“Elections should be held on April 16th – the day after we pay our income taxes. That is one of the few things that might discourage politicians from being big spenders.” — Thomas Sowell
You’ve probably seen the headlines:
Jess Bezos, Warren Buffet, and Elon Musk pay almost no taxes.
How is that possible?
How is it legal?
And the more evocative: How dare those guys pay no taxes?
What if I told you that there’s a way you can potentially reduce your tax bill to zero?
I’ve done it!
I’ve got down to around a little below 1% total income tax rate.
The last four years, I’ve saved over $170,000 in taxes.
Some people call them loopholes.
I call them government incentives.
The government will incentivize certain things in the tax code, such as housing and energy, to reduce your tax bill.
Let’s jump into it!
1. Several Paths to Reduce Taxes
There are several paths you can take to reduce your tax bill.
One is that you can pay high taxes.
Many people say there’s two things in life that are unavoidable:
One is death, and the other is taxes.
Is that really true?
I would say the second part is optional.
But there are still people who will pay the high tax.
In California we have a great thing called state income tax.
The highest rate is 12.3%.
(That’s for annual income above $625,000.)
This is in addition to the top federal tax rate of 37%.
If you combine those two rates, that’s a whopping 49.3% tax!
If you don’t have state income tax your rate could be 37%, and if you have state income tax it could be as much as 50%.
There are also additional fees if you are self-employed.
If you’re self-employed, you’ll have to pay taxes on top of all that, which could bring your tax rate as high as 60%.
Some people choose to pay these rates.
They treat the government as a partner and split their income 50-50 with them.
The second way to reduce your taxes is using real estate to lower your investment income on paper.
In order to imagine this, let’s picture two buckets.
One bucket is your regular income from your job or business.
The second bucket is your investment income.
In the investment income bucket, you can use depreciation to reduce your income.
The third way is to take advantage of the real estate professional designation, which is an IRS designation.
You can use the designation to pay almost zero tax.
I’ve used this strategy for the last four years to get a 1% tax rate.
Let’s dive into each of these options.
2. Pay High Taxes
You probably don’t want to pay high taxes.
Unfortunately, a lot of highly-paid professionals just see no way out.
Robert Kiyosaki talks about this in his book, Cash Flow Quadrant.
If you haven’t read this book, it’s from the author of Rich Dad, Poor Dad.
Tom Wheelwright is a CPA who has worked with Robert.
He came up with the taxes for different quadrants.
You’ve got the employees on the upper-left and business owners on the upper-right.
Below that are the self-employed on the bottom-left and investors on the bottom-right.
There are numbers beside each section.
The employee has 40, which means that 40% of their income will go to taxes.
For self-employed, it’s 60%
20% for a business owner.
And finally, 0% for an investor.
If you’re on the left side of this quadrant, you wanna get to the right side.
Tom has this saying: “If you want to change your tax, you have to change your facts.”
That basically means if you’re working as an employee, you’ll never be taxed like a business.
If you’re working as a self-employed person, you’ll never be taxed like an investor.
You need to fight it!
Find out how to get that into business expenses.
Get into passive investments.
At the end of the day, it’s about learning where you’re at and what is possible.
A lot of people in the left quadrant just take it.
They think they have to pay 40% to 60% taxes for the rest of their life and there’s no way around it.
But there is!
And we’re going to talk about it:
3. Use Real Estate
Another way that people reduce their taxes is through real estate.
Let’s go back to the two buckets: one for job or business income and the other for investment income.
There are things you can try to get income out of the job or business bucket and put it into the investment bucket.
One way is using retirement accounts.
That would get money out of your income and defer it to a later point.
You can also do expense deductions.
For an EQRP, which is a type of investment account, you can put in up to $61,000 or $67,000 per year.
The account also defers taxes for a number of years.
If you focus on the investment bucket, it allows you to take advantage of depreciation.
If you invest $100,000 into a multifamily deal, that could produce around $90,000 of passive losses in year one.
As you get income from that property, you may be able to take some of that as a deduction based on all the depreciation you got in year one.
It allows you to defer those taxes and potentially write some of them off.
You could even move that cash into future deals!
That’s a huge benefit.
If you can defer taxes, you can continue to invest whether it’s through retirement or using depreciation through real estate.
4. IRS Real Estate Professional Designation
Let’s talk about the real estate professional designation.
In California, I know two guys who are medical professionals.
They sold their practice for $5 million this year and had a lot of gains from that.
In California, the tax rate they’ll be paying is around 40% to 49.3%.
That means they’ll be paying between $2 million to $2.5 million in taxes.
That’s almost half of what they made.
The guys I know are very smart.
Their wives acquired the real estate professional designation.
In order to earn this designation, you have to do 751 hours a year.
Real estate has to take up 51% of your working time.
The designation allows you to take depreciation from your investments and apply them to ordinary income.
Normally everything stays in your investment bucket.
As a real estate professional, you can take all the depreciation from the investment bucket and put it in your job or business bucket.
If I can invest $100,000 in a deal like that, I can get usually $80,000 or $90,000 in passive losses that work against my income on the property.
Isn’t that magical?
Either you or your spouse can have the designation.
There are two ways to do this.
One is if you’re a business owner.
You could you scale your work down to where you only work half of the time
That would allow you to put 51% of your time in real estate and receive the designation.
The second way is if you’re somebody who’s in the E-quadrant and you work a lot.
You could convince your spouse to dedicate 15 hours a week to real estate and they could qualify as a real estate professional.
The two medical professionals did this.
They sold their business and reduced $2 to $2.5 million in federal taxes to $0.
California has a state income tax, so they would have still had to pay around $450,000 in state income tax rates.
Because depreciation doesn’t apply in California, they asked “How do we get rid of this?”
They ended up finding a way through something called a conservation easement.
It’s a trust that acts like a syndication
Every $1 you put into the conservation easement becomes $4.50 of actual tax reduction.
If the medical professionals put around $100,000 into the trust, it acts like a donation.
That donation will reduce their taxes by $450,000.
They were able to pay $100,000 in this type of grant to lower their millions of dollars in taxes.
If you look for them, there are very creative ways to reduce your taxes.
I have one last example about a guy working in the medical field and his wife is a CEO of a major company.
They went to a tax consultant because they had all of this depreciation they couldn’t use because neither was a real estate professional.
The tax consultant said this couple would keep more money and pay less taxes if he left his job.
They could use the depreciation against his wife’s high income.
That was a real eye opener! Paid more to NOT work his corporate job and focus on their real estate portfolio.
The government writes tax laws this way because they’re trying to incentivize things like housing.
There’s also stuff in the energy space that will allow you to reduce taxes, even some as ordinary income.
If you are interested in learning more, reach out!
Also, let us know:
How are you going to reduce your taxes?
Leave a comment below and start a conversation!
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Disclaimer: I am not your investment advisor. This is for educational purposes only. I am not giving specific advice on what you can do. I am simply giving my opinions.