When you’ve helped thousands of clients prepare successful tax strategies, you’re likely to have a trove of insight to share. Such is the case for Clint Coons, a founding partner at Anderson Business Advisors.
As Tax Day looms, Think Realty caught up with Coons to learn some of his broader tax advice for real estate investors. It’s important to note that every person’s and business’s situation is different and that you consult with a certified public accountant before filing your taxes.
1. Maintain detailed records and stay organized
One pitfall that Coons sees often is investors’ lack of detailed bookkeeping. Don’t make your life a nightmare when April 15th rolls around. Ensure that you keep records of cashflow, expenses, profit and losses, and other key performance indicators.
“Keep good books and records — that’s number one,” Coons said. “I see that as a problem for a lot of real estate investors. Keeping strong books and records is key to making planning and return prep go much smoother.”
Keeping that vital information, however, isn’t enough. Real estate investors must also be well organized and should have a process for how to receive and maintain their data to make tax filing easier and to maximize their returns.
Let’s look at deductions for expenses and how to track them, for example.
Working from home: Home offices are common for real estate investors. There are two important conditions to consider before tapping this deduction. The Internal Revenue Service states you “must regularly use part of your home exclusively for conducting business. For example, if you use an extra room to run your business, you can take a home office deduction for that extra room.” Also, investors must show that “you use your home as your principal place of business. If you conduct business at a location outside of your home, but also use your home substantially and regularly to conduct business, you may qualify for a home office deduction.”
Mileage: Your mileage can rack up when you’re driving between your properties. Starting on Jan. 1, 2020, the IRS allows citizens to write off 57.5 cents per mile driven for business use. There are a variety of mobile apps investors can use to make this tracking task easier, including Everlance, MileIQ, Hurdlr, and many others.
Interest: Investors can also write off interest that accrues on loans. Investors should be able to deduct home mortgage interest, points, and mortgage insurance premiums. Recent regulatory changes have set the limit of deductions of up to $750,000 in mortgage debt.
Depreciation: The IRS allows taxpayers to claim residential properties will depreciate over 27.5 years, meaning that at the end of each year, the value of improvements — also known as capital expenses for renovations — divided by 27.5 can be deducted from taxable income for 27.5 years. In other words, you can reduce income taxes because of your properties’ depreciation.
2. Cost segregation
Coons said, “While it depends on the type of investor, folks should consider a cost segregation strategy.” This seemingly little-known tax-planning strategy can enable real estate investors to not only realize cashflow more quickly but also simultaneously reduce tax liability.
Commercial or residential properties often depreciate over 39 years or 27.5 years, while personal property or land improvements typically depreciate over 5 to 15 years. The tax strategy reclassifies parts of a building to personal property or land improvements, thereby allowing them to depreciate within a shorter time period than the building as a whole.
As Coons mentioned, however, cost segregation is not for every type of investor. Cost segregation studies can be quite expensive, and investors may not reap the cost in tax savings via depreciation or even through the property’s sale. Consult with an attorney or CPA to see if cost segregation is a good idea for you.
3. Set up the right business structure
Once again, every investor’s situation is different. But regardless of your real estate investing goals or strategy, Coons said it’s important to have the right structure for your business.
For example, if you’re a fix-and-flip investor buying and selling properties in your home state, Coons recommends this scenario:
You, the investor, have set up a C-Corporation in the state in which you reside, and you plan to buy and sell property through that entity. To have more asset protection for your growing brand, flippers should consider setting up Limited Liability Companies that are owned 100 percent by the C-Corp.
Then, rather than purchasing properties through the C-Corp, use one of your LLCs to purchase and sell the property. After the property sells, dissolve the LLC to limit the potential harm to your broader organization. A C-Corp can establish and dissolve as many LLCs as it’d like, thereby allowing an investor to protect assets throughout their organization, he added.
“The reason is I don’t want to be in the middle of a flip three years from now and somebody comes back and sues me for something that occurred three years earlier because it could seriously disrupt my business,” Coons said. “By dissolving the limited liability company, you’re making it go away because people would say ‘Well, he’s out of business. That LLC is no longer working.’”
You can learn more about Coons’ recommendations and strategies on the Anderson Business Advisors YouTube channel.