Hello everyone. I run a real estate investment company that focuses on investing in defaulted promissory notes secured by commercial and residential real estate nationwide. We also invest directly in fee simple real estate.
These projects vary in length. While we intend to hold on to as many projects as we can long term, from time to time there are some early exit opportunities that make sense for us.
We typically fund these deals with all equity through private placement with varying % interests of ownership and different investors and investor types (ie. IRA, personal, LLCs, corporations) on each project. Accordingly, we set up a pass through LLC on every acquisition.
For 2017 we have 6 entities that would require state and federal filings including K-1s for investors. In 2018 we expect another 8-10 additional entities to be added to the existing 6 entities.
I consulted with a CPA that specializes in this field. The fees were $1,500 for entities that hold only a loan and $2,000 for entities with fee simple real estate owned. This includes federal and one state filing. So 2017 we're looking at about $12,000 in tax prep and in 2018 we're looking at about $32,000 in tax prep.
That pricing model doesn't seem scalable to me. I get that price includes CPA advisory but over time, as deals are similar to another, the advisory component becomes less valuable, as you already have the model in place. At the pace we're growing, why not just hire an accountant/CPA in house?
Is there a better pricing/compensation model that works for both a tax filer and a business with multiple LLCs that's scalable?
@Andrew Fielder For tax prep, the fees seem high to me, but I don't know how many K-1s you are issuing nor do I know the complexities the CPA firm may be facing. If you are issuing tons of K-1s to investors, I can see how the fees could be justified.
In terms of the fixed prices for tax prep, ideally, in the future, the price will always remain fixed. Thus, when your profit increases, the fees don't increase proportionately.
Ultimately, every tax return will be labor intensive, some more so than the other. I always laugh when someone says "If I bring you 50 entities, will you discount them?" No, because it's still the same cost for me. There's little-to-no economies of scale related to this type of tax preparation (and trust me, we've invested a crap ton into our technology).
Should you hire an in house accountant? It's a decent thought, but your talent pool will be limited. You'll be relying on one person, rather than a firm with processes in place. You can scale into a CPA firm, but a single hire will always have some form of ceiling.
Over time, as you scale, I'd argue the advisory component will become more and more valuable. Your model may be the same, but the larger you get the more complex it will become to manage. Knowing when to make strategic financial/accounting/tax moves will become much more valuable than preparing tax returns.
I have no idea how much revenue you're generating, but you may want to look into outsourced CFO services. @Taylor Brugna is the guy at our firm that runs that side of the business, so he may be able to dive deeper into it than I can.
An outsourced CFO will help you navigate everything, from advice to compliance, and help you make financial decisions. They will manage your books, taxes, your budgets, vendors, clients, investors, and provide transparency into the financial side of the business. In my opinion, that's where the most value is added once you scale to a certain point.
Hire a good CFO, pay $250k. Outsource to a CPA firm, pay 1-2% of revenues (generally).
If you're not at that point yet, but you plan to scale to that point, you need to look into CPA firms that provides that service. Because at some point you'll need it, and already having built out relationships will save you tons of time, money and stress.
@Andrew Fielder , what kind of allocations are written into your operating agreements?
Are they pro rata or are there complicated distribution waterfalls, etc.?
I would say that if there is some complexity in terms of how the cash (and therefore income allocation) goes, then those fees sound justified to me.
However if everything is a straightforward pro rata allocation, it sounds a bit steep for a smaller CPA firm.
Granted however when I was managing funds with tons of entities like yours at a "Big 4" firm in Irvine we would charge $7,500 a pop. So go figure.
Also, I assume that when you refer to "intend[ing] to hold on to as many projects as we can long term," you are referring to the fee simple real estate. What is your typical strategy with the notes? Do you convert to real estate, flip these notes, work out a discounted payoff, etc.?
Also, on average how many states per entity? That obviously also impacts the pricing.
Partnership returns are normally more complex than other tax types. Members of an accounting firm have to read a partnership agreement.
Below are some things that can make a partnership return complex
- Is income/losses straightforward among all the partners or is there something unique like a preferred return, a hurdle or a waterfall.
- The amount of partners within the partnership. For each partner - the accounting firm has to review that the name, SSN/EIN, address is entered correctly.
- The amount of states the business does business in. You may potentially have to file an a state return.
Since there are IRA's - the partnership may have to issue a note indicating what each IRA's share of UBTI(unrelated business taxable income) is.It looks like you are paying roughly $2,000 a return
2017 - $12000 / 6 returns = $2,000
2018 - $32,000 / 14 or 16 returns = $2,285 or $2,000
It is not easy to say if this is a lot or little.
It depends on information such as how complex the return is, how many state returns you are filing and how many partners you have.
Factors to consider when hiring an accountant instead of paying for the services of an accounting firm.
- You need to pay for the cost of the accountant and the overhead.
Overhead includes items such as rent space of accountant, technology, software, trainings etc
- You also have to have someone review the work that he is doing is accurate. It is hard to find an accountant who is familiar with all tax situations.
@Brandon Hall I hear you but these are pretty low activity entities, simple situations and simple ownership structures. I actually approached my CPA who I used for last years tax returns, admittedly he doesn't specialize in the note space but understands it and does do a lot of tax prep for real estate investors. He quoted me less than $1,000 for all the entities and my personal tax return. For me the cost/benefit of the specialization in the note space isn't there yet. Perhaps as the complexity of my company continues to grow the benefit will be there.
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