With the April tax deadline behind us, how do you feel?
Did you use all of the real estate tax loopholes that are available to you as a real estate investor?
Are you satisfied with the results but feel you may have left some money on the table by not maximizing your write-offs?
Are you confused as to why you owed more in taxes than you anticipated?
Or are you just glad that you filed extensions so now you have more time to actually file your 2015 taxes?
Regardless of which of the above categories you fall under, rest assured that there are things that can be done to help improve your tax situation.
Believe it or not, now is actually the best time to do some planning to reduce your taxes for the current year. I know that some of you may be thinking, “Give me a break, I just spent a ton of time on my 2015 taxes, and if I ever hear another word about taxes, it would be too soon.”
The reality, however, is that now is actually the best time to put some strategies in place for the 2016 tax year. Here are a few reasons why.
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Missing allowable deductions is the single most common reason why people overpay their taxes. The tax code is complex, and most people just have a really hard time understanding what to deduct. Now is the time to educate yourself about what common items are legitimate business deductions for your real estate activities. If you have not done so, be sure to check out our latest book Tax Strategies for the Savvy Real Estate Investor.
So what are business deductions? Well, they can be virtually anything! To determine if an item is a deduction, ask yourself these two questions:
- Is it ordinary for my real estate business?
- And is it necessary for my real estate business?
Most investors include common rental-related deductions on their return, property taxes, mortgage interest, and repairs that are generally necessary and ordinary. What about general and administrative expenses, such as cell phones, business cards, office supplies, meals and entertainment, as well as travel?
Let’s start with business cards: Are they ordinary and necessary for your real estate business? More than likely, they are, so it would meet the criteria for a business deduction.
If you have a home office, then part of your utilities, mortgage, taxes, and even home improvement costs may be tax deductible.
Perhaps you decide to take an investor to dinner. Is it reasonable? Yes, it’s a pretty common business expense. Is it necessary? If you are discussing business, then yes, it is likely necessary. The IRS does, however, prohibit any “lavish” expenses. What are lavish expenses? Well, that’s not exactly outlined in the tax code and is at the discretion of the investor to decide if their outing is a reasonable business expense.
Oftentimes, investors will try to deduct their family vacations. Taking the kids to Disneyland is not a business deduction. Even if you stop by an open house, it is very unlikely that you could substantiate that deduction. However, don’t completely rule out vacations as business expenses. In some cases, vacations could be partially or fully deductible if you plan ahead. Check out our article on “5 Strategies to Make Your Summer Vacation a Real Estate Tax Write-Off.”
Capturing Your Expenses
Once you understand what items are deductible, the next step is to make sure that you capture all these legitimate deductions. Did it take you countless hours to gather up your documentation? Was it impossible for you to find all of your repair costs and receipts for your business expenses? If this describes you and you do not want a repeat of that next year, now is the best time to put some systems into place to automate, systemize, and simplify your record-keeping processes.
What we are talking about is good bookkeeping. Don’t be alarmed — bookkeeping does not need to be complicated, and it does not need to involve fancy software. It does, however, need to be a system that works for you. Excel is easy to use. QuickBooks is great for automation. Take the time now to play around and find something that works for you. Leverage what your CPA uses and leverage what other investors are doing. Don’t reinvent the wheel. Whatever you choose, do it often to make sure your books are up-to-date. The best way to minimize taxes is to make sure that you capture all your expenses.
One of the biggest obstacles that prevent people from accumulating wealth and generating cash flow is the major burden from taxes. Every year, people gather up their tax documents to give to their tax preparer and then just sit back and wait as the tax preparer puts in the numbers, only to later tell them the bad news of how much is owed that year.
One of the easiest ways to minimize taxes is to use the correct legal entities. Now, we are not saying you need to have an entity to write off business expenses. For the most part, all legitimate business expenses can be written off as tax deductions regardless of whether you own an entity or not. Entities can, however, provide you with certain tax savings based on the different tax treatments of income and tax rates. For example, for someone with an active RE business, operating in the correct entity can save up to 15% in self-employment taxes. For someone making $100k of income, this can be a savings of $7k or more each year.
Another example is for those with a very high personal income tax rate, it is possible to use legal entity strategies to shift income into lower tax rates.
Why exactly is now a good time to look into these strategies? Well, the type of entity that makes sense for your real estate business depends largely upon the expected net profit for the year. As we head into the second quarter of 2016, now is the best time to look at how we did on our real estate business so far and also to make some projections for the rest of this year. If you wait until October or November to start looking at tax and legal entity strategies, it may be too little too late.
Please keep in mind that today’s blog post is not intended to teach you everything about taxes. It is not up to you to understand thousands of pages of the tax code. Nor is it up to you to keep up-to-date on all the ever-changing tax loopholes and pitfalls. That is the job of your tax advisor. Just as you are an expert in your industry or your real estate business, your tax advisor should be your champion when it comes to taxes. Leverage their knowledge and expertise to help you keep more of your hard earned money.
With the tax deadline behind us, now is the perfect time to get in touch with your CPA. Tax planning does not need to be scary or time-consuming. Your CPA does not need to be feared. They can and should be a friend that you feel comfortable speaking with. By sharing your current transactions, investing plans, and personal or family changes, your tax advisor should be able to advise you on the best way to set yourself up to minimize taxes for the 2016 year.
Investors: Did you take advantage of real estate-related deductions this year? How are you planning proactively for next year?
Let me know with a comment!