Why Your Tax Strategist Should Probably Be a CPA
Last week, BiggerPockets released an article written by Paul Moore titled “How Hiring a Tax Strategist—Not Accountant or CPA—Could Save You Thousands Every Year.” As a CPA myself, when I saw that pop up in my email newsletter, I immediately thought, “Oh great, here we go.” I even had a few of my clients reach out and ask about the article, citing that they thought our firm had been great tax strategists for them and asking why the author was recommending not using a CPA.
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Here’s the rub: Upon digging into Paul’s article, it became evident that he never intended to bash CPAs. In fact, there’s a high chance his tax strategist is a CPA. So why would the article’s title say otherwise?
I believe the intent of the article was to emphasize the importance of ensuring whichever tax professional you hire, whether CPA or otherwise, is versed in tax strategy. Regardless of whether your tax professional is a CPA or not, their lack of proactive planning and knowledge of the real estate niche could indeed cause you to lose out on savings. While this insight was the core message of the article, it was easy to fixate on the title and assume that all CPAs cause their clients to miss profitable deductions.
[Editor’s Note: To curtail further confusion caused by the title of this article, we have changed it to: “How Ensuring Your CPA is a Tax Strategist Could Save You Thousands Every Year.” Apologies to any CPAs who are indeed real estate tax-strategy savvy.]
So today, I’d like to expand on Paul’s article to provide you with more insight. I’m going to cover why the tax industry is chock full of poor talent. I’ll show you what you need to look for in both credentialing and real estate knowledge. Lastly, I’m going to provide you with a few hard-hitting tax strategies that you can implement immediately.
Low Quality Tax Professionals Are Abundant
The barrier to entry to become a “tax professional” is extremely low. I mean really low. All you need is a Preparer Tax Identification Number (PTIN) to prepare another person’s tax return. Guess what it takes to obtain a PTIN? Go on, guess.
Fifty dollars and 15 minutes. Yes, you read that right. Don’t believe me? Google “IRS how to obtain PTIN,” and you’ll see how easy the registration process is. Someone with absolutely zero experience can obtain a PTIN and begin preparing your tax return. Scary, isn’t it?
The problem is that the big box retail tax prep stores hire these folks. During my college years, a friend of a friend landed a summer gig at one of these big box retail stores. His GPA was hovering around a 1.5, and I wouldn’t trust the guy as far as I could throw him, yet his PTIN qualified him for the cheap labor the big box store was looking for.
On the other end of the spectrum, there are CPAs and EAs (Enrolled Agents) who are awful at their jobs too. They became credentialed after failing their tests multiple times, they prepare returns full of errors—or slightly better, they prepare squeaky clean tax returns but never offer proactive tax planning.
Taking it one step further, high quality tax professionals servicing the real estate industry are few and far between. The term “high quality” means those who will provide that proactive tax planning, which resonates with what Paul was trying to emphasize in his article. Real estate investors and business owners cannot afford to hire cheap tax preparers who are only going to prepare a tax return and then kick you out the door shouting, “See ya next year!” Real estate moves very fast. You need someone in your corner at all times ready to launch into a series of strategic tax implementation.
The lack of quality competition in the real estate niche allowed me, in my mid-20’s, to grow a real estate CPA firm to a national client base and five employees. To give you perspective, most CPA firms take 5-10 years to achieve what we have in two.
I don’t say this in a braggadocios way at all. My intent is truly to demonstrate that there is a massive need for quality tax professionals in the real estate niche, yet few high quality CPAs and EAs are actually pursuing the niche.
Credentials and What to Look for
Even though there is a lack of high quality professionals servicing the real estate niche, I want to provide you with tools to help aid your search.
First and foremost, you do not need to hire a CPA. You do not need to hire an EA. You should hire someone who has solid tax experience, specifically related to real estate. That may be a CPA, EA, or your non-credentialed neighbor. Personally, I would not engage a tax professional that does not have at a minimum a Masters in Taxation. I like to see that someone was able to commit grueling hours and brain power to obtain a credential and, at the very least, that they have proven they studied the intricacies of taxation.
Though credentials are important, I highly recommend that you look beyond the credential when seeking out a tax strategist. You need to find a tax professional who is an expert in the real estate niche. You can look for publications, white papers, blog articles, books, podcasts, videos, anything that gets the professional talking about real estate and showcasing their knowledge.
The content that CPA firms produce allow you to understand their look and feel. You get a sense of how they approach and work with their clients and how proactive they will be with their tax planning. You want to feel like you know the firm, how they interact with clients, and how they deliver advice before you ever call them up for your initial consultation.
You should also connect with people in the Forums on BiggerPockets or participate in local real estate groups and ask for referrals. If someone is willing to refer their tax professional, there’s a good bet that (1) the tax professional has real estate knowledge and (2) the client experience is solid.
A good client experience is imperative. Many CPAs are great at being a CPA but stink at running a business. Their systems fail, they take forever to reply to your question, and ultimately, they leave you upset. Admittedly, our firm has struggled to scale our systems as we’ve on-boarded clients. It’s now a laser focus of mine to provide all of my clients with a “wow” experience. We achieve this through proactive planning, reminding clients of deadlines, reaching out if we haven’t heard from them in 45-60 days, and having a smooth and seamless tax prep process (which we are still working on). Every week, I ask my employees to provide examples of how they provided a “wow” experience for a client. How will your tax professional provide you with a “wow” experience?
Do You Need a Free Consultation?
Most CPAs offer a free consultation. Our firm has a free upfront consultation, but not with a CPA or tax professional. Why? These free consultations became free tax planning sessions because we CPAs really stink at selling. So, I hired someone who doesn’t have a tax background but can thoroughly explain our service offerings and what it’s like working with us. Because we produce so much content, clients are very rarely put off by this.
Do you need to talk to the tax professional prior to hiring them? You may want to; that’s totally up to you. If they produce a lot of content, can you get a feel for how they educate and interact with clients? Do they have a podcast or video so that you can see them and hear their voice? This content may put your mind at ease.
My point is don’t think it’s a requirement to have a free consultation with a tax professional. It may be for you personally, and that’s totally OK. Know that about yourself and find a firm that will offer that type of client experience. Again, it’s all about the client experience you desire.
5 Killer Tax Strategies You Can Set in Motion Today
Now for the juicy stuff. Let’s get right into it.
1. Using a Roth IRA Over 529 Plan
I wrote an article on this a couple of months ago. If you have a child between ages 7 and 17 and you have a nice rental portfolio built out, hire your child. Pay them through the real estate as an employee. It takes some structuring, but works beautifully. You can pay them up to $6,350 per year. Why? That’s the standard deduction. If they earn less than the standard deduction, they don’t file a tax return. So you’ve paid them, and you get a tax deduction; they earn money, but don’t have to report it. Best of both worlds. Even better—there is an exemption for FICA taxes for children under the age of 18. So it’s truly tax-free money.
We then put the money into a Roth IRA and call that our “college savings” because you can withdraw contributions tax-free and penalty-free at any time. The earnings portion can stay in the Roth and continue to grow over time for the child. This is NOT a retirement planning strategy. This is intended for folks who have to make a choice of where they should contribute $2,000-$6,000 per year to save for college. If you can contribute more, this may not be the best strategy for you.
2. Implementing the Domestic Production Activity Deduction (DPAD)
If you run a real estate building, development, contracting, or flipping business, you may qualify for DPAD. The catch is that you have to pay yourself via a W-2. So, folks running an S-Corp should be jumping at this. The DPAD is a 9% deduction on your qualified income or AGI, whichever is less. Let’s say you net $200,000 from flipping activities. You pay yourself a $95,000 salary. Your AGI is $205,000. You can qualify for an $18,000 deduction (9% x $200,000), which will translate to roughly $5,000 in tax savings (assuming 28% tax bracket).
3. Itemizing Repair Invoices
If you are a landlord, then you need to be careful what invoices from contractors and service providers say. Ideally, you will have them itemized as much as possible. If items on the invoice are less than $2,500, then you may be able to qualify for the De Minimis Safe Harbor, which allows you to expense costs less than $2,500. There is a catch: If you are repairing a certain unit of property (UOP), the costs are aggregated to that UOP. Take an HVAC UOP for instance. We cannot itemize the motor, the belt, the casing, the electrical, etc. and deduct those costs. We’d have to add up the costs of the HVAC and, if over $2,500, we’d have to capitalize and depreciate.
4. Timing the Real Estate Professional Status Correctly
If you have a decently sized rental portfolio built out and you do not have a property management company managing the rentals, you or your spouse can likely qualify for the “real estate professional” status. The benefit is that you can deduct your passive losses. To qualify, you need to demonstrate that you spent 750 hours and greater than half of your time in real estate. The “greater than half of your time” rule disqualifies folks with full-time jobs. But that’s only the first step. You will then need to demonstrate that you materially participated in your rental activities, generally showing that you spent 500 hours working in/on your rental portfolio.
There is a ton of great information on this tax strategy already out there. What’s not well-known is that you can couple the real estate professional status with a cost segregation study and achieve truly beautiful results. A cost segregation study allows you to identify personal property and land improvements and depreciate them over 5, 7, or 15 year periods rather than 27.5 years. In layman’s terms, you get a huge increase in your annual depreciation expenses for five years. But here’s the cool thing: If you perform a cost segregation study in year four rather than up front, you get to write off, in year four, all of the depreciation you could have taken had you performed the study up front when you bought the property. On a $250,000 property, a cost segregation study will allow you to write off an additional $10,000 per year for five years. But if you do the study in year four, you get to write off years one through three in year four, resulting in a year-four write-off of $40,000 over what you would normally have taken.
Related: How Debt & Taxes Make the Rich Richer and the Poor Poorer
So, as an example, let’s say you own five rentals, and you or your spouse is planning on quitting your job next year. Let’s also assume you’ve owned each rental between 2 and 5 years. Next year, when you quit your full-time job, we’d want to qualify you as a real estate professional. On top of that, we would also want to perform a cost segregation study on each rental. Doing so will allow us to take the additional depreciation that we’ve missed without limitations on deductible passive losses. Without the real estate professional status, you may be limited to the passive losses you can write off. That’s why timing this is critical.
5. Using a Home Office to Unlock Transportation Deductions
If you don’t have a home office and you’re deducting travel to and from your home and a rental property or project, I have bad news—you’re toast if you’re audited. Your transportation expenses are considered a personal commute when traveling to and from your home if you do not have a home office. The IRS deems this as traveling from “home to business location” and is thus non-deductible. Add a home office, and you are traveling from “business location to business location,” which the IRS deems is a business trip and fully deductible. Semantics unlocks the ability to fully deduct your transportation expenses.
This was a long enough article. Thanks for sticking through it. I hope you learned a bit about the tax industry and what to look for. I really hope you can take one of the tax strategies I highlighted to your tax professional and implement them today.
What do YOU look for in a CPA? What have your past experiences with this industry been?
Leave your comments below.