Accounting is the non-glamorous side of real estate investing, yet it is a critical component of cash flow and negotiations. You need to be well-versed in the latest federal and state rules surrounding taxes and accounting (e.g., exemptions, depreciation, deferrals, deductions, marginal tax rates, etc.) so you can use these tools to your advantage.
While I wish there were a way to make federal and state law as exciting as “doing deals,” unfortunately I haven’t figured out how to do it. With that said, a solid knowledge of tax laws and a good certified public accountant on your team, one who can advise you on your short- and long-term portfolio, will allow you to maximize your cash flow and wealth accumulation.
The questions below represent some of those that you as a real estate investor need to keep in mind and pose to your tax adviser throughout the year:
1. Are any changes anticipated to occur over the next 12 months that will affect real estate investing?
This is one of the most important questions you can ask your adviser because it covers the entire gamut of areas that could affect you as a real estate investor. In order to take advantage of the benefits that Uncle Sam provides entrepreneurial real estate investors, you have to know the rules. This not only covers depreciation, amortization, deductions and capital gains rates, but also your marginal tax rate.
2. What is the adjusted basis for each one of my properties?
If you are contemplating the sale of one of your properties, you want to estimate your capital gains tax and work with your accountant to minimize your tax obligation.
3. Has anything changed in relation to estate taxes?
While a Trump administration may try to do away with the estate tax, for now let’s assume that it will be with us indefinitely and could affect your estate. This is not only important for you and your family, but when negotiating a purchase transaction, it may be important for sellers who are liquidating their estate. If you can ease their burden in any way, you have provided a value and furthered a relationship that may lead to a purchase. In times of stress and loss, people often need someone upon whom they can lean or look to for leadership. Let your understanding and knowledge be the crutches they can lean on.
4. What are the Medicaid liquid asset minimums for the year?
This is important especially for older Americans who may be holding a lot of cash, as Medicaid potentially may not cover any illness they experience. Before Medicaid will provide coverage for medical care, a person’s liquid assets must be depleted to a particular amount. A promissory note is not considered a liquid asset. This fact will allow the beneficiary of the promissory note to maintain an income while not holding a “liquid asset.” You can also establish co-beneficiaries within your promissory note so that upon the primary beneficiary’s death, the note and related income may be handed over to their decedents as the beneficiary did not have to burn this asset to pay for medical attention.
5. In your opinion, am I minimizing my exposure to liability by holding my properties in their current entity structures?
As an investor and business owner, it is your responsibility to minimize your exposure to lawsuits and protect your assets. There are many ways to structure your ownership, and you need to identify those that best meet your needs and goals. Work with your team members (accountants, attorneys, estate planners) to help guide your decision-making.
6. Are there any changes in the Section 1031 tax deferral program?
Tax laws are always changing, and you don’t want to make 1031 exchanges with outdated information. This could cost you a lot of money if not handled properly with qualified intermediaries.
7. Are there any new vehicle, tools or equipment incentives this year?
As your real estate business grows, you inevitably will buy things that are tax-deductible. Items purchased for your business as capital expenditures can be written off. A portion of your car expense can be written off as well.
8. What is the current long-term and short-term capital gains rate?
Knowing the workings of capital gains taxes will have an impact on both the buyers and the sellers. When negotiating, you need to be aware of the taxes that the sellers are paying as well as the tax they will have to pay upon sale. Knowing the rate the sellers are paying provides a great insight when negotiating, as it is likely that the sellers are not thinking about the $50,000 check they are going to have to write to Uncle Sam when selling their fully depreciated four-plex. This may be enough for them to consider carrying the financing.
9. What is the maximum “special allocated” loss an active partner can take this year?
$25,000 if you make $100,000 or less and then after that $1,000 for every $2,000 over $100,000. At $150,000 it is eliminated. Passive participants cannot record any losses. A “real estate professional,” however, is not limited in the amount of losses that can be recorded. If you are involved in a partnership, make sure your accountant is aware of the structure.
10. What advice do you have that may limit my tax liability this year?
Empower your CPA to think creatively (but legally) to reduce your tax obligations for the coming year.
11. What do I need to do to be classified as a “real estate professional” and how will this benefit me?
Being a real estate professional will allow you to save thousands of dollars in taxes. Your tax adviser can help educate you on how to do this.
12. Based on your review of my accounting procedures, am I maintaining appropriate records in case of an audit?
Given the low cost of computers and computerized accounting programs, you can afford to work with your accountant to set up proper bookkeeping and record-keeping practices to ensure that you are maintaining appropriate financial records.