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Question: I just finished my first full year in real estate after several years in a job where I was on straight salary. I actually earned quite a bit more money than I thought I would as a Realtor. The bad news is that because of my income tax bill I kept a lot less of it than I thought I would. Any suggestions on how to keep more of what I earn?
Answer: It seems you have learned your first lesson in the accounting facts of life - the difference between gross and net. I'll pass on some suggestions based upon my own experience, plus that of a couple of accountant members of my network who specialize in real estate.
Most importantly, it is critical that you understand clearly "who you are". Essentially, you are a one person business. Although you will always work under your managing broker's direct and personal supervision, for all practical business and tax matters you are a self-employed entrepreneur - an independent contractor in the truest sense.
That means everything you spend to generate business for yourself is deductible as a business expense. In other words, you won't pay tax on that amount. The critical element is to know what is a legitimate business expense and what is not.
How important is that? Let's assume that you fail to claim $1,000 in legitimate expenses. That means you will pay federal and state income tax on that amount, plus a hefty social security contribution. Rates being what they are, that will easily amount to several hundred dollars. So for each and every dollar in allowable business expenses you fail to claim you will make a charitable contribution to Uncle Sam (federal) and Aunt Samantha (state).
Should you do your own taxes? An "old head" in the office in which I first worked as a Realtor gave me this practical bit of advice: "Doing your own taxes makes about as much sense as doing your own brain surgery. Get a pro". That's excellent advice. The first year I was in real estate I found a Certified Public Accountant (CPA) who was recommended to me by another very successful Realtor in our office. I've never regretted that decision. He actually seems to enjoy delving through the pile of paper my wife and I dump on his desk each April. Go figure.
My guess is that there’s an accountant in your community who would be delighted to make a presentation each year to your local Realtor membership on how independent contractor Realtors can best meet the income tax challenge. Handouts welcome that detail acceptable business expenses.
If you decide to seek professional help, ask around among your associates (the successful ones) for suggestions. While the services of a CPA or other tax preparer will not come cheaply, the strong probability is that they will end up saving you money in the long run. And personally I place a very high value on the peace of mind it gives me to have a pro doing the mind numbing number crunching involved in preparing a tax return.
Even if you hire help, the major burden of record keeping throughout the year is still yours. You need to make your job as easy as possible by reducing everything to a written record. Central to that is your daily calendar on which you list your appointments and other activities. There are some really fancy products on the market, including some fancy computer programs, but the important thing is to have some kind of daily log. As a matter of routine you should document all of your important activities.
You also need to develop the habit of getting receipts for everything. That will be easier if you routinely pay by credit card or by check. When that's not possible and you pay cash, jot down the amount, the date, and the purpose. Have several large envelopes labeled by expense category for all your receipts.
One of the real challenges when we discuss income tax is that rules change so frequently. Each year I purchase one of the national tax books as a reference. The better job you do of preparing your information for your accountant, the less your bill is likely to be. And here’s a lesson I learned from my military career - “choose your enemies wisely.” Several prominent leaders throughout history have made a serious and fatal mistake in this regard.
The moral to the story is that you wish to be very conservative in your income tax strategy. You do not want the IRS as an enemy.
The feds are fond of saying that you are not expected to pay any more tax than you legitimately owe. If through oversight or ignorance you do, however, the strong likelihood is that they will keep it and not even send you a thank you note. That should provide you a very strong incentive to get your tax act together.
Best Regards, Ken Edwards