Smart Investors Who Run Their Own Real Estate Businesses Take Advantage of Every Tax Deduction Possible
The thrill of posting profits from your first real estate deal is priceless. But paying taxes on that deal come April — well, that’s not so priceless. Taxes can end up costing you big time, especially if you don’t have a plan in place. That’s when it pays (literally) to develop a tax strategy.
“For most businesses, taxes are one of the largest — if not the largest — expenses,” says Gary Milkwick, vice-president of operations with The Tax Club, based in New York. “If investors make money, they need to have a tax strategy to minimize the tax burden. If they are losing money on an investment, they can decrease their income from other areas.”
Even though paying taxes may be the last thing on an investor’s mind, it should be one of the first things they plan for, Milkwick says.
The first step to developing a solid tax strategy is simple: hire a professional to help.
“There are some general strategies you can employ, but to really come up with something that is going to be effective, you have to meet with an expert,” Milkwick says.
Forget about sifting though the tax code yourself or taking advice from a “buddy” who does his own taxes. Tax law changes daily, and specialists get regular updates with code changes that are most applicable to their client base. Do-it-yourselfers tend to miss important deductions and credits that really add up.
“People don’t take advantage of everything they’re entitled to and often end up paying more in taxes,” Milkwick says. “The worst-case scenario is that they do something wrong and get in trouble with the IRS.”
A tax professional will create a customized plan to minimize your tax burden and maximize the money in your pocket. And you don’t have to be netting six figures to benefit.
Often, people will put off hiring an accountant because money is tight or time is short. But, Milkwick says, if you go too long without a good accountant, you could be leaving money on the table.
“It’s really common for accountants to say, ‘If only you would’ve come to me three years ago …’ ” he says. There isn’t much that can be done after-the-fact (or filing). “The good thing about real estate is you can be cash flow positive but for tax purposes actually have a loss.”
After you’ve hired an accountant, be sure to meet with him or her in the fourth quarter of the year. Don’t wait until the New Year (or later) for a bookkeeping sit-down.
“We call our clients in October and November to talk about where they are at,” Milkwick says. “We look at purchases they may be making or need to make and see if they can purchase something by December to get a tax deduction in the current year.”
Setting up the appropriate entity is one of the most crucial parts of a tax strategy. Having the right entity structure can mean the difference between ordinary income taxed in a standard tax bracket and capital gains taxed at 15 percent.
So what is the “right” entity? Well, that depends. Investors may have one LLC, multiple LLCs, an S-Corp or a C-Corp.
“A person might choose an LLC and that might make the most sense for somebody who is flipping houses,” Milkwick says. “An S-Corp could save other people a lot of money. It depends on the situation and the investor.”
The right entity could save an investor thousands of dollars. A licensed tax professional will be able to assess the type of entity that is the best fit and do the legwork in its creation.
Once you’ve set up your tax system, don’t forget to use it.
“It is super important to make sure you have some kind of system to keep track of everything,” Milkwick says. “A lot of people don’t even think about tax stuff from the prior year until April 14 and then they’re doing all of this crazy stuff to make the deadline.”
People miss deductions all the time simply because they forgot to document what they did, he says.
“If you set up a separate entity for your business activities, get a separate checking account, get a business credit card and be consistent in using those,” Milkwick recommends.
Then, all that is necessary come tax time is to print and itemize statements, not search through stacks of files for the right receipt.
Now that’s priceless.
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