Hi, everyone. This is the How to Lower Your Tax
Bill podcast. I'm your host, Terrence Hutchins.
I'm a financial and tax advisor in the Dallas
Fort Worth area. And the goal of this podcast
is to help you listeners get educated on different
tax strategies that you can implement to improve
your tax situation immediately. Each episode,
we'll break down useful tax tips you can use
to save money, no matter what your personal or
business income situation. Because our motto
is, keep more of what you earn. So let's get
into today's episode. All right, welcome back
to another episode of how to lower your tax bill.
We have been going through a series talking about
real estate and some different strategies you
have. even as a W -12 employee to enhance your
current tax situation. So today we're going to
talk about getting suspended. Now that might
bring back some not so fond memories for some
of you, but we're not looking at this from the
angle of being in school. We are looking at it
as it relates to your real estate. So when it
comes to being suspended in real estate, we'll
kind of define what that means. We'll talk about
how do you overcome having your losses suspended
in this case? And what are some strategies you
could employ if you have suspended losses? and
how you might be able to better utilize them
to just overall enhance your financial situation.
So just to give you a little bit of background,
back in 1986, that's when the tax code introduced
these passive activities loss rules, and they
introduced the dynamic of having three different
buckets of your money. So we talked in previous
episodes about portfolio income, that's income
from stocks, bonds, dividends, interest. Then
you have active income, which is generally from
your W -2 jobs, your businesses that you're actively
involved in. And then you have your passive bucket.
So passive income is real estate defined by a
default with a few exceptions, and also things
that you don't materially participate in. Those
are considered passive activities. So if you
have a passive activity like real estate, the
IRS limits you on how you can treat the losses
you receive from your rental properties. So especially
in today's environment with, you know, I'm in
Texas, so we have a lot, we have high property
taxes and insurance rates. With those two elements
plus interest rates, it's hard for properties
to cashflow when you first buy them. So between
the depreciation expense and the taxes and interest
on the front end, you probably are seeing a negative
on your tax return. Now, if you look and thought,
hey, I bought this rental, I'm about to clean
up, but you're a high income earner. then you're
gonna notice that there's a form 8582 that shows
that that loss that you incurred is unallowed,
unless you have a few exceptions. So we've dug
into this before, but just to give you a recap
on the suspended loss. So that suspended loss
is gonna be able to be carried forward to future
years, and you can only use that loss in a few
situations. So number one, if your income is
below $150 ,000, then you can actually use the
loss and it won't be suspended, or it won't be
so much suspended. So for example, let's say
you make $100 ,000 and you have a $20 ,000 tax
loss. The IRS gives you up to a $25 ,000 that
you can deduct against your regular income. So
instead of you paying taxes on $100 ,000, you're
going to pay tax on $80 ,000 minus your standard
deduction or itemized deductions. Alternatively,
let's say your losses were $40 ,000 and you made
$100 ,000. You could only take the $25 ,000.
That's your cap. The other $15 ,000, that would
get carried forward to future years. You could
also use that suspended loss if you have positive
income. Now, before I begin to that, if you're
thinking about, if you're kind of right there
on the threshold, let's say you make 152, or
even if you're at 140 ,000 and you don't do a
401k account, if you contribute to your 401k,
you can actually get more of the loss unlocked.
So it's almost like a double deduction, because
once your income exceeds 100 ,000, you no longer
can use the full $25 ,000 deduction. once you
exceed 150 ,000, you can't use the deduction
at all. So for example, if you make 125, you
can use 12 ,500 of the $25 ,000 limit. The other
12 ,500 would be carried forward to future years.
So if you're kind of right in between 100 and
150 ,000, or you're over 150 ,000 just barely,
you could look at doing a 401k contribution or
increasing it so that you get below the threshold.
And that allows you to unlock some of the losses.
My convention is kind of like a double deduction.
You could also think about, okay, if I have some
long -term rentals, maybe I'd get a short -term
rental in here. I do a cost segregation study.
I take a big tax loss. That's going to get me
below the threshold. And so not only do I take
a loss for my short -term rental, I can take
the loss from my long -term rentals up to the
$25 ,000 cap. So that's a way to maybe enhance
your tax situation. And these are the tragedies
that you want to just look at on a year -by -year
basis. That's why it's important tax planning
doesn't start when you're about to file your
taxes. Tax planning is a proactive thing that
you could just look at your situation to assess
what options are available to you. And then based
on number one, the investment value of whatever
you're doing. Then, okay, what's the most optimized
tax situation you could be in based on the facts
of your situation. Okay, so we're talking about
suspended losses. So we talked about, hey, if
I get below the $150 ,000 threshold, I can take
up to 25 ,000 of my real estate losses in a given
year. The rest of those losses would be carried
forward. You could also either start making passive
income. So if you have a lot of real estate losses
and they're accruing every year, you could say,
hey, how about I try to raise my rents? How about
I try to make these rentals more cash flow positive?
How am I getting to midterm rentals? So, you
know, I'll make a little more cash flow. So I'm
going to be making more money. But because I
have these past losses, I'm not going to have
to pay these taxes on my income gains that I
get. You could also potentially look at a passive
activity like a real estate partnership or something
syndication. Those are things that you could
try to say, Hey, I have these losses. I could
offset it from positive passive income. So if
I invest in something passively and I make $30
,000 and I have some suspended losses of, you
know, $20 ,000, I could use that 20 ,000 offset
the 30, even if my income is above the threshold.
So the else you could do is you could basically
try to become a real estate professional. Now,
we've talked about that dynamic before, but if
you or your spouse become a real estate professional,
meaning it's your full time job, and you work
at least 750 hours in the activity, and then
you materially participate in the rentals that
you have, you can be considered a real estate
professional. If you become a real estate professional,
it will not allow you to unlock the previously
suspended losses, but it will allow you to unlock
the losses in the current year. So let's just
say, for example, you have $100 ,000 of losses
over the years, and all of a sudden, you wanna
get into real estate full time. And you have
another $10 ,000 in the current year of losses.
So now you have a total of $111 ,000. You can't
take those $100 ,000 from before, but you can
take the $10 ,000 for the current year. So if
you become a real estate professional, that will
allow you to use those losses to reduce your
overall income, let's say from being a realtor
or your W -2 income from your spouse. One other
strategy that could be viable is let's just say,
for example, you own a commercial building or
you own a residential building that could make
sense for you to actually work out of. So not
your primary house, but you have a separate building
that you have a business that you can operate
from. So let's just say you've been renting out
a commercial building and you have suspended
losses in that commercial building from years
before and your income is above the $150 ,000
threshold. You can say, hey, what if I move my
office into that building? I pay myself rent,
you know, at a fair rate, but now I can use those
prior losses to offset my business income. Okay.
And then you could even supersize this by doing
what's called a grouping election, or you would
group them together, I should say. And then you
could also supersize it by doing a cost segregation
on your commercial building to where now you
could enhance the depreciation, create an even
bigger loss. And you add that to your prior losses.
And that will allow you to deduct against your
business income. So I'm going to get into that
grouping thing in a future episode just to dive
into that more in depth. But that is a strategy
if you have suspended losses that you could use
to unlock if you operate your business out of
the building that has the suspended losses. Now,
probably the biggest opportunity that you have
is if you just sell the property. So if you have
a lot of losses tied up in a property, or let's
just say you have a group of properties that
aren't grouped together. And to clarify that,
the IRS... basically allows you to isolate your
rental properties as an individual activity,
or they will allow you to group it together as
if it's one whole activity. So if I own 10 rentals,
I can basically say, okay, how much time do I
spend in one of these rentals, and I have to
spend at least 100 hours generally in each of
them, or I can group them all together as one
activity. The benefits of grouping them is it
allows you to seem as if you materially participate
in all of them, if you materially participate
overall. So if you spend at least 500 hours overall
between you and your spouse, then the IRS will
think that you materially participate in all
10 rooms, even if you only spend a few hours
in one of them. That's the positive. The negative
is if I do have suspended losses and I group
my activity as one activity, I basically have
to sell all 10 of my activities to use a suspended
loss. So let me give you an example just so I
can provide more clarity. Let's say you do have
those 10 rental houses and collectively you have
100 ,000 of losses in them. One of them has a
$60 ,000 loss and you say, hey, I'm gonna go
ahead and sell this property. And so we're gonna
ignore depreciation for a second, but let's just
say that you get a $60 ,000 capital gain on that
property. Well, the $60 ,000 loss that you have
will completely wipe it out. Alternatively, let's
just say that you had a $25 ,000 capital gain.
and you had a $60 ,000 suspended loss carried
forward on that property. Well, now that $60
,000 loss can become completely deductible. So
not only do you get rid of your $25 ,000 gain,
you also have a $35 ,000 loss. That loss can
then unlock to potentially, let's say you, that
$35 ,000 also got you below $100 ,000 of income
at the same time. Now you can deduct the other
$25 ,000 of losses up to the previous limit we
talked about if your income was $100 ,000 or
less. and you have suspended losses. So these
are all things that, one, probably you work with
a professional just so you can map it out properly.
But two, it does give you a lot of flexibility
when you do have these losses on how you decide
to use them. Whether that's, hey, I can expand
my portfolio and actually start cash flowing
more. Now I have some income to offset it. So
I can make, you know, five, six figures of income
and potentially offset it with the prior losses
I have. I could decide to sell one of the properties
that has the suspended losses. depending on my
income amount, I might be able to not only deduct
the losses from that property, but also bring
into play some of the other losses I have to
reduce my other income. You can also think about
if I did get rid of a property and then it had
a loss and let's say there was a small gain attached
to it, I can look at that same year to also potentially
sell some of my stock that I set in gain and
be able to offset the capital gain on that. I
could look at maybe doing Roth conversions in
those years so that if I convert to a Roth, I
now have tax -free income that's growing. So
you wanna take advantage of the losses when you
have them. So you get a low tax year, you wanna
look at many strategies as possible to make sure
that you are fully taking advantage of that time
because it may not come back around in the future.
So once again, if you have any questions about
this topic or others, you can email us at questions
at logosfg .com and we will address your question
on a future episode. But for this week's court
case, we're gonna talk about something that happened
in 2005. This is May versus commissioner. And
this guy, Richard May, managed multiple rental
properties. And according to court filings, he
spent roughly 40 hours a week managing all the
activities that he had, but he did not make this
grouping election on his tax return. So I talked
about before, if you, let's say you only spent
a few hours on one rental and you have, and you're
considered a real estate professional. but you
don't group your rent off together, that rental
that has losses that you didn't group, you actually
can't use those losses because you haven't materially
participated in that property. So if you don't
spend 100 hours in every property, then the losses
you have for those properties, you can't use
unless you make this grouping election as a real
estate professional. Mr. May did not do this.
So even though he was a real estate professional,
he had real estate losses. The IRS still said
that he was subject to the $25 ,000 limit for
his losses because he didn't actually put this
election. So the IRS can be unforgiving if you
don't follow the procedures because in this case,
he probably had a lot of real estate losses and
that would have reduced his income in total versus
him only having to take $25 ,000. So if it came
down to, hey, are you gonna have to pay tax because
you didn't follow the procedures to the letter
of the law, then they're gonna hold you to that
standard. So it's important to be very thorough.
to make sure you review your tax return with
your tax professional, to make sure you make
all your proper elections so that you're not
in the boat Mr. May was where he actually missed
out on elections just because he didn't add a
simple statement to his tax return. So a good
lesson to be thorough, have a tax plan on a year
by year basis, do your due diligence and to keep
more of what you earn. I'll talk to you guys
next week.