“Death and taxes and childbirth. There’s never any convenient time for any of them.” ~ Margaret Mitchell, Author of Gone With the Wind
If you’re a tax-paying citizen, this quote is likely to make perfect sense to you. Nobody loves taxes, at least at a deep intrinsic level, irrespective of it being a responsibility we must share. According to a report published on the Motley Fool, a finance website, out of the gross tax collections worth $2.86 trillion in 2013, individuals paid $1.54 trillion or 54% of them, with an average individual tax bill of $8,548.
However, the average individual tax bill doesn’t project a clear picture of average tax rates. For an instance, the average person earning between $125,195 and $175,817 was taxed at 21%. If you made $150,000 during the given financial year, you would’ve paid $31,500 in taxes. That’s nearly four times of the average individual tax bill in 2013.
If you’re a fairly successful real estate investor, saving on taxes could be a potential challenge for you, and you might have been spending a lot of time figuring out effective tax strategies.
Self-Directed Solo 401 k plan: 3 Tax Saving Strategies for Realtors
At Sense Financial, a major part of our clientele involves real estate professionals, seeking effective methods to cut their taxable income. As a self-directed Solo 401k plan provider, we help our clients cut their taxable income by a huge margin; precisely up to $59,000 in 2016.
A Brief Insight into Self-Directed Solo 401 k Plan
Solo 401 k plan is a qualified retirement plan from the IRS,targeting owner-only businesses and self-employed individuals. As a part of the annual contribution limits, you can contribute up to $53,000 in 2016 along with a catch-up contribution of $6,000 for professionals above the age of 50 years.
The primary attraction of this plan is its ability to invest in a plethora of investment options, including real estate, tax liens, tax deeds, mortgage notes, private lending, and private businesses along with the traditional investment options.
Contribute up to $59,000 of Your Real Estate Income in 2016
If you are a realtor with no full-time employees, you can contribute up to $59,000 in 2016. The contribution includes a salary deferral contribution along with a profit-sharing contribution.
- Salary deferral contribution: Under the salary deferral contribution, you can put up to $18,000 in 2016along with a catch-up contribution of $6,000 for professionals above the age of 50.
- Profit-sharing contribution: The profit sharing contribution allows you to contribute 20to 25% of your business income, with maximum cumulative contributions of $53,000 or $59,000, for professionals above 50 years, in 2016.
Case I: Melinda,41 years old and a real estate investor operating as a corporation, had a net income of $180,000 in 2015. She could contribute up to $18,000 under salary deferral contributions along with profit-sharing contributions of $35,000, cutting her taxable income by $53,000 in 2015. It is important to consider that although 25% of her business income is$45,000, Melinda can only contribute up to $35,000, as the maximum contribution limit comes into play.
Case II: Bob, 53 years, operates as a part-time real estate professional, generating an income of $60,000 from his real estate business in 2015. Bob contributes $6,500 in his company-sponsored retirement plan, which cuts his salary deferral contribution in the Solo 401k plan to $17,500 in 2015, making net salary-deferral contributions of $24,000. As a single member LLC, Bob can further contribute up to 20% of his business income or $12,000 in 2015, allowing him to cut his taxable income by $36,000.
Find out your annual contributions for 2015 with our contribution calculator.
Purchase Rental Property with Solo 401 k plan & Defer Taxes on Rental Income
If you already have a self-directed Solo 401 k plan, start purchasing rental property within your retirement account. The IRS allows investing in real estate through a Solo 401 k retirement plan, which means you have the option to defer taxes on your rental income until distributions.
You will have to purchase the property through your Solo 401 k plan, and if there are insufficient funds in your account, you can use non-recourse financing to fund the transaction. Unlike IRA plans, the use of non-recourse financing through a Solo 401 k plan does not trigger any additional tax. Make sure that the maintenance cost of the property goes through your retirement account only, and the rental income comes directly into the plan as well.
A large part of our clientele is involved in rental property investment, including single family homes, multi-family apartments, and even commercial real estate. Investing in a rental property with your retirement plan can help you restrict your tax burdens while offering the benefits of real estate investing.
- Tax-deferred growth of rental income
- Ability to finance property purchase using non-recourse loan without paying UBIT tax
- Retirement account pays for maintenance
Pay Taxes on Capital Gains at the time of Withdrawals Only
The same rules apply to the capital gains realized from the sale of a property within your Solo 401 k plan. Unlike regular real estate transactions, you can defer taxes on your capital gains to as far as your withdrawals. It allows you to keep the entire gains within your plan, and these funds are available for your upcoming real estate transactions.
Every now and then we hear real estate success stories from our clients but this one was even beyond our imagination.
One of our clients, Bill, invested in an organic mango farm in Panama, spread across 2.5 acres, and it was managed by a local turnkey operation company. His next investment came out to be a Neem tree farm in Brazil, and he was able to make these investments with a self-directed Solo 401 k plan. Any income procured from these farms in the future will directly go into the self-directed account.
A self-directed Solo 401 k plan helps you in creating a diversified retirement portfolio while offering complete freedom in asset selection. It is time to leverage your retirement savings and build a retirement account that will truly outlast you.
Another version of this article appeared on Marshall Reddick Real Estate Portal.