Real Estate Accounting Tips

I went to a investor club meeting today, and the speaker was a CPA. Here are the important things that I was reminded of, or learned for the first time:

• If you buy a property, you can only deduct expenses up to the amount of your basis in the property. So if you buy a property for $100,000, you can't deduct more than $100,000 worth of fix up expenses, until the property starts generating income to offset additional expenses.
  
  
• With an S-corp (or an LLC that elects S-corp taxation), you can only deduct what you personally put in, NOT what's financed! So if you buy a property for $100,000 and put $10,000 down, you can only deduct up to $10,000 of expenses, even if you spend $50,000 fixing it up! When you sell the property, you can then deduct expenses up to the amount of gain you had, so if you sold the $100,000 property for $150,000, you could then go ahead and deduct the $50,000 you spent on fixing it up. That seems really lame. I have always elected S-corp taxation to avoid self employment tax, so I'll have to re-think things with any LLCs that are doing real estate.
  
  I think you would be OK as long as you flipped the property in less than a year. But if not you would be stuck with expenses that you couldn't deduct. I need to look into this more...
  
  
• With an LLC (that elects sole proprietorship or partnership taxation?), it's basically the opposite of the S-corp -- you can only deduct expenses on a property up to the amount that you financed, not what you put down. So if you buy a property for $100,000 and put $10,000 down and finance $90,000, you can deduct up to $90,000 of expenses. That seems bizarre.
  
  
• Tim the CPA said that you generally save by filing as an S-corp if you're making in the 65-100K range.
  
  
• Real estate agent income typically goes on schedule C, and you pay self employment tax on schedule C income. So you want to have as many deductions on schedule C as possible to reduce self employment tax. For example, taking a deduction for a home office would move some of your mortgage interest, that would typically be deducted on schedule A, over to schedule C, thereby reducing the amount of income that you have to pay self employment tax on.
  
  
• If your full time job is investing in real estate, then the IRS would consider you a "dealer". A dealer does not get to use capital gains rates, everything is taxed at ordinary income rates. And a dealer cannot do a like kind exchange (1031). You do not want to be a dealer! Being a real estate agent does not make you a dealer, but just having a license doesn't automatically get you out of being considered a dealer. It just depends on where you're making your money and spending your time.
  
  
• A "real estate professional" can take an unlimited amount of deductions on investment properties. A real estate professional is defined as someone who spends at least 750 hours (I think that was the number?) per year in their real estate activities, AND makes at least half their money from their real estate activities. If you are not a real estate professional, you can deduct up to $25,000, but even that amount gets reduced or eliminated if you make more than 100K. So it's good to be a real estate professional.
  
  
• Tim was not clear on this point, but he believes that short term capital gains can only be offset by short term capital losses, not by long term capital losses. So if you lost money on the sale of a rental home that you owned for more than a year, you could not use that loss to offset fix-and-flip income.
  
  
• You are supposed to send a 1099 to anyone that does any work for you that you pay over $600. Unless they're a corporation (C-corp or S-corp) in which case you don't have to. The penalty if you don't send 1099s is $25 per 1099. Even if you didn't send the 1099, Tim didn't think the IRS would disallow the deduction for the work, as long as you had an invoice. So sending 1099s seems like unnecessary work unless you have hundreds of them. Easier to pay the fine if you get audited.
  
  
• To deduct mileage for your automobile, you're supposed to write a check to yourself and record it as an expense. The other option besides tracking mileage is to depreciate the vehicle, but you can't do that unless you use it at least 50% of the time for business purposes.
  
  
• Having expenses on your VISA bill is NOT sufficient record keeping. You have to have receipts and invoices or you're screwed in an audit.
  
  
• When doing cost segregation in order to accelerate depreciation on long term properties, each category of items has its own time period that you depreciate it over. The house itself is 27.5 years, personal property 5 years, land improvements such as sidewalks or major landscaping, 15 years, etc. Commercial properties are depreciated over 39 years.
  
  If you buy a property, it's not OK to just estimate the value of each item. You have to have a professional do the cost segregation analysis, if you want it to stand up to IRS scrutiny. But if you do an improvement yourself, then you aren't estimating, so you can segregate that item. For example, if you spend $2000 on a new sidewalk, you can depreciate that $2000 over 15 years (instead of 27.5), because you know exactly how much you spent for it. But if you buy a house that already has a sidewalk, you can't just say "I think that sidewalk is worth about $2000".