Ideas to reduce taxes when income is excessive?

[calmloki]

Looking for ideas; It is really evident that wife and I didn't follow the normal path. We had very little remuneration from working for others. With no kids we focused on property, buying sad little unfinanceable places mostly on owner carrry contracts and mostly during times when real estate values were in the toilet. We then made those sad places what we saw in our mind's eye, primarily with our own labor. Betwixt the two of us we had a pretty good blending of economy and design, conscious of window view sightlines, traffic flow, storage, room use and sound. We were young and showing off to each other, and the gal's willingness to keep working on a project into the night day after week after month kinda shamed me into keeping up. Result was that as time went by that focus resulted in a number of rental houses and apartments. Rent came in and we kept paying everything off. Got to the age of 60 and had planned to sell everything, but oops! 2009 real estate crash so we held and just kept taking in the rents. We have been divesting the last ten years or so, carrying contracts as they are a well secured fixed income sort of investment. Rents keep going up though, and our last 19 apartment units bring in about 130 in taxable income, well over twice our annual spend as homes and cars are paid off. Add about 250 from T-bills, interest from land sale contracts, property loans, CDs & savings in 2024. Dividends contributed about 50, capital gains 20, IRA and social security 30. Line 11 AGI is 499.

So. We are very very fortunate, but our IRS tax of over 105 gets my attention. Moreso when California sticks it's paw out for another 25. I've read that one can take out a loan on an income property, pay the 8% interest and write it off as a business expense. Years down the road the property gets sold and the loan paid off, reducing the capital gains. Seems way too good to be true. Am I miss-stating the technique? Do we need to dump more dollars into stocks we don't sell with their relatively small dividends? Feel pretty sure there are ways to greatly reduce our taxes but I'm not savvy to them. Our long time tax person is real straight arrow, but maybe no forthcoming with tax saving ideas. What would you do in our position?

 

[Koolau]

Looking for ideas; It is really evident that wife and I didn't follow the normal path. We had very little remuneration from working for others. With no kids we focused on property, buying sad little unfinanceable places mostly on owner carrry contracts and mostly during times when real estate values were in the toilet. We then made those sad places what we saw in our mind's eye, primarily with our own labor. Betwixt the two of us we had a pretty good blending of economy and design, conscious of window view sightlines, traffic flow, storage, room use and sound. We were young and showing off to each other, and the gal's willingness to keep working on a project into the night day after week after month kinda shamed me into keeping up. Result was that as time went by that focus resulted in a number of rental houses and apartments. Rent came in and we kept paying everything off. Got to the age of 60 and had planned to sell everything, but oops! 2009 real estate crash so we held and just kept taking in the rents. We have been divesting the last ten years or so, carrying contracts as they are a well secured fixed income sort of investment. Rents keep going up though, and our last 19 apartment units bring in about 130 in taxable income, well over twice our annual spend as homes and cars are paid off. Add about 250 from T-bills, interest from land sale contracts, property loans, CDs & savings in 2024. Dividends contributed about 50, capital gains 20, IRA and social security 30. Line 11 AGI is 499.

So. We are very very fortunate, but our IRS tax of over 105 gets my attention. Moreso when California sticks it's paw out for another 25. I've read that one can take out a loan on an income property, pay the 8% interest and write it off as a business expense. Years down the road the property gets sold and the loan paid off, reducing the capital gains. Seems way too good to be true. Am I miss-stating the technique? Do we need to dump more dollars into stocks we don't sell with their relatively small dividends? Feel pretty sure there are ways to greatly reduce our taxes but I'm not savvy to them. Our long time tax person is real straight arrow, but maybe no forthcoming with tax saving ideas. What would you do in our position?

No idea about the plan to reduce taxes, but I'd be looking for a professional (if not your tax guy) then someone else who really knows their stuff. It sounds like it would be worth dropping a couple or three grand on professional services to figure this out.

Of course, as you hint, this is a pretty nice problem to have. But, I completely understand your motivations and desire to save tax money. Best luck.

 

[SecondCor521]

I've read that one can take out a loan on an income property, pay the 8% interest and write it off as a business expense.

I'm not an expert on income property. It does look like, though, that mortgage interest is deductible - see Schedule E line 12.

However, that just means that the 8% mortgage is really costing you more like 6% after the tax benefit. You're still paying 6% interest. Maybe that's OK, maybe not. The point is, "writing it off" doesn't somehow make it free.

Years down the road the property gets sold and the loan paid off, reducing the capital gains. Seems way too good to be true.

Because it is. Capital gains is, approximately speaking, the sales price minus the cost basis. Neither of those numbers are affected by the loan.

Am I miss-stating the technique?

Probably, but again, I'm not an expert. Doesn't sound like something that makes sense to me the way you presented it though.

Do we need to dump more dollars into stocks we don't sell with their relatively small dividends?

Compared to what alternatives? Your T-bill etc income is twice your rental income, but you started off talking a lot more about the latter than the former.

Feel pretty sure there are ways to greatly reduce our taxes but I'm not savvy to them. Our long time tax person is real straight arrow, but maybe no forthcoming with tax saving ideas. What would you do in our position?

I'd consider moving out of California, but that is more than just a tax question.

I'd consider finding a person who can talk to you about tax saving ideas who is also a straight shooter. There are plenty of people who can do the former but are not the latter - I personally wouldn't get mixed up with those types.

At your level, you probably need someone to take a wholistic view of taxes and the rest of your life - estate tax implications, next generation tax implications if you have kids, long range tax planning. I'd pay them by the hour and expect to pay $500 an hour or in that ballpark.

 

[pb4uski]

... I've read that one can take out a loan on an income property, pay the 8% interest and write it off as a business expense. Years down the road the property gets sold and the loan paid off, reducing the capital gains. Seems way too good to be true. ...

I don't get how paying off the loan reduces the capital gain. The capital gain is the sale price less sale expenses less cost basis. It is too good to be true.

On the other part, consider substituting Fa municipal bonds for US Treasuries and CDs perhaps.

 

[azxracer]

Surprised you don't have an LLC to own & manage your properties. I'd suggest a good tax lawyer and accountant to help guide your decision making.

 

[TickTock]

Might want to look at changing FI AA somewhat out of CDs and USTs into tax-free municipal bonds. That's a difference in lower yields vs. difference in higher taxes paid.

 

[pletal]

Might want to look at changing FI AA somewhat out of CDs and USTs into tax-free municipal bonds. That's a difference in lower yields vs. difference in higher taxes paid.

I'll second that. We were over 400k in AGI. In the last few years have reduced it to about 220 by buying Multi Year Guaranteed Annuities. You don't pay tax till they renew, but you can do 1035 Exchange. This may help.

 

[Midpack]

Congrats, honestly. I don’t have any suggestions, I’m battling the same issue at about half the (largely passive) income, and far more than we spend…

 

[GrayHare]

You report 10x more interest income than capital gains when the latter type receives more favorable tax treatment. Since your goal is to pay less tax, move some of the interest bearing investments into ones that instead generate cap gains.

 

[TheWizard]

You report 10x more interest income than capital gains when the latter type receives more favorable tax treatment. Since your goal is to pay less tax, move some of the interest bearing investments into ones that instead generate cap gains.

I think you mean Qualified Dividends, not Capital Gains. And their no point in holding managed stock funds in taxable that might have Capital Gains Distributions.
Doesn't seem like they would ever have to sell stock funds for income in their lifetime.

Now if they sell a real estate property, the CG amount could be rather nasty, especially with depreciated basis. So I'm not sure how to deal with that; maybe leave as is until eventual stepped up basis?

 

[GrayHare]

I think you mean Qualified Dividends, not Capital Gains.

No, I mean cap gains. For example, not that I would recommend switching this much, but if the OP moves the T bills generating 250 in interest to a stock like BRKB, voila, annual taxable income drops by 250, meaning the OP's income tax will go way down. When the OP eventually sells some BRKB, cap gains will be taxed more favorably than interest income.

 

[audreyh1]

Reduce your nest egg?

Seriously, that is one of our strategies.

 

[SnowballCamper]

Congratulations on your first world problems! I'm not a regular reader of Warren Buffet's letter to shareholders but this recent one caught my eye, and here is a quote from it:

For sixty years, Berkshire shareholders endorsed continuous reinvestment and that enabled the company to build its taxable income. Cash income-tax payments to the U.S. Treasury, miniscule in the first decade, now aggregate more than $101 billion . . . and counting.
************
Huge numbers can be hard to visualize. Let me recast the $26.8 billion that we paid last
year.
If Berkshire had sent the Treasury a $1 million check every 20 minutes throughout all of 2024 – visualize 366 days and nights because 2024 was a leap year – we still would have owed the federal government a significant sum at yearend. Indeed, it would be well into January before the Treasury would tell us that we could take a short breather, get some sleep, and prepare for our 2025 tax payments.

 

[Trailwalker]

Might want to look at changing FI AA somewhat out of CDs and USTs into tax-free municipal bonds. That's a difference in lower yields vs. difference in higher taxes paid.

There's a lot of noise right now about the rules possibly changing. Kiplinger article below.

GOP Eyes Taxes on Municipal Bond Interest: What You Need to Know

My crystal ball is foggy.

 

[Koolau]

I'll second that. We were over 400k in AGI. In the last few years have reduced it to about 220 by buying Multi Year Guaranteed Annuities. You don't pay tax till they renew, but you can do 1035 Exchange. This may help.

Doing a 1035 just puts off the taxation. I suppose you can keep doing it until you die, but that means you don't plan to spend the money. YMMV

 

[pb4uski]

Doing a 1035 just puts off the taxation. I suppose you can keep doing it until you die, but that means you don't plan to spend the money. YMMV

And annuities don't get a stepped up basis.

 

[COcheesehead]

Things to reduce taxes:
Itemize on your taxes including any business expenses, mileage for healthcare, dental expenses , eye expenses. Every penny.
Give to charity
Add energy efficient devices to your home
Contribute to an IRA
Tax loss harvest aggressively
If eligible, fully fund HSA’s
Defer income, if you can

 

[engineernerd]

Agree with others here who point out that (1) the capital gain when you sell a property is exactly the same whether you took out a loan against it or not, and (2) paying interest so that you can deduct it on your taxes makes no sense (pay $x so you can save 24% or 32% of $x?).

I'd say selling fixed-income investments and buying more stocks (stock index funds or stock ETFs) would probably be your best bet for reducing your tax bill. But your land sale contracts and property loans are probably difficult to sell off, which would leave only the T-bills, CDs and savings accounts available to sell in order to buy stock funds. Problem is, if you did that, you might find yourselves in trouble during the next economic downturn.

 

[calmloki]

Appreciate all the thoughts. I phrased myself poorly - land sale contracts interest, loans, and CDs contributed about 150, last year we were over a hundred income just on the T-bills, mostly 6 month or shorter - this because the California state tax savings made them more attractive than CDs. This year will be less thanks to a drop in yield and my pulling 575 out to fund two short term property loans, one for profit and one for family - but that means state and federal taxes on both as regular income. Still will leave 5 property contracts making monthly payments, can't do anything about them.

Stock tax loss harvesting isn't going to happen for some time yet - we bought and held and Morningstar says we are up 163% - our worst performer is the NVDA stock that spun off and is still up 42%. Any stock sales will generate large capital gains, though still better than the ordinary income tax rate.

Was looking at municipal bonds vs. T-bills and they are awful close to the same effective yield. Looking at the Ca GO bonds for 1 year Fidelity says the anticipated tax equivalent yield is 4.413% - but that's based on a fed tax rate of 37%. Tax rates and NIIT only apply to the amounts over the minimum trigger income, I'm not at 37% fed rate, and it looks much like the same as staying in T-bills or Agency bonds. Was real hopeful on the munis, and am pretty much a neophyte, so feel free to enlighten me.

We do keep real close records on the rentals, and write off anything we can - medical and dental thresholds we aren't meeting for writing off - happy about that. Energy efficiency is addressed by shifting ourselves from Oregon the SoCal as the seasons change, not being wasteful, and doing a dynamite job on our home restoration in Oregon. No joy on HSAs or IRAs. Gifting is as the mood moves us, and mostly to people we know.

Property sales bite hard tax-wise. Not in love with continuing to run them but our NW will take a noticable dip if we sell and pay the taxman. We did do a bit of property gifting - not outright, but having some payments being made and filing some form that counted against our lifetime gift exclusions.

Buying stocks vs being so much in cashlike things sounds like the best option so far - getting away from regularly posted income and instead just watching the values go up, then selling only what we need and paying tax on that, leaving the remainder for heirs to get at a stepped up basis. Hard for me to do, even with evidence in Morningstar. Dependence on the mood of the populace just feels bad to me. Having our shares bounce up 15 and down 40 just feels dumb. I'm too darn fixed on the idea that an apple worth 20 cents today should be worth 20 cents tomorrow.

Oh - moving to Nevada is an instant big tax savings. Only thing is, we are around friends and relatives North and South, and the mood in Nevada just doesn't feel right to me - kind of desperate. It's not all about the money.

 

[engineernerd]

If you don't mind moving every few years there is one other idea available - taking advantage of the tax-free capital gains on the sale of your primary residence: Topic no. 701, Sale of your home | Internal Revenue Service

Home prices are no longer stable things, so it's safest to do this with homes you have already owned long enough to be sure they will generate enough capital gains to make it worthwhile. Given that buying and selling homes comes with significant transaction costs as well as inconvenience.

Regarding stock investments, the volatility is not a problem if you have flexibility about when you cash them in. Sounds like you do (you will still have plenty of other income to meet your needs after you buy them).

 

[Fermion]

If I made $500 grand a year I would probably just pay the taxes and be happy rather than move an entire household every few years. That sounds like retirement torture.

 

[engineernerd]

If I made $500 grand a year I would probably just pay the taxes and be happy rather than move an entire household every few years. That sounds like retirement torture.

I agree, but I also know people who seem to like shopping for houses enough to move fairly often. It can also make sense if you are a "snowbird" - though switching your official state of residence is a bit of a hassle in itself.

 

[Exit 2024]

Looks like your RE is a full blown business. Can you open solo 401k and fund it to the max for both of you? It will not eliminate taxes but will rather shift it to the future years, $70k/person will give you some planning room.

 

[Fermion]

Looks like your RE is a full blown business. Can you open solo 401k and fund it to the max for both of you? It will not eliminate taxes but will rather shift it to the future years, $70k/person will give you some planning room.

Would that make any sense at all considering the OP's age? "Got to the age of 60 and had planned to sell everything, but oops! 2009 real estate crash so we held and just kept taking in the rents. "

My math says they are well into RMD age, so how does shifting money into a 401k help? I may not understand RMD well though so you could be right.

 

[engineernerd]

Looks like your RE is a full blown business. Can you open solo 401k and fund it to the max for both of you? It will not eliminate taxes but will rather shift it to the future years, $70k/person will give you some planning room.

Problem with that is payroll taxes.