. Now, based on this, what should be the strategy for buy-and-hold investors? Buy under a corporation (LLC?) and pass the losses through that organization back to the investor?

Diane, thanks a lot for that info. Seems like it is time to go back to review the strategy for many of us. More and more 'hints' from congress... they want more business owners, not investors.
 
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Diane Kennedy

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Aug 31, 2007
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I'm not that savvy about this topic, but if I am understanding this correctly, Mr. Andviv filing on his own will get hit, but Andviv Inc will just report a K-1 number back to Mr. Andviv, after using the deduction/loses in its favor?

I've always heard that being classified as a Real Estate Dealer was the worst thing that could happen to you. Now, based on this, what should be the strategy for buy-and-hold investors? Buy under a corporation (LLC?) and pass the losses through that organization back to the investor?
Andviv Inc, if it's an S Corp, won't really help in this regard. That's because all the tax info flows through to you personally. If it's a buy and hold for a passive loss, you don't get the deduction against other income.

I'm not against real estate investing - my husband and I still have some, but not nearly as many as we did 3 years ago.

On the Real Estate Dealer: You are absolutely right. If you'd asked me three years ago, my whole strategy would have been to try to get you out of that. Now, if you'r subject to AMT, I'm trying to figure out how to get you in!

I'm not sure I really understand what Congress is thinking with this. To be honest, I knew this was coming for the past 5 years but I was sure they'd fix it before we hit this point. I think it's complicated, taxpayers aren't complaining and there are way bigger issues in the country today. So, no one is giving it any attention.
 

andviv

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So now how do we get into being classified as Dealers? What should I ask my tax adviser so she can guide me in the right direction?

I found this definition, but for sure there is more involved.

Q. What is the Difference Between a Real Estate Investor and a Real Estate Dealer?

A.

Real estate investors purchase real estate with the intention of holding their properties and gaining a financial return.

Real estate dealers buy and sell real estate as part of their everyday business. Real estate professionals who are involved in “flipping” (i.e. buying real estate with the intention of selling it for a profit in a short time frame) are usually considered dealers. Also, builders and contractors who build houses and sell the finished houses to customers are also considered dealers.
 

sulli

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Jul 26, 2007
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Diane,

Please let us know when your book will be available! I'm very interested. :smx9:

Thanks,
Ryan
 
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Diane Kennedy

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Aug 31, 2007
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Andviv:

That was a good definition that you found.

A real estate dealer is involved in buying and selling inventory. It's just like buying and selling anything - it's a business. A real estate investor is buying to hold.

Here's where it gets grey: It's possible that a real estate investor might buy a property with the intent of holding it to rent and then changes her mind when she realizes that the market doesn't support it as a rental or the property isn't a good rent prospect or any of a hundred other reasons. She might immediately sell it. Does that make her a dealer? Not necessarily, the IRS says, if the intent was to hold the property and the investor just changed her mind.

That's usually the argument we make to try to get out of the real estate dealer status. Now, it's almost like we have to take the opposite side if we're subject to AMT. "Wait, I'm still a dealer! It just happened to be that I couldn't sell it for the price I wanted and am now having to rent it for awhile."

First step, though, has to be to find out if AMT is an issue for you this year...or is likely to be for next year.

AMT planning is often backwards from reg income tax planning, so you don't want to "think" it'll be one thing and then find out it will be the other.
 
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Diane Kennedy

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Sulli:

I have 6 books with a major publisher out right now, and a couple of self-published ones are still floating around that are over ::shudder:: 13 years old. My next book is scheduled out the beginning of next month "The Maui Millionaires for Business" (book 2 in a series)

Diane
 

Russ H

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Diane's books are great reads. :)

And they more than pay for themselves! :thankyousign:

-Russ H.
 

Bilgefisher

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Diane, are there any of your books you would recommend for someone new to investing? Or just dive in?

I will be investing in real estate. I already have "Loopholes of the Rich"
Other possibilities I noticed were "Insider's guide to making money in Real Estate" or "Real Estate Loopholes, Secrets of Successful Real Estate Investing"

Btw, I want to thank you for your contributions to this board. I am simply blown away by the number of successful people willing to help others on this forum.
 

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Diane Kennedy

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Aug 31, 2007
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My books are more related to tax issues. The two of mine that I'd recommend: "The Insider's Guide to Real Estate investing Loopholes" (a good foundational tax book for real estate investors) and "The Insider's Guide to Tax-Free Investing" (my personal favorite, it's more sophisticated, but it's the best book I've done on how to get around BOTH income tax and AMT)

For learning about real estate - personally, I like David Finkel's books a lot. They are pretty detailed, even to the point of giving you scripts on how to talk to sellers and buyers. If you're serious about getting out and "do-ing" (ie, not just theorizing, like some people like to do as a way to avoid jumping) then they are fantastic. Dolf deRoos's books are great for the "why" and David Finkel's books are great for the "how." There was a great review on this forum on Gary Keller's book. You can't argue with success. He really does know what he is doing - both in building a business (Keller-Williams; BTW my husband is a partner in a K-W office) and in building wealth with real estate.
 

Bilgefisher

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Aug 29, 2007
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My books are more related to tax issues. The two of mine that I'd recommend: "The Insider's Guide to Real Estate investing Loopholes" (a good foundational tax book for real estate investors) and "The Insider's Guide to Tax-Free Investing" (my personal favorite, it's more sophisticated, but it's the best book I've done on how to get around BOTH income tax and AMT)
I'm sorry, my question was poorly worded. Your tax books for Real estate. You answered my question though. Thank you.
 

Cat Man Du

Contributor
Jul 30, 2007
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Diane,

If you are considered a " dealer " don't you have to pay social security on gains as well as the income tax?? If so, would this not bring you up to the same percentage combined as the Alternative tax 28% ? Thanks for you posts - You really are a credit to this forum.
 
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Diane Kennedy

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Aug 31, 2007
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Cat Man Du:

Let me run through a couple of scenarios:

Let's say you have taxable income of $150,000 (after your itemized deductions, exemptions, etc), but you know you have $50,000 of real estate passive losses. And because you know all about Real Estate Professional status and that if you qualify (and you made sure either you or your spouse qualified) that you can take the full $50,000 of loss against the income. So, you only have to pay tax on $100,000. I'm going to guess (without looking at the table) that you'll pay about $20,000 in federal tax on that.

But you discover you're subject to AMT! That means you can NOT take the loss against your other income, so you now have $150,000 that is taxable!

And worse yet, it's subject to the flat rate of 28%! So you'll now how to pay $42,000! in taxes.

Reg income tax: $20,000 AMT: $42,000

But, if we can prove that the real estate loss came because you were a real estate dealer, then it's a business. Because it's a loss there is no self-employment tax, and you're back paying tax only on $100,000.

****

Scenario #2

Real life example:

A guy hit it big on a property sale, quit his job, made sure he had no other income so he could only pay the long-term capital gains rate of 15% on his $1,000,000 gain on the property.

He set aside $150,000, invested the rest of it - $850,000 - in the next deal and was doing the happy dance!

That is until he discovered that he couldnt' take capital gains tax rate because he was subject to AMT. That meant he owed 28% of $1,000,000 or $280,000.

Reg Inc Tax: $150,000 AMT: $280,000

******

If you're making taxable income from your real estate holds, Cat Man Du, you are absolutely right. Doesn't matter because it's all income anyway. it's when you get the tax breaks that you have to be careful with AMT - losses don't go against gains like you think they would and you lose deductions.
 
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sulli

New Contributor
Jul 26, 2007
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"The Insider's Guide to Tax-Free Investing" (my personal favorite, it's more sophisticated, but it's the best book I've done on how to get around BOTH income tax and AMT)
Diane,

Where can I find this book? I did not see it on Amazon? I found "The Insider's Guide to Tax-Free Real Estate Investing". Is that what you meant?

Thanks,
Ryan
 

china

New Contributor
Sep 27, 2007
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Los Angeles, CA
But, if we can prove that the real estate loss came because you were a real estate dealer, then it's a business. Because it's a loss there is no self-employment tax, and you're back paying tax only on $100,000.
But can the IRS declare this hobby income if you keep claiming losses?
 
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Diane Kennedy

Bronze Contributor
Aug 31, 2007
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Diane,

Where can I find this book? I did not see it on Amazon? I found "The Insider's Guide to Tax-Free Real Estate Investing". Is that what you meant?

Thanks,
Ryan
Yep Ryan, that's the one.

It's pretty sad that I don't know the title to my own book....

:smx4:
 
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Diane Kennedy

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Aug 31, 2007
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But can the IRS declare this hobby income if you keep claiming losses?
China, I'm so glad you asked that question! I get to clear up a Tax Myth.

I hear people say, again and again, that you have to have income x years out of y years in order to take a business loss against other income. (Generally, it's thought you have to have income 3 out of 5 years)

This is really old information and was based just on little piece of tax law. Since then the IRS has come up with 9 factors that they look for when deciding if it's a business...or it's a hobby. Income is one of the 9, but only one. In general, the IRS feels it more important to see that you're running your business like a business (good record-keeping), that if there is a loss you are trying to improve it (getting a mentor, hiring good advisor, getting education) or (my fave excuse for real estate based businesses) the business is based on long term appreciation, not current income.

Best example I've got in real life is Amazon. How many years was it that it ran at a loss before they finally posted income? Plus they had monumental losses - it wasn't writing off $10k or $20K. It was writing off MILLIONS of dollars. And yet we wouldn't ever consider Amazon a hobby. We just need to act like big business to get the same benefits.
 

andviv

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Diane, thanks a bunch for clarifying this tax myth. You surprise me a lot and have made me realize the tax code changes way faster than I --and most people-- recognize and/or understand. I was thinking of declaring you "Asset of the month", but I'm now concerned that maybe we will have to somehow pay taxes on that also ;)

By the way, I've been reading your blog and have found a lot of information there as well.

Thanks again, Rep++
 

kurtyordy

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Dianne,

the 75k threshhold, is this for single, married or both?
 

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