If you have been keeping up with my blogs, you now know the powerful tax advantages of real estate investments. Passive losses are when a business or investment shows a loss on its K-1. Tax strategies such as cost segregated depreciation, interest deductions, and de minimis safe harbor allow real estate investors to earn lots of money from their properties yet still claim losses on their K-1. Furthermore, these losses can be leveraged to offset gains in other areas of an investor’s portfolio such as capital gains from stocks.
A quick example: your real estate investment earned you $100,000 but the K-1 reported a $25,000 loss. Additionally, your investment in Google’s stock did well in the same year and you sold a few shares for a long term capital gain of $67,400. Normally, in the highest tax bracket, you would have to pay 20% taxes on this long term capital gain plus 13.3% California tax as well as 3.8% Obamacare tax! This totals to 37.1% in taxes equaling $25,000 ($67,000 x .371). However, since you are an astute investor, your $25,000 dollars worth of passive losses from your real estate investment, completely offset your big gains in the stock market, resulting in you paying NO taxes!
Forbes article about California’s 13.3% tax on capital gains: https://www.forbes.com/sites/robertwood/2017/08/31/californias-13-3-tax-on-capital-gains-inspires-move-then-sell-tactics/#356b1e4a2097
The GOP tax reform bill changes the taxation of stock options (CNBC article) to being taxed once liquidated rather than exercised. Many of my dad’s clients are compensated via stock options and would love to see this bill pass. Additionally, clients with stock options would do well to harvest passive losses achieved from real estate investments to offset the capital gains of liquidating stock after exercising their options. However, in order to be able to offset gains from the sale of stock options using passive losses, the stock must be held for one year. If the stock is sold in less than a year, then the gains will be taxed as ordinary income (not short term capital gain, even!); painful, especially for high earners. If the stock is held for a year, then the transaction is taxed as long term capital gains and is eligible to be offset by passive losses which can be achieved by investing passively in real estate funds or projects.
To read more about the tax implications of stock options: https://www.salary.com/Articles/ArticleDetail.asp?part=par414
Other tax tips regarding stock options: https://blog.wealthfront.com/exercise-stock-options-taxes/