Best Tax Tips for Real Estate Agents & Tax Write Offs to Pay Less Taxes
In this video we discuss the best tax tips for real estate agents so they pay less taxes as realtors. We provide many examples of tax write offs a real estate professional can deduct in their income tax return to lower their tax liability as much as possible.
This video is intended for education purposes and should not be taken as legal, financial or tax advice. You should consult with a professional about your unique situation before acting on anything discussed in these videos. Freedomtax Accounting and Multiservices Inc., Freedom Insurance Financial Inc., Freedom Realty Source Inc., and Freedom Immigration International Inc. are providing educational content to help small business owners and individuals become more aware of certain issues and topics, but we cannot give blanket advice to a broad audience. Freedomtax Accounting and Multiservices Inc., Freedom Insurance Financial Inc., Freedom Realty Source Inc., and Freedom Immigration International Inc. or its members cannot be held liable for any use or misuse of this content.
Hello from FreedomTax Accounting, we’re an accounting firm where we have been providing quality tax and accounting services, now for over 20 years. In this video, we’re going to provide the best tax tips for real estate professionals, basically so you can pay less taxes, and who doesn’t like that? So, let’s go right into the content because we have a lot to talk about.
Now, you need to know that FreedomTax is part of Freedom Group where we also provide tax accounting, immigration, insurance and financial planning services, so we can help you in many ways. Also, in FreedomTax, we are a full-service accounting firm, but we specialize in foreign national real estate investors; if you have a foreign national or a foreigner as a real estate client, they have special tax needs. We specialize on those types of foreign national tax clients, especially if you have a foreign seller, you need to talk to them about FIRPTA, we are experts at the FIRPTA tax withholding, so we can help you with the FIRPTA tax withholding if you have a foreign real estate seller as a real estate client.
Now, what will we talk about in this video? The first thing, in the first section, we’re basically going to talk about how real estate agents pay taxes and what type of taxes do you as a real estate agent pay. Also, we’re going to talk about what you should do to pay less taxes, we’re going to talk about different tax strategies that you should implement in order to pay less taxes. And the last part of the video, we’re going to talk about the things you should be doing or best practices to avoid an IRS audit as a real estate agent.
So, the first thing you need to consider for tax strategies as a real estate agent is “What type of business structures do I work under for my real estate business?”. Usually, a real estate agent who is starting out, they usually start working as a Sole Proprietor, meaning that they’re self-employed, meaning that they’re working under their name. Now, most experienced or real estate agents that have been doing this for many years, maybe their real estate business has grown, and I’m pretty sure that most of you know real estate agents that they form or are working under a PA.
Now, the PA is an old business structure, it’s not that it’s bad, but we recommend that all real estate agents work under an LLC. A new real estate agent or an experienced real estate agent, they should be working under an LLC, in this video we’re going to talk about that a little bit further on; or they can also work under a corporation. Now, you may say well “I don’t see the S corporation here, because I have real estate agents that they work under an S corporation” well, that’s true, is that the S corporation is not a legal business structure; the S corporation is a tax assignment, basically a legal business structure that now, it is assigned to pay taxes as an S-Corp, so the S-Corporation is a tax designation; for example, you can have a legal LLC and that legal structure of the LLC can pay taxes as an S-Corp. The PA can pay taxes as an S-Corp. The corporation can pay taxes as an S-Corp. Why? Because the S-Corp is a tax designation, it’s not legal business structure.
How do most realtors pay taxes or what taxes do real estate agents pay?
Now, once again, most real estate agents start working as a Sole Proprietor, but this way of paying taxes also applies if you are a real estate agent that is working under an LLC. Why? Because when you work under an LLC and you’re the only owner of the LC, meaning that now your LLC is a single member LLC, the automatic tax designation for a single member LLC, is that it pays taxes as a Sole Proprietor. So, legally you are an LLC, that way you get the legal protection, but for taxes you pay taxes as a sole proprietor.
How do sole proprietors pay taxes?
If you are a sole proprietor, meaning you are working under your name, or if you have an LLC as the single member, you’re going to file taxes under form Schedule C. The Schedule C is a tax form that goes inside form 1040 which is your personal tax return. It’s not a separate tax form. Schedule C goes inside your personal taxes. How does Schedule C work? You report your total real estate commission or sales of the year, then you have all your business expenses and then, you have your net profit at the end of the year. That net profit gets reported on your personal tax return as additional income; this additional income is going to pay federal tax, which starts at 10% but right now it can go all the way up to 37%. Why? Because the tax rate is determined by the total household income; so, the total household income will determine the tax rate that this net profit is going to pay on your personal tax.
(Remember, we’re recording this video in 2021, so these are the current tax rates. This may change a little bit in the future, but tax rates don’t change that much).
So, you know you’re going to pay federal tax on the net profit of your schedule C, but you’re also going to pay self-employment tax, which is 15.3%, which most of that is social security tax. So, at minimum you’re going to pay the 10% federal tax, and you’re going to pay 15.3% self-employment tax, so at minimum you’re paying 25.3% in taxes. That’s the way Sole Proprietors or single member LLCs, those are the taxes that you pay.
How do you pay less taxes?
The more expenses you report, the less net profit you have. the less taxes you pay. The best tax strategy to pay less taxes as a real estate agent is to take advantage of all the possible business expenses that you can deduct. All the legal business expenses that you can deduct, because basically you don’t want to get into trouble with the IRS.
What are business expenses? I think, one of the most common questions that we get here from our real estate agent tax clients is, “what can I deduct on my tax return as real estate expenses?” or “what is the best expense as a realtor?” Well, there are many things; basically, anything that you need to pay in order to work as a real estate agent is a business expense.
Now, the IRS says that those business expenses need to be ordinary and necessary. What does that mean? Ordinary means that they need to be business expenses that are considered normal in an industry. So, if you are a real estate agent, ordinary business expenses are expenses that a real estate agent usually must pay in their industry; for example, if you’re a real estate agent and you buy a set of knives, knives are not an ordinary business expense for realtors. Now, if you’re a chef or work in the food industry, then buying knives is an ordinary business expense. And a necessary business expense is something that you need that’s not out of the norm, for example, you may say well “I need a Ferrari to work as a realtor” well, you may think but that’s not necessary, you can work as a realtor with any type of car. So, the business expenses need to be ordinary and necessary.
The most important thing that you should know is you need to keep good documentation of all your business expenses, and we’re going to talk more about that a little bit further on. Now, if you want more detailed information on the business expenses that you as a real estate agent can get, can deduct from your taxes, take a look at IRS Publication 463 or IRS Publication 535; that’s the specific tax laws that you can use to get detailed information on the business expenses that the IRS is going to allow you to deduct as a real estate agent.
Now, examples of business expenses or the most common business expenses that real estate agents deduct:
First is Marketing, basically all that you pay for your marketing is a business expense, your business cards, your website, your google ads, whatever you pay for the yard signs, the magnet that you put on your car, anything related to marketing, flyers, balloons that have your real estate logo on them, anything related to marketing is a business expense.
Another thing is real estate coaching, training and education. Now, see that here, we emphasize real estate. You can deduct any type of coaching, training and education for the real estate industry; for example, if you take a cooking course, your cooking course is not related to your real estate business, so the course that you took for cooking is not a real estate business expense. Also any type of Real Estate Licensing or Renewals, once again, Licenses and Renewals related to your real estate industry- Also any Real Estate Associations or Listing Services as the MLS, for example, there are a lot of real estate associations, they have an annual fee, that annual fee you can deduct as a business expense but, let’s say that you also are part of a chess club or a tennis club, and that tennis club pays $500 dollars a year; that tennis club fee is not part of your real estate business, not a business expense, so it has to be related to the real estate business.
Other examples of expenses that you can deduct are gifts. Now there are some rules to the gifts that you can give for your real estate clients. If you give a gift to your real estate client, the maximum you can deduct is $25 dollar per gift, if it’s a single person, if it’s a couple married and the couple that is married are your real estate clients and you give them a gift, you can deduct up to $50 dollars, if they are a couple that’s married. So, if you buy you a single person who’s your real estate client, you buy them a $50 dollars Amazon card, if it’s single, you can only deduct $25 dollars, but if that person is married and both are your clients, if you buy them a $50 dollars Amazon card, then you can deduct the full $50 dollars.
Any software or business tools that you pay to run your real estate business; for example, we have a lot of realtors that they have a CRM system so, they can keep track of their clients contact information, email blasts, they also have a mileage tracker, most real estate agents they have an app on their phone that tracks their mileage and I think it’s like $5 dollars a year something like that; so, that’s a software that you use to run your business. Office 365., if office 365 has an annual fee that you need to use Microsoft word, Microsoft excel, PowerPoint, that is a business expense. We also have several real estate agents that do their own accounting, and they pay QuickBooks online; the monthly fee for QuickBooks online, that is a business expense, all right.
Also travel, travel that is business related; for example, let’s say that you are in Miami and you have a client that is buying a home in Jacksonville and instead of driving, you decide to take a plane from Miami to Jacksonville to see your client, or see a property, or see a listing, then that is a business trip, or if you need to travel to another state for a real estate conference, then that business trip you can deduct the airfare, the hotel, the rental car and all your meals while you are in the business trip, but it has to be business related and, once again, you need to keep documentation and proof that it was a business trip; receipts, flyers of the event, things like that.
Another common business expense that a realtor can deduct are office supplies; your stapler, your pens, your sticky notes, the ink for the printer, your printer paper, those are all office supplies. Now, you can also deduct office equipment, but there are several rules. If you buy any office equipment that’s above $2,500 dollars, you cannot deduct it 100% in some cases; for example, if you buy a new laptop and that laptop is now $3,000 dollars, or you buy a desk, or you buy a printer, or a server; office equipment that’s over $2,500 dollars, you cannot take the full tax deduction unless you use section 179 of the tax law, that allows you to deduct a 100% of the office equipment, but you can only use that the first year; or if you have equipment that’s over $2,500 dollars you have to depreciate it in 3 to 5 years. Now, if you can use a 100% deduction the first year, why would you do the depreciation in 3 to 5 years? Well, for example, let’s say that is your first year and your real estate business has a loss, why would you take 100% deduction on a loss? Maybe you take part of the loss and then the other part of the deduction you use for future years that is going to help you bring your taxable income down.
Other examples of business expenses for real estate agents are food and entertainment. There are a couple of changes here and things you have to be aware of, is that usually the regular rule for food and entertainment is that if you go out on a business dinner, or business lunch, or you buy meals for your clients, you can only take a 50% deduction. Now, for the tax year 2021 and for the tax year 2022, if you are taking your clients to a restaurant as a business meal, then it can be 100% tax deduction, but that’s only for those 2 tax years and that’s something that the government did in order to stimulate the restaurant industry due to Covid, because the restaurant industry was one of the hardly hit during Covid, so in order to stimulate the restaurant industry, there are allowing a 100% deduction on business meals, for year 2021 and 2022.
Professional services. Whatever you pay your CPA, if you hire an attorney for something, when you do an open house, and for example we have realtors that they have musicians, a guitarist playing in the open house, a musician that’s playing music in the open house, that’s an independent contractor that you’re paying for your business. If you’re paying someone to put out the yard signs around the open house; any help that you pay someone for marketing, those are professional services, if you pay a graphic designer, those are all professional service that you can deduct, but if you pay these independent contractors more than $600 dollars a year, you need to give them a 1099 at the beginning of the next tax year, so you can deduct it as a business expense and then they can file you their taxes.
You can also deduct your cell phone, but it’s only the percentage of the cell phone bill that’s used for business, for example, if you use the same cell phone for business and personal, let’s say that you have evidence to show that 50% of the time, you use the phone for personal phone calls and 50% of the time, you use the cell phone for business, then you can only deduct 50% of your total cell phone usage; or if you have a family plan as a cell phone and you have four lines, let’s say is $25 dollars per line, so it’s $100 dollar cell phone bill, you cannot deduct 50% of the $100 dollars, so if it’s four lines, $25 dollars each, so if you take your cell phone line which is $25 dollars and you use your line 50% for business so it’s 50% of the $25 dollars of that cell phone bill. Unless you have two separate phone lines, and one line is for personal and the other line is only for business, then that business line you can deduct 100%. If you’re working under an LLC and the cell phone, your mobile account is a corporate account, meaning that either T-Mobile, AT&T, Verizon, you have a corporate account, meaning that the invoice is under your business name, then that can be 100% deducted as a business expense.
Now, the final two expenses, they also have a little bit of controversy and one of the most audited by the IRS. The first one is transportation, your transportation expenses can be deducted in two ways, the first way is using the Standard Mileage Method, is the simplest way of doing it basically you need to keep track of the miles that you drove for your real estate business, and for 2021 you get 56 cents per mile deduction. This is the simplest form, but here you cannot deduct gas, repairs, the car payment, maintenance, none of that can be deducted because this formula includes all that.
The second way of doing your transportation expense is using the Actual Expense or the Itemize method, this is a little bit more complicated but sometimes it’s worth it to go through the extra work to get a higher tax deduction for transportation. Basically, you need to figure out what percentage of time do you use the car for your real estate business, for example, let’s say because you use your car for personal reasons as well; once again, let’s say that you can prove that 50% of the time you use the car for business, that means that the entire year’s expenses for auto maintenance, repairs, gas, auto insurance, parking, lease and tolls, then 50% of that you can deduct as a business expense, it doesn’t have to be 50%. Let’s say that you say, “I use my vehicle 25% of the time for my real estate business”, then you can deduct 25% of all these expenses as a transportation expense.
Now, and I think this is the tax deduction for real estate agents that bring the most confusion and controversy, especially in the eyes of the IRS. It’s the Home Office Expense. Now, there are real estate brokers that allow their real estate agents to work on the brokerage office and they give them a desk, so they can work from that desk, usually these brokers call that the “Broker Desk Fee”; if you’re a real estate agent and you are already paying your broker a broker desk fee, the desk fee is an expense but then you cannot take your home office expense. So that’s something you need to know
Now, similar to the transportation business expense, the home office expense can be deducted in two different ways. One way is using the simplified method, this is the simplest form and it’s similar to the transportation tax deduction where the government already gives you a standard formula (once again, these change every year so you need to check what’s the formula for the year you’re filing taxes); for 2021 is $5 dollars per home office square feet, with a maximum of 300 square feet, so basically a maximum of a $1,500 dollar simplified method home office tax deduction. Basically, take a measure of your home office space and find out what are the dimensions, the square footage. If you find out that your home office is a hundred square feet, then you take 100 and you multiply by $5 dollars and you can take 5 times 100 is $500 dollars, that’s your home office expense, but let’s say that you have a home office that’s 500 square feet, the maximum is 300 square feet, and this is the maximum amount that you can take as a home office expense.
The second way that you can take the home office expense is using the Itemized or Regular Method. This is a little bit more complicated, but once again depending on the case, it may be worth going through a little bit more work because you’re going to get a higher tax deduction. Basically the first step is that you need to calculate the percentage of the home office compared to your home, for example, let’s say that you have a 2,000 square feet home, and the 2,000 square feet home you have a 200 square feet home office, that’s 10% of the total square footage of the home; now that you know that is 10% of the home, then you can deduct 10% of all these home expenses, the mortgage, the insurance, the utilities, the repairs, the depreciation; but the first step is to calculate how much percentage of the home is the home office that you use. You must be very careful using this method, because even though you can get a higher tax expense, the last couple of years the IRS has been very, very careful and we have seen an increase in IRS audits concerning the home office expense, unfortunately because a lot of people abused this type of tax expense. So, I’m not saying that you shouldn’t do it, but if you do it, keep good documentation and make sure that it is being done correctly.
Now, there are more advanced business expenses for real estate agents, I would say this is more for real estate agents that are working under an LLC. There are retirement accounts that offer good tax deductions, for this please contact our office and you can talk to one of our financial planners, because depending on your case, there are several retirement accounts that you can use for business expenses as well.
Going now to the third part of this seminar, what are the best practices that you should follow in order to avoid an IRS audit if you are a real estate agent?
Very important and a lot of realtors make this mistake, keep a separate bank account for your real estate business. Even if you don’t have an LLC, even if you’re working as a real estate agent under your name. Have a separate checking account for your business. Don’t mix personal income and personal expenses with an account that has business income and business expenses. Keep personal account and a business account, keep it separate, that way you’re going to avoid a lot of trouble with the IRS.
Once again, documentation is very important, you should always keep your tax records; usually it’s 3 years, but we recommend up to 7 years, just in case there’s an IRS audit. Now there’s a lot of ways of documenting your business expenses, there are a lot of apps available on your phone that can keep track of your expenses where you can take pictures or receipts, and that keeps them all organized for you. Not only should you take pictures of your receipts or scan them, because receipts tend to fade over time, so it’s better for you to have a digital folder of your tax documentation.
Another best practice or a recommendation is, if Tax Day is getting near and for some reason you still don’t have all your tax documents; for example, April 15th is getting near, if you have an S-Corp it’s March 15th and you still haven’t done your taxes, file an extension, even though your taxes are not done. Why? Because the extension is going to save you the filing late penalty, and you get an additional 6 months to file. Remember, there are 2 tax penalties, the first one is for filing late, and the second one is for paying late, so the extension only covers the filing late penalty, but if you owe taxes, the extension does not cover the paying late penalty. So, your CPA should tell you an estimated amount of taxes that you’re going to pay, so if you file an extension, you should send it with a payment, even if you’re overpaying, because you’re going to get that as a refund of whatever you overpaid.
Another best practice is that you should work under an LLC for the legal protection, even if you’re a new realtor. Why? because if you’re working under your name and working under a single member LLC, you pay taxes the same way as a sole proprietor as we showed you before, but you get the legal protection, meaning that if anything happens in your real estate practice and somebody wants to sue you, the lawsuit is going to go to the LLC, not under your name, so your personal assets are protected. Now, if you are working under an LLC or a corporation or PA, when your net profit is over $40,000 dollars, then you should have your LLC, or corporation, or PA, file taxes as an S-Corporation, and let me show you why.
Let’s say that you’re a single member LLC, you start off as a real estate agent, and remember single member LLCs, they start paying taxes on their form schedule C, as we showed you before. Remember the sales, the expenses and the profit get reported over here, you pay federal tax starting at 10% and you pay self-employment tax that is 15.3%. Now, what happens when you convert that Sole Proprietorship into an S-Corporation? It’s similar, you don’t file form schedule C, now you file form 1120-S which is a separate form, which unfortunately is a lot more complicated and a lot more expensive, and here the net profit also gets reported under your personal tax with the main difference that you do not pay self-employment tax, so you automatically save 15.3% in taxes. Now, you may ask yourself “Why doesn’t everyone do this?” Is because the S-Corporation has other requirements, for example the S-Corporation, the form (the 1120-S form) is a lot more expensive, the way you do your accounting is a lot more complicated, so you most likely are going to have to pay a CPA to do your bookkeeping; also a requirement for the S-Corp is that you need to pay yourself under payroll, meaning paying a payroll service, every 3 months sending a payroll tax report, payroll tax payment every 3 months. So, the S-Corporation during the year has a lot more expenses, but once the net profit is $40,000 dollars or more, you save so much in taxes at the end of the year that it makes sense to pay those additional expenses during the year, but if this is less than $40,000 dollars, then just keep the sole proprietorship because the S-Corporation may not be a good fit for you.
Thank you for watching this video, remember to subscribe to our YouTube channel. We always recommend our realtors to take a look at our playlist that is called “Tax Strategies on Real Estate Investing”, we have many videos in that playlist that you could learn more about tax strategies for yourself or for your clients, you can share those videos for your clients and they’re going learn as well.
Once again, thank you for watching. This information is general information, every case can be different, we always recommend that you consult your tax professional, if you want our consultation, this is our contact information and we will gladly help you in any tax accounting needs that you may have, especially if you have foreign real estate clients, remember that your foreigners that are selling real estate they have specific tax issues, and we specialize on foreign national real estate investors.
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