Financial planning requires a system you can follow to be fully prepared for tax time. It’s imperative that as real estate investors and business owners, you create an accounting strategy that avoids expensive mistakes, gets the most deductions, and plans your wealth building accordingly. Here are some tips on how to achieve those goals.
DEDUCTIONS FOR REAL ESTATE INVESTORS
When it comes to maximizing deductions, it is much more beneficial for real estate to be considered a “business” and not just an “investment”. Being considered also a business will give the property owner these advantages over being considered just an investment:
1. Eligibility to deduct start-up expenditures
2. Eligibility to deduct Section 179 first-year expensing in certain situations
3. Better eligibility to deduct depreciation in certain situations
4. Better eligibility to claim interest expense
5. Eligibility to fully deduct operating expenses on rental or business schedules as opposed to miscellaneous itemized deductions, where there are limits.
6. Eligibility to fully deduct expenses for a convention, seminar, or similar meeting.
7. Eligibility to take advantage of certain fringe benefits, such as a Medical Reimbursement Plan under IRC 105(b).
8. Eligibility to fully deduct rental property losses with less or no limitations
9. Better eligibility to fully deduct losses on the disposition of the property without any limitations
Common Tax Planning Mistakes and how You can Avoid Them
Mistake #1: Deducting Expenses in the Wrong Place
There is a right and wrong way to take your tax deductions. One of the most common mistakes accountants see with their clients is deductions taken in the wrong place. Make sure you are taking your tax deductions on the right forms and schedules!
Mistake #2: Limited by Passive Loss Rules
Here is another common mistake entrepreneurs and real estate investors make on their returns. You must ensure your accountant prepares your taxes so you are not being limited on your tax write-offs by the passive loss limitation rules.
Mistake #3: Real Estate Professional Status
Real Estate Investors have to be very careful in this area. The IRS looks at what you do for real estate and how much time is spent doing it. You want to qualify as a real estate professional so you can benefit from real estate tax deductions. As a real estate professional, you can take advantage of an unlimited amount of real estate deductions every year. This is a special election that must be attached to your tax return when you file it. The average tax savings between a real estate professional and someone who is not a real estate professional is anywhere between $15,000 to $35,000 each and every year!
Mistake #4: Missing Carryforward Tax Benefits
Carryforwards are certain types of tax deductions, losses, or tax credits that you could not use in the past, but get ‘carried forward’ on your tax returns from one year to the next. Many of these deductions can get lost between the years by poor record keeping or an incompetent accountant which can be a very costly mistake.
Mistake #5: Lack of Proactive Planning and Analysis
The best way to minimize your tax liability is with proactive tax planning and analysis. Proactive and frequent planning sessions with your tax advisor allow you to take advantage of opportunities that can significantly diminish your tax liability.
The Difference Between Tax Preparation and Tax Planning
Tax preparation for the March 15th or April 15th return is not considered advance tax planning. It is merely tax compliance as opposed to voluntary tax reduction planning. Though returns aren’t due until April, they cover a tax year that ends Dec. 31. Some of the best tax-reduction moves really need to be done by mid-November or early December. They often take some advance planning. Getting a head start could make you a lot happier in April, giving you a bigger refund or a smaller check to write to Uncle Sam
EARLY START TAX PLANNING CHECKLIST
1. If you own a business, do you have an EIN number, an operating agreement, and a separate bank account?
2. Have you recorded all the income and expenses related to the business on the business bank account? This is a huge audit item this year.
3. If you own an investment property that was foreclosed or sold as a short sale, have you considered the impact of the cancellation of debt income on your individual income taxes? Have you calculated the loss of sale of investment property?
4. If you generated any kind of active real estate income, have you considered restructuring your business to minimize the impact of self-employment taxes?
5. If you have significant real estate education expenses, have you registered a business in order to minimize your audit exposure by deducting these expenses?
6. If you have significant business expenses and already have a registered business, have you considered converting to a partnership to avoid an audit flag?
7. For homes that have been repossessed, do you know the rules on recourse vs. non-recourse debt?
8. Do you understand what your tax filing requirements are for the states where your business is registered such as annual filing, personal property tax returns, etc.?
9. If you own investment property, have you considered doing a cost-segregation study in order to increase your depreciation expense?
10. If you bought or sold property last year, have you considered the impact of capital gains, adding rehab expenses to the basis of the property, and whether the holding costs (mortgage interest, taxes, and insurance) are deductible this year?
THROWBACK QUESTION from my blog:
QUESTION: I acquired a house in September. I evicted the previous owner in December. I paid the eviction costs in January. I listed the house for sale in March. I expect to sell the house next year The house is most likely a dealer property. Should I expense the eviction costs on my tax returns, or should I add them to the basis of the house?
ANSWER: It depends on what your investment intent is. If your intent was to buy, hold, then sell, then yes, you can deduct the eviction costs from your taxes. If your intent, was to buy, fix, and sell then those costs are added to the cost basis of the house.
I address many of these issues in my Wealth Building Plan. Make sure you are getting the best tax advice. Let me evaluate your financial and tax situation, then develop a customized tax strategy just for you. Together, we will come up with a strategic plan designed to answer your questions as you build your own customized wealth-building plan. You can get more information at WealthBuildingPlan
