Nobody likes paying taxes. Wouldn’t it be great if you could find a way to avoid it entirely? There’s no shortage of beat-the-IRS strategies out there to choose from, especially on social media. But do they really deliver what they promise? After all – if it were that easy, wouldn’t everyone be doing it?
There’s a video circulating on Instagram where an influencer teaches his daughter how to avoid tax on $200,000 of income. (His name isn’t important – the question here is simply whether it works.) Let’s take a look at his plan, then see if it stands up in the real world.
“When you get your first job and you’re making $200 grand, your goal is to get that income to $11,000. Your taxes on this is going to be $1,100. I want to spend $189,000 on goods and services that can make me more money next year because I’m never paying the IRS. Let’s say I make $200 grand, and I could keep $189. I’m going to take that and go buy a $400,000 piece of real estate that’ll give me $189,000 depreciation, and now I only pay taxes on $11,000.
You’ve got a job with me, $200 grand a year. You’re not going to spend any of that money on your lifestyle. You’re going to park all that money into a real estate deal and use it as a down payment to buy an income-producing property.”
Our influencer has the right idea. Invest as much as possible into deductible activities to offset taxable income. Except, there are a few teensy-weensy problems with this specific plan.
- First, who makes $200,000 at their first job? So many of the tax hacks you see on social media apply only to very specific, rare situations.
- Second, the plan doesn’t avoid tax on $200,000 of income. It avoids tax on $189,000. That leaves just $11,000 for luxuries like food and shelter. We can certainly debate how much a $200,000 earner should be setting aside to invest. But no reasonable advisor would recommend 94.5%. Especially considering the employee’s FICA taxes will eat up more than the entire remaining $11,000!
- Next, there’s no way you’ll be able to take $189,000 of depreciation on a $400,000 property. To generate that kind of writeoff, even with aggressive cost segregation and bonus depreciation, you’ll need to buy at least a million dollars’ worth of property. Oh, and how are you going to get a million-dollar mortgage if you’re only showing the bank $11,000 in income?
- Finally, there are generally two ways to depreciate that much real estate against ordinary income. The first is to qualify as something called a “real estate professional,” which isn’t likely if you’re working hard enough to make $200,000 at your job. The second is to operate the property as a short-term rental so the passive loss limits don’t apply. The short-term route means more work. And it poses extra risk as more and more cities regulate or even ban short-term rentals.
As attractive as tax-free living may sound, it just isn’t doable for most people who want to live somewhere nicer than in a van down by the river. It’s more realistic for retirees who can allocate their assets to nontaxable sources like Roth IRAs or cash-value life insurance. But even then, it takes more planning than you’ll find on a social media post.
Don’t hate paying taxes so much that you cut your nose off to spite your face. Don’t hate the IRS for the job they do collecting them – it’s Congress that makes the rules. And call us to help with a plan that puts tax savings in a proper place with your other financial goals.