Contributing Authors: Kenneth Hoffman and Ivy Fivey
It's not uncommon for rental real estate investors or new business owners to have losses for tax purposes. For tax planning, it's a common assumption that if you have no income, it eliminates the need for tax planning. After all, there is no tax to pay when there is no income.
This is not true. In fact, with no income, there's a high probability that tax benefits will be lost. This is why there is a need for tax planning if you have no income or if you have losses. It's a special type of tax planning - reverse tax planning.
Here's How It Can Cost You:
Our practice recently met with a couple whose business income and salary were $150,000 combined. They also had rental real estate losses of $150,000 (good use of depreciation) and they met certain rules so they could take their rental real estate losses against their other income. Their combined business and real estate income was $0 so they had no tax liability. The reason this couple came to us was to talk about their taxes for next year, not their current taxes. They knew they had $0 net income for the current
year and no tax liability. They wanted to focus on next year because they knew they would have a substantial amount of income next year.
This couple was surprised when we shared that they absolutely needed to do tax planning for this year. If they didn't do any tax planning, they would lose deductions and pay more tax next year than they were legally required to pay. This couple had itemized deductions (this includes their home mortgage interest, real estate taxes and state taxes) and personal exemptions totaling $60,000. Based on their current planning, this $60,000 would not be used because they had $0 taxable income and with these specific types of deductions, you either use them or lose them.
They had to do something different in order to not lose these deductions forever.
A Special Type of Tax Planning
Normally, tax planning focuses on maximizing deductions and reducing income. In this case, we needed to reverse that and decrease deductions to increase income. After
the reverse tax planning, the business income and rental losses netted to $60,000, which was then offset by the $60,000 of itemized deductions and personal exemptions.
The end result was they still had $0 tax liability BUT because they increased their income $60,000 this year (to offset their itemized deductions), they would report $60,000 less income next year. In their expected tax bracket for next year, that is at least a $15,000 tax savings.
Tax planning works in many ways. If your tax liability is zero, make sure it isn't costing you in lost tax deductions.