Real Estate Investing: 6 Tax Challenges & Solutions
Taxes may not be the best part of real estate investing for many individuals. However, those that embrace them head on, instead of burying their heads in the sand, will find that they can get a serious edge if they take them seriously. Taxes can either take a big bite out of your income and wealth, or can serve as an advantage for your company.
Ignoring taxes is a sure fire way to run into financial stress. So here are 6 common tax challenges real estate investors face, and even more ways to turn these scenarios into profit centers:
1. Delinquent Income Taxes
Past due federal income taxes can quickly go from being out of mind to your most urgent fire to deal with. Wait too long to deal with them and back income taxes can become IRS tax liens, income levies, and result in bank account seizures. While it may not be a fun issue, taking it head on is the best approach. There are payment plans available. The IRS will often settle for less than owed to get tax payers back in the system. Even a new accountant might be able to help revise past returns and find breaks and credits you missed.
2. Trouble Setting Aside Money for Estimated Tax Payments
Those real estate investors that have fallen behind on income taxes have found it increasingly difficult to save any money at all. Without great accounting and an advanced tax plan, you could be shelling out 50% or more of your income in income taxes. There are ways to lower this burden, such as maximizing contributions to retirement accounts, and increasing charitable giving, or potentially even spending most of the year out of the country to gain tax exemption while you catch up.
3. Paying too Much Tax
Wealthy investors often seem to pay a fraction of the taxes that those earning far smaller incomes are being hit up for by the IRS. This doesn’t require any illegal tax evasion, super expensive and complicated offshore shelter corporation strings for asset protection. Perhaps forming an LLC or C Corporation to invest under, getting a better CPA, or keeping better records is the answer.
4. Tax Penalties on Selling and Switching Real Estate Investments
Those realizing large capital gains when flipping houses or restructuring income property portfolios are aware that the IRS wants a big slice of the action. Fortunately, tax codes also provide several legal and financial options for minimizing liability when selling investment property. Two of the most notable are self-directed IRAs and 1031 exchanges, which can defer or eliminate those taxes. It is also critical for real estate investors to keep track of their records including loan payoffs and net proceeds from closings. Mistakes can be made. If a title company goes out of business later on, you may not be able to prove your case. This became a major issue in the wake of the crisis, when mortgage payoffs weren’t recorded or property taxes weren’t paid out of escrow. If you had a $500,000 mortgage that was paid off at closing, but that wasn’t reflected, the IRS will consider that income and expect tax on it.
5. Bookkeeping Expenses
Great bookkeeping is essential for maximizing cash flow and operations, as well as minimizing taxes. Quality is definitely the smart choice here, but there are ways to curb bookkeeping costs. Perhaps your accounting firm can integrate with financial software in your office to automate sending data, and streamline the hours needed to prepare reports and tax returns. Some real estate investors may find that they can benefit from consolidating mortgage loans and operational structures to minimize the work load and reduce risks of mistakes too. Perhaps you don’t need a full time in house bookkeeper. Maybe this work can be outsourced offshore, or on an as needed basis for a few hours a quarter. Perhaps consolidating job functions and having a GM or office manager take on this work can allow you to trim waste, keep them busy, and pay them more money. Learning how to professionally prepare your own taxes isn’t a bad idea either. You may not find this the best practice to do year after year, but it can help with tax planning, and vetting others to help you.
6. High Property Taxes
Property taxes can take a big bite out of proceeds when flipping houses and holding rental properties for income. They can also jump significantly when new budgets are approved, or properties are reassessed by the county property appraiser. This is especially true on new construction property. First, note that there are many exemptions and breaks to be had, and far too many homeowners don’t take advantage of them. Secondly, some taxing authorities and areas are notorious for broken tax systems and consistently sending out overblown bills to as much as 50% of local property owners each year. This situation has been compounded further in recent years after properties have dipped in value, and a string of natural disasters has damaged homes. Thousands of properties are likely eligible to be re-assessed and could see tax bills dramatically lower is assessments are corrected. There are professional firms and attorneys that provide these services every day.
It is always important to speak with a certified tax professional and ensure the moves you are considering making are right and profitable for you. Still, most real estate investors can, and should be paying far less in taxes, and tax related costs.