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7 Common Tax Mistakes of New Real Estate Investors

by Amanda Han on April 17, 2014 · 11 comments

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Common Real estate tax mistakes

Over the years, I have come across thousands of real estate owners and small business owners across the U.S. and have unfortunately witnessed many mistakes that are costing thousands of dollars in over paid taxes.

What a shame that so much money just going to waste and in Uncle Sam’s pocket!

Let’s take some time to look at these mistakes that we should avoid:

1. Personal funds used for business and real estate expenses are nondeductible
Most real estate or business start-up often needs cash support from the owner to cover operational expenses. If you use your personal funds to pay for business or real estate related expenses it is very important to make sure you are clearly tracking the expenses. Any expenses that are incurred for the business or for real estate are generally deductible, even if you use your personal money.

2. Tipping the IRS will make me “Audit Proof”
If you over pay and tip the IRS, they do not care. What they do care about is if you under pay your taxes or cannot substantiate your deductions. So if you “tip” the IRS in one area, it doesn’t necessarily mean the IRS won’t make you pay penalties if you underpay in another area. To be on the safe side, it is always better to pay exactly what you owe, that is the best way to “audit proof” yourself. Make sure to track everything correctly and have the right documentation. Also make sure you are working with a knowledgeable advisor that can help ensure you are tracking and deducting everything correctly.

3. You are allowed more deductions by being incorporated
Forming a legal entity does not necessarily mean that you get more tax deduction. As indicated in #1 above, real estate or business related expenses may be deductible regardless of where it is paid from. If you do happen to have a legal entity that you operate your real estate business from, make sure to use it correctly. A mistake I often see if someone who has an S Corporation formed to reduce taxes but all income is still being paid to their personal name. If this describes what you are doing, you may want to make the change quickly to that your income is actually being paid to your legal entity.

4. Taking the home office deduction is a huge red flag to get audited.
The above statement used to be true, but those days are long gone. Because of so many people now able to work from home, the IRS cannot possibly audit all tax returns claiming home office deduction. As long as you keep excellent records to satisfy their requirements, you are fine. There is no need to fear an audit. You do not want to miss out on the benefits to taking the home office deduction.

5. If you don’t take the home office deduction, business and real estate expenses are not deductible.
If you do not take the home office deduction, all is not lost you can still claim many deductions for your real estate. You are still allowed to take deductions for your real estate maintenance supplies, business-related phone bills, travel expenses, wages paid to contract workers for property improvements, depreciation of equipment used, and other expenses related to running a home-based business,. These may still be legitimate tax write offs even if you don’t take the home office deduction.

6. Filing an extension gives you an extension to pay any taxes owed.
Filing an extension only allows you to extend the filing date of your tax return. It does not extend the time you have to pay the tax due. You may be charged penalties and interests from the date your taxes are due if they are not submitted on time.

7. Can’t Deduct General Expenses
Most real estate investors are great at deducting property specific expenses such as mortgage interest, management fees, property taxes, and insurance. What a lot of people miss out on are the general and overhead expenses that a lot of real estate investors have. Examples include car or travel expenses, marketing expenses, cell phones, and meals to name a few. As long as the general and overhead expenses are related to your real estate business, they are generally tax deductible items even though they are not specific to one particular property.

These are just a few of the mistakes I often see especially from newer investors. Educating yourself is the key to avoid overpaying taxes! There are many ways you can significantly reduce your tax bill … all it takes is knowing how.

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{ 11 comments… read them below or add one }

Martin Cortez April 17, 2014 at 4:09 pm

Amanda – thanks for the illuminating post. For the majority of my time in real estate, my CPA has discouraged me from the taking the home office deduction. I need to review that option with him for next year’s tax return.

I cannot agree with you more about creating a separate legal entity to both keep easier books and greatly reduce your tax burden. One major perk I have enjoyed over the years by having a C Corp is being able to deduct a large portion of my annual shareholder’s meeting expenses. This past year, I had the meeting in Hawaii so naturally my family came along for the trip. Family time and tax savings… what a country!

Reply

Amanda Han April 18, 2014 at 1:28 pm

Thanks Martin. There are ways to use corporations to maximize the home office write off and also fly under the IRS radar using reimbursement plans. Be sure to discuss this with your CPA if you do have a qualified home office.

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Elizabeth Bassett April 18, 2014 at 6:44 am

Thanks so much for your posts Amanda! I have learned more from you in the past month than I have from my accountant in 10 years (I am looking for a new accountant with some real estate knowledge).

I had also heard that the home office deduction was an audit trigger. I don’t have a dedicated home office set up yet, but plan to very soon so we can begin taking that deduction.

Thanks again!!!

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Amanda Han April 18, 2014 at 1:29 pm

Thanks for your comment Elizabeth. I am so happy that you have found useful information you can implement to save taxes for yourself!

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Sharon Tzib April 18, 2014 at 8:45 am

#3 is by far the most misunderstood concept I see on the forums in BP. I hope more people read your blog so they form an entity for the right reasons. Thanks, Amanda!

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Amanda Han April 18, 2014 at 1:30 pm

Thanks Sharon! Yes…#3 is one of those common myths that really makes me angry. I don’t know where this misinformation comes from but we need to tell people the truth and hopefully bigger pockets is the starting ground to share the truth =)

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Erick T April 21, 2014 at 7:34 am

How does this work for Owner-Occupant landlords? I live in a 3unit multifamiily and manage the tenants in the other 2. If I buy, say a mop and bucket to clean my unit and then occasionally use it in another unit when the tenant moves out does that mean it’s a business expense?
If I buy a dehumidifier for the basement that only my unit uses, would it be a business writeoff? The basement is under all of the units, so technically it’s a shared basement.
And what about the water bill for the whole building?
Is there a rule for what % an item is used for business vs personal that the IRS goes by?

Thanks for the great writeup!

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Amanda Han April 21, 2014 at 1:38 pm

Thanks for your comment Erick. Yes the IRS generally accepts a reasonable allocation method when you have mixed-use items such as your example. Here are my thoughts personally:
1. mop and bucket…immaterial, just write it all off as business
2. dehumidifier…if only you use it for your unit then it is personal and non-deductible against the rental income. You can use it to offset any gains on the sale of the property still.
3. Water bill: allocate it amongst your and tenant units.

The IRS does not have a set percentage for you to allocate so it depends on each person’s facts. For the water, if there is a way to see usage by unit that is the best. Otherwise I would suggest looking at using sq ft allocation as an example of alternative method.

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Cuong Le April 21, 2014 at 7:53 pm

Thanks Amanda for the reminders and tips. You are right about #7. We’ve been so cautious to keep everything straight so we don’t get audited that we don’t take deductions like meal. As long as we discuss anything business related and keep good records, we shouldn’t give up these deductions since they add up.

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Shaun April 24, 2014 at 5:30 pm

I am happy to see that I don’t really make these mistakes.
Did miss out on home office until amending my 2012 return but have it there and 2013.

BTW you totally get more deductions by having an entity.
The course you bought that said you needed one is education. The attorney fees to draft the paperwork is a deduction. All the filing fees are deductible. And of course paying your accountant to file the extra paperwork for the entity returns and doing anything like K1s.
Tons of deductions, you just have to spend all the extra dollars to write each off.
Not the greatest strategy. :)

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Amanda Han April 24, 2014 at 5:36 pm

Agreed….dont spend money just to get the tax deductions. ala “tail wag dog syndrome”

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