Depending on the state where you live and also the state where you are investing, the amount of money you will have wrapped up in real estate investing taxes can significantly vary. As the US tax code continues to change and develop every day, there are also many different laws and regulations surrounding investment taxes that will continue to change as well. Part of the best real estate investment strategies includes a plan for dealing with this.
Cut Through the Jargon
Taxes are inevitable, which is why it is so important to understand all of the financial implications of a real estate investment before making a purchase or getting started in the business. You need to know how investment property taxes work in the states where you want to invest. There are also a variety of loopholes and tax breaks that you may be able to benefit from, depending on your specific situation. Doing your research and regularly keeping up with tax laws will help you to stay informed and make better investment decisions.
With years of experience managing a successful real estate business and handling property taxes, I know what it takes to properly manage these rules and regulations. Save thousands using the advice in the following posts.
On Friday, December 22, 2017, tax reform legislation was signed into law by President Trump.
After the tax plan was signed, my business partner and I had a meeting with our CPA to discuss tax strategies for both the remainder of 2017 and for the upcoming year. They also provided us with the chart below, which summarizes the key provisions of the new law. I recommend meeting with your CPA to determine how the tax reform will impact your business and what tax strategies to implement to maximize your benefits.
Disclaimer: The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, investment, or tax advice or opinion provided by CliftonLarsonAllen LLP (CliftonLarsonAllen) to the reader. For more information, visit CLAconnect.com.
How do you think real estate entrepreneurs will be impacted by the new tax reform?
Diane Gardner, a certified tax coach, launched a business with the specific focus of providing tax advice and offering tax planning for real estate investors of all sizes and experience levels. In our recent conversation, she provided four legal ways to reduce our tax bill.
The first thing you need to do to decrease your tax bill is make sure you are in the right entity type. Many investors, especially beginners, will hold property in their personal names. Not only does this open you up to potential liability issues down the road, but it also opens you up to paying unnecessary taxes.
Diane said, “by being able to move [properties] over possibly into a different type of entity, whether it be an LLC, an S Corp, a C Corp, or something along those line, they were able to do some tax planning with that, because we have more to work with at that point.” For example, she said, “we can look into setting up a management company and hiring maybe a spouse to work in that company, and then being able to write off potentially 100% of all your out-of-pocket medical costs.”
By being in the right entity, there are a lot of nice tax strategies that will decrease your tax bill, which you wouldn’t have been able to take advantage of by keeping the properties in your personal name.
#2 – Automobile deductions
Another basic tax deduction are automobile related expenses, which Diane said are often overlooked. “Make sure that they’re taking advantage of all their auto deductions, whether they’re taking standard mileage or they’re actually tracking actual costs.”
#3 – Meals and entertainment
A third, and also often overlooked tax deduction are meals and entertainment. “How many times are they meeting with potential investors, potential seller, buyers, whatever it might be? Make sure that they’re taking full advantage of that write-off as well.”
These first three strategies – right entity type, automobile deductions, and meals and entertainment – are simple and should be implemented immediately to decrease your tax bill this year.
#4 – Hiring family, both children, spouses, AND parents
A more complicated, but lucrative tax strategy is hiring family members to work in your business. You may know that you can hire your children to work in your business, but did you know you can hire your parents as well? Diane’s mom has been working in her business for years. It helps lessen her tax burden, but secondarily, it benefits her mother by providing her with extra income while her “dignity remains intact because now [she’s] feeling worthwhile and important again.”
Diane said, my mom “needs just that extra little bit each month to make ends meet, so I have hired her to work in my business. She fills out a time sheet, just like all my other staff do. She gets paid an hourly rate. We have her do various things around the office, and in the end, I would be helping her whether it came out of my personal pocket or it came out of my business pocket. But by hiring her to work in my business, I’m able to write off that many, versus I just cut her a check out of my personal account. That’s not a write-off for me.”
This strategy is slightly more complicated than the previous three because there is a little more effort and work required. Diane said, “you do want to have a job description and you want to have and keep a time sheet. And you actually have to set them up on payroll. You can’t just give them money and then at the end of the year to do a journal entry and drop this into my books so I can take it off my taxes. You actually have to pay them payroll and withhold the appropriate taxes, and just really make the point that they are a bonified employee, and that you are paying them a reasonable salary or a reasonable hourly wage.”
When was the last time your accountant brought you an idea that saved you thousands of dollars in taxes?
That was the question that pushed Travis Jennings, who has educated the wealthy on better techniques to improve their finances, investments, and taxes for over a decade, to launch an automated online platform to share the solutions of the top 1 percent with beginner investors. In our recent conversation, he provided three techniques to save thousands of dollars on this year’s taxes.
Technique #1 – Rent your house to your business
If you create a LLC, then by definition, you are a business owner. As a business owner, there are many different ways to decrease your tax bill. One well known example is deducting the square footage of your home office. However, what most investors don’t know is that they can rent their entire house for business events.
Travis said, “let’s say that I threw a pool party and I invited a friend of mine that was potentially going to become a client. Well, as long as we discuss business and we take notes, I get to rent my home to my business for that day.”
To determine how much in rent you can deduct, go to a site like Zillow.com, look up your homes estimated monthly rent, divide by 30, and that is how much you can write off for each event. For example, let’s say Zillow says your home could potentially be rented for $3,000 a month. That’s $100 per day. If you host a business event once a month, that’s a $1200 savings.
Travis said, “there’s some structure to that. You want to take notes. You want to have [meeting] minutes. You kind of want to briefly write down what you discussed that was business, and just in case one day you ever get audited, you’ll have some proof as to what you did.”
I host a monthly poker event with some friends and investors, so I plan on implementing this strategy immediately, and you should too!
Technique #2 – Hire your kids
Do you have kids? Put them to work and realize even more tax savings. Travis has three kids, and he puts all three to work at his home office. Once your kids turn seven, which is the age of Travis’s youngest, you can hire them.
Travis said, “you may have heard of this, but I’m going to give you a twist that’s even more fun. So what if we hired our kids at the 0% tax rate? What if we paid them $6,300 a year? Well, then effectively what we would be doing is shifting dollars off of my tax return and putting it onto their tax return. And if we’re paying them just enough to be in the 0% tax rate, if I’m in the 40% tax rate, I’ve just saved 40%. So on 3 kids at $6,300 a piece, I’ve just saved myself about $8,000 in taxes.”
Technique #3 – See if you have the right CPA
The biggest mistake a typical real estate investor makes from a tax standpoint is never upgrading accountants. “I would say that most investors – real estate included – don’t start off with the ten million dollar projects,” Travis said. “They build up to it. So then the accounting professional or your tax advisor is typically the advisor that you had in the beginning. I would say that most people don’t grow or they don’t reevaluate their trusted advisors enough. They just roll with what they’re comfortable with.”
The CPA that specializes in new development and a standard CPA, for example, have two completely different skill sets. If you have the wrong CPA for your niche, you could be missing out on huge tax savings.
A great way to determine if your CPA is the right fit, and if they are capable of getting you the most tax savings, Travis said to ask them “Can you tell me about one of the solutions in the last month or so that you implemented with a different client to save them a bunch of money in taxes?” He said, “if they stutter, if they seem unsure how to answer it, then they’re probably not doing a lot of proactive tax planning.”
In my conversation with tax expert Jeff Hobbs, he explained a little known and little understood method that is virtually guaranteed to put money in your pocket. The method is called cost segregation, and Jeff explains what it actually is and why every investor should look into the benefits.
What is Cost Segregation?
Cost segregation is the identification of building components and reclassifying the tax life on each of those components. In a cost segregation study, a building is literally broken down into all of its individual components – all the wood, studs, screws, nuts, bolts, cubic yards of concrete, square yards of carpeting, gallons of paint, etc.
Most commercial properties establish a 39-year depreciation schedule, and most residential properties establish a 26.5-year depreciation schedule. However, the IRS assigns a tax-life to each of the individual components. Most components that qualify for accelerated treatments can have their tax life reclassified to either 5, 7, or 15 years:
5-year tax-life components: tangible, personal property assets (carpeting, secondary lighting, process related systems, cabinetry, ceiling fans, etc.)
7-year tax-life components: all telecommunication related systems (cabling, telephone, etc.)
15-year tax-life components: land improvements (parking lots, sidewalk, curbs, landscaping, site features like a flag pole or a pond, etc.)
Why Would An Investor Use Cost Segregation?
Jeff says that the best reason to apply cost segregation is because it puts money in your pocket. For example a typical $1 million asset is going to provide the owner between $50,000 and $150,000 in federal income tax savings. If the study resulted in $80,000 in tax savings and the investor owed the IRS $80,000 in federal income tax, then that just paid 100% of the tax debt!
When Jeff engages with a client, he provides a guarantee! For properties that are sub-$500,000, he guarantees a 300% ROI (return based on cost of services). For properties that are over $500,000, he guarantees a 500% ROI. His average client ROI is 1200%. With the typical $1 million building, the $80,000 tax benefit from the example above would cost between $4000 and $7000, depending on asset size, complexity of asset, where it is located, and the documents that the client has available.
Are Cost Segregations Always Beneficial?
There are only two occasions where a cost segregation study isn’t beneficial. (1) If you are a non-profit organization or (2) you aren’t profitable. In base occasions, you aren’t paying taxes, so getting a tax savings isn’t going to do anything for you.
Everyone wants to save as much as they can on their income taxes. Therefore, at the very least, it pays to look at what the benefits of cost segregation can do for you. A quick Google search of “cost segregation service in (city)” is the best place to start!