Transferring business and real estate interests to children can let real estate losses offset income.

[03:11]

"Most of us have children, parents, somebody that we could transfer an asset to and still have control over the asset. So all we have to do is we just transfer it over here to child or, in many cases, a trust for the child."

[04:32]

"And then whatever percentage we want to of the real estate, we could transfer close to 100 percent, say 98. Now we have 98,000 of loss and we're using that ninety eight thousand dollars loss to offset that hundred thousand dollars of income."

[05:31]

"Well, it depends what jurisdiction you're in, if you're active, if you're passive, if you're a real estate professional and what other things are going on, because it might hurt your estate planning or help it."

Full transcript

Hello everybody. My name is richard c wilson, founder of the family office club, and I have tom wheelwright with me, which many of you probably know. Um, I know a few dozen people have read his book tax-free wealth and the book has been mentioned a few times during our interview series. So welcome here, tom, thanks. Thanks so much for having me.

It's great to be with you. Great and um, right before we jump into this tax strategy, um and the advice you want to give here in the short interview, give us just a real high level view, a little bit of your background and how you got got into this space to begin with. Absolutely so, um, I have 40 years of experience as of this year in the tax area, including, uh, three years in the national office of ernest and young national tax office, 14 years as an adjunct professor in the masters of tax program at arizona state university, four years as the in-house tax advisor for fortune 1000 company. I have a master's of tax degree and I spent 25 years buying, building and selling cpa firms and now I run a multinational network of cpa firms, awesome, great, great context.

So the topic you wanted to discuss today has to do with the treatment of passive income and ordinary income, or active income. Maybe, more accurately said, can you go into a little bit on a high level of what that is and what you wanted to cover? Yeah, so one of the big issues that particularly real estate investors run into is they, they don't they. They work in their business full-time.

They really can't be a real estate professional, and yet real estate is the biggest tax shelter we've got right now and we'll continue, we think, to be so for the next few years. And so how do you use those passive losses now, okay, instead of having to wait until you actually sell the development, for example? Okay, great, and what it? What are a couple of those strategies?

Or what is? What is something that's often missed or is possible for those professionals? Well, let me, if I can, let me show you um, and I'll describe it as we go for those listening. The biggest issue I run into is that people think, well, it's passive, so therefore it's not deductible. And that is not correct. It's passive, so it's only deductible against passive income.

So the question, one question, is how do I make it non-passive? That's the real estate professional question. But the other question is how do I make my active income passive income? And it's really not that difficult if you consider that most taxpayers with this problem have a business right. So here we have the taxpayer and let's say we have an s corporation down here, and then, on the other hand, what they own is they own an interest in a bunch of real estate, which we probably do through llcs, and they also own that.

So here's the real estate over here, owned through a partnership, right, right, or an llc tax as a partnership. Now all we have to do actually really simple. Most of us have children, parents, somebody that we could transfer an asset to and still have control over the asset. So all we have to do is we just transfer it over here to child or, in many cases, a trust for the child.

Okay, and we transfer. What do we do we transfer? First of all, we transfer an ownership in the s corporation, which is long as it's a qualified subchapter s trust or grantor trust, it will qualify and we transfer an ownership interest in the real estate company. And now what we have is because the children, assuming the children, aren't working in the business.

Now this income is passive, this is a passive activity income, or a pig, I'll call it a pig, which is our common, common parlance, and over here we have a pal and pals can be offs, can offset pigs. So all we're doing is, let's say, we have a, a million dollars of income in this s corporation and we have a hundred thousand dollar loss in this real estate. Well, we transfer 10 interest over here and we have a hundred thousand dollars of income, and this is passive income. And then whatever percentage we want to of the real estate, we could transfer close to 100 percent, say 98.

Now we have 98,000 of loss and we're using that ninety eight thousand dollars loss to offset that hundred thousand dollars of income. Now, voila, we get um. Just like magic. We have um passive losses being used currently. Now it even gets better when you're talking about biden's tax plans, because you're going to lose that basis, step up under his current tax, what he's proposing, and so there's no reason to keep it.

You might as well transfer it to your child. They get the appreciation. There's all sorts of estate planning here. Plus, on top of that, you get the income tax planning. So the big issue is: we have to do estate planning, income tax planning at the same time, right, right, that's one thing we've heard many times. You have to look at things holistically.

You can't just take what someone says at a conference and think, okay, I'll go off and do that. Well, it depends what jurisdiction you're in, if you're active, if you're passive, if you're a real estate professional and what other things are going on, because it might hurt your estate planning or help it. If you're looking at the broader picture versus not right. No, that's exactly true.

And and the good thing about this one is these can be syndication. So they see, these could be clearly passive activities where you might not even be able to be active. If you were a real estate professional, I mean, I think you probably can, but it's tougher to be active in a limited partnership type position than it is in a general partnership position, and this is a really easy opportunity to get you know, basically a two-for-one: you get income tax planning and estate planning all at the same time, right, yeah and uh. Would this create an issue, though, if, um, the trust set up on the children's name, you know that if you wanted to benefit from the income coming off or take profits out, is, is that money now stuck within that trust and has to be used for that child, or is it full of use of being able to take it?

So? So, first of all, remember that this is in a trust that you probably control, okay, and second of all, remember that it doesn't have to be distributed to the child. And third, remember you can always take salary from your business so you can use the money here and over here. You're controlling this completely and you don't have to distribute this so you can maintain complete control of this and really have whatever money you you need, okay, and still get the benefits when you want the benefits, got it, got.

It makes sense. So, anyone who's um a sega seven figure earning doctor or physician listening to this, anyone who owns a business and has a lot of active income, you might find when you invest in some things, it provides you with a passive loss. And what tom's talking about here, if I understand correctly, is that you're not going to be able to use those passive losses to offset your active income, something where you're controlling it and you're working in it full time. Uh, unless you perhaps use a structure like this or you find some other way to have passes.

Passive losses match up with your passive income. It has to match up on both sides. That's essentially that, the dummy down version for people like myself that are not a 40-year tax expert, of what you're saying here. Right, well, really, simply, all we're doing is converting ordinary income to passive income, and passive income, of course, is the best kind of income because it can be offset by passive losses.

So it's, and we're converting it, not by anything we do, but simply by who owns it. Right, right, makes sense. Okay, great, um well, is there anything else you want to add to that before we sign up for today? I appreciate you. You know, doing this, uh, this quick video for us. No, absolutely happy to do it.

Um, you know, anybody, of course, needs any help. We've got, uh, like I said, we've got cpas all over the country and in canada, and just contact us at weltability.com. We're happy to help. Awesome, great. Thank you, tom, appreciate it, thank you.