Some of you may think that this article is absurd. Tax time is not going to be here for several months. Why would anyone be thinking about taxes right now? I’m sure that many of you are not thinking about 2015 tax returns yet. In fact, I will bet that a few of you may have just recently filed 2014 returns.
However, before we get too far into the holiday season, this is a good time to start planning to reduce 2015 taxes. Right now is actually the best time to start year-end planning to see what your tax situation looks like for 2015. This will allow you to see if there are any steps that you can take between now and the year’s end to minimize your taxes. Once the year is over, there are very few things (if any) that can be done to change your 2015 tax situation. To help you get a head start, here 5 things to consider.
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What Does Your Income Look Like for 2015?
First things first, you’ll need to get an idea of your income and expenses for the year. Get together with your bookkeeper or property manager to see what the numbers tell you. Did you make more money than you anticipated? Or did you end up with some losses this year? Planning cannot occur unless your advisor knows what income and expenses you had this year.
Have you had any major changes? If so, make sure you let your CPA know. Examples can include purchasing or selling properties, job changes, personal or family changes, and investing in new ventures. If you have a potential upcoming change, be sure to discuss it with your CPA so they can advise accordingly to uncover any potential strategies.
Do You Have the Correct Legal Entity?
Business activities and income can change drastically from year to year. What many investors do not know is that sometimes entities may need to change as well. Just because an LLC worked well in the past doesn’t mean it is still the best entity for 2015. Entities should be reviewed each year to make sure that the structure is still the most beneficial for you.
An example of this is our client Adam, who started a fix and flip business a few years ago. In the beginning an LLC worked well for him because he was doing this on the side and not making a huge amount of money. However, this past year, Adam started doing flips full time and made over $100k in profits. If he had kept his LLC as is, he would have owed federal and state income taxes, as well as an additional 15 percent in self-employment taxes on that income. Instead, by electing to be treated as an S Corporation, Adam will be able to save around $6,000 in taxes. If you find yourself in a similar situation, this should definitely be a strategy to discuss with your tax advisor before year-end.
Do You Meet the Real Estate Professional Requirements?
The “real estate professional” status can be a great benefit to an investor. If you or your spouse have higher income from wages, interest, or capital gains, then your real estate losses may be limited or disallowed for that year. The losses are then carried forward each year until you are able to use them. For some investors, the losses are not used until they sell the property. One strategy to avoid this problem is by claiming real estate professional status. As a real estate professional, you may be able to deduct all of the losses without having limitations from other income. The catch is that you must meet two criteria in order to qualify.
- First, real estate must be your primary job. This means that you spend more time actively involved in real estate as compared to all of your other jobs combined.
- Secondly, you must work over 750 hours in real estate during the year.
If you can meet both of these requirements, then you may stand to save a large amount of money in taxes. In fact, one of our clients recently lowered his tax bill by a shocking $20k by claiming real estate professional status.
Before claiming real estate professional status, make sure that you log your hours so that in the event of an audit, you can prove that you met the criteria to take the deduction. If you are short on hours, now is the time to sign up for real estate classes or spend more time rehabbing or managing your properties. All of your hours must be completed during 2015, so make this part of your year-end tax planning.
Do You Have a Retirement Account in Place?
Although a lot of retirement accounts do not need to be funded until April of next year, some of the more powerful ones do need to be set up by year-end. Plans such as 401(k)s and Defined Benefit Plans must be set up by December 31st, although you may have as late as October 15th of next year to put money into it. If you anticipate owing a substantial amount of tax, having a retirement account to fund may help you reduce that liability while putting money aside for tax deferred growth. A maximum contribution is not always needed either; even just contributing a small amount can help. For example, just before this past October 15th deadline, our client Mark made a $7,000 SEP contribution and lowered his tax liability by over $2,000. The key is to strategize before year-end to determine what type of retirement account is best for your situation.
Have You Set Up a Year-End Planning Meeting Yet?
The holidays are usually a busy time of year for most people. With parties, shopping, and the winter break, make sure that you plan ahead and allocate some time for proactive tax planning. Keep in mind that year-end can be a busy time for your tax advisor as well. Make sure to call your CPA now to set up a time for strategic planning. Give yourself plenty of time to implement these new strategies before the New Year is upon us.
What have you done to start preparing for tax season?
Leave your questions and comments below.