Category: Tax Planning

How To: Millennials Saving Thousands by Using a Defined Benefit Plan

Do Millenials know what a Defined Benefit Plan is?  How often do Millennials think about their retirement plans? Retiring is like that high school crush you never quite figured out. Intriguing yet perplexing, offering promises of golden years filled with leisure, yet fraught with the complexities of financial planning. As millennial small business owners, we’re steering the ship of our enterprises through the choppy waters of the present, but it’s crucial to keep an eye on the horizon. And by the horizon, I mean retirement. Yes, that seemingly distant future where we hope to reap the rewards of our hard labor. But as we chart this course, weighing the anchor of retirement plans with a balanced perspective is essential. Let’s dive into the pros and cons, with a dash of wit, as befits our generation that grew up on a diet of memes and existential humor.

The Good #1: Defined Benefit Plans are Tax Advantages Galore

A Defined Benefit Plan is a Millennial cheat code for taxes. First up, let’s talk about the wonderful world of tax breaks. Enrolling in any retirement plan can be like finding a cheat code in the tax game. Contributions to plans like 401(k)s, SIMPLE Plans, or IRAs can lower your taxable income in the year of the contribution.  This means Uncle Sam gets a lot less and you keep a lot more.

An added benefit is that your investments will grow tax-free until you decide to cash out and buy that dream villa in Thailand.

The Good #2: Attract and Retain Top Talent with your Defined Benefit Plan

I considered this for a long time.  Due to the cost, Defined Benefit Plans are usually used by family-run, sole proprietors, and husband/wife businesses.

If you have the kind of business that needs technically adept employees (in whatever niche you are working), then it might be more important to your business’s success to have continuity with your employees.  If that’s the case, offering a Defined Benefit Plan to your list of employee benefits may be the cherry on your employment sundae.

The Good #3: Compound Interest, Baby!

I love compound interest.  Every investor should.  Curiously enough, this is a concept that confuses folks.  If you aren’t confused, skip ahead.  If you are, let’s take a look at how it helps.

We learned that contributions are tax deductible.  We also learned that appreciation and income from your investments are tax-free at the time it is earned.

Compound interest is free money.

Let’s say you contributed $100,000 to your DBP on January 1, 2020.  Annual earnings on your investments earns 5% per year.

Your balance on January 1, 2020 is $100,000

Your January 1, 2021 balance is $105,000 ($100k x 5% = $5k, $100k + 5k = $105k)

Your balance on January 1, 2022 is $110,250

Why isn’t it another $5k?  Because you are also earning income on the income you earned the previous year.  $5,000 x 5% = $250.

That’s compounding in a nutshell.

The Good #4: It’s a Motivation Booster

I’ve had clients tell me this.  At first, I didn’t think much of it, but as I aged I started to get it.

Having a retirement plan in place is like having a tangible representation of your dreams and aspirations for the future. It’s a constant reminder that you’re not just working for the weekend (something all too familiar to those of us who are self-employed).

You’re building towards something bigger, something that’s waiting for you down the road. This can be a powerful motivator, driving you to push through the tough times and aim for the stars—or at least a comfortable recliner by the beach.

The Bad #1: The Complexity Conundrum

Now, let’s address the elephant in the room: retirement plans can be as complicated.  If this isn’t your world, it can feel like you’re playing a game you don’t know the rules to.

A Defined Benefit Plan is one of the most complex retirement plans available, and any Millennial considering one should really do a lot of research.

With terms like “vesting schedules,” “contribution limits,” and “required minimum distributions,” it’s enough to make your head spin. And this doesn’t begin to illustrate the administrative duties required.  And did you know your retirement plan will now have its very own tax return?

For small business owners already juggling a million tasks, delving into the intricacies of retirement plans can feel like learning a new language. But fear not, for the internet (and financial advisors) exist.

Make sure your financial advisor is aware of the administrative requirements and that they can handle them.

The Bad #2: The Cost of Commitment Can Be Steep

Offering a retirement plan isn’t just a verbal promise.  With it comes financial commitments and administrative responsibilities that will be around for as long as you offer the plan.

There are setup fees, annual fees, and sometimes, matching contributions to consider. It’s akin to adopting a pet; it’s rewarding, but it requires ongoing care and attention (and yes, money). 

For small businesses operating on tight margins, the costs may not be worth the outcome.  I love these plans for Sole Proprietors and Husbands/Wife teams.  When you start including employees, the contribution and admin costs will go up exponentially.

The Bad #3: The Lock-In Effect

This is the issue where I get the biggest pushback.  I get it. You grew up in a different world than my old ass.

A Millennial contributing to a Defined Benefit Plan will no doubt feel constrianed. The “lock-in” effect feels different to different people.

In essence, the “lock-in effect” means your retirement savings are earmarked for retirement, so access is a little more complicated.

How complicated?  Well, not really.  If you need to access the funds you may have an early withdrawal penalty of 10% (and whatever your state may charge).

Your retirement savings are not like a regular savings account where you can dip in for a spontaneous trip to Tahiti or that Porsche 992 you have your eye on. These funds are meant for your retirement years, and accessing them before the IRS retirement date can come with penalties and taxes (you get a deduction for the contribution, you pay tax when you withdraw). It requires discipline to keep these funds untouched, which can be challenging when life throws a curveball (or several).

…And Finally: Millennials and Defined Benefit Plans

As a millennial small business owner, you’re not just planning for the next quarter; you need to be looking decades ahead. Integrating a retirement plan into your business and financial strategy is a move done sooner rather than later, one that also promises massive tax advantages, especially for the Sole Proprietor.

Yeah, there are complexities, some big costs, and commitments to navigate.  If you are looking for a path to a comfortable and secure retirement, then think of it like planting a tree. The best time to plant it was yesterday, and the second-best time is now.

So, let’s embrace the challenge with the same enthusiasm we apply to all aspects of our lives, from mastering the latest social media trends to prioritizing sustainability. After all, retirement planning isn’t just about securing our future; it’s about building a legacy that reflects our values and aspirations. And who knows? By the time we’re ready to hang up our entrepreneurial hats, we might have figured out the plot of “Inception.”

How To Use S Corp Payroll for Optimal Tax Planning

Your S Corp payroll can save you MONEY! As an S Corp shareholder, you are required to be on the companies payroll.  Let’s look at the best way to “pay” yourself as an S Corp owner.

Introduction

S Corporations (S Corps) can be looked at as a great blend of a pass-through taxation and liability protection.

What this means is you have an entity that pays tax like an LLC (or partnership), but gives you the business structure of a corporation.But as an S Corp, you are required to be on payroll.  This allows you to set your payroll salary at a level which the IRS would be happy with, but also allows for distributions, which save on payroll taxes.

Navigating the intricacies of payroll as an S Corp owner is important for compliance and tax savings.  Let’s check out a few strategies that help S Corp owners make the most of their payroll structure.

S Corp Payroll

You must be on payroll if you actively participate in running the business and are a more than 2% shareholder.  This is only a requirement if you actively work in the business.  If you don’t actively participate in the business, you aren’t required to be on payroll.

This balance of compliance with IRS regulations is the key to maximize your tax savings. The key lies in determining a reasonable salary and strategically utilizing a mix of salary and distributions.

What is a “Reasonable Salary”?

This part of your S Corp payroll is required. This is always the hard part.  Mostly because the IRS has no real guidance other than the wage must be “reasonable”.

The easiest way to establish a baseline is to determine what you would pay someone to do your job.  Put together a job description and we can use that to research comparable pay.

To establish what a “reasonable salary” is for your specific business, you should consider industry standards, their skills, experience, and responsibilities to avoid the risk of “unreasonably low” salaries.

When I’m assisting a client with finding their “reasonable salary”, I always review what other companies are paying.  Indeed.com, Salary.com and Payscale.com are a few sites I look through.

Another consideration is the success of the business in question.  If you can’t afford, or the business doesn’t generate enough income to pay a salary based on your findings, then pay less.

Generally, a shareholders salary must be at least 50% of your net earnings before paying yourself.

You Are Tax Planning Even If You Didn’t Know It.

Finding the best balance between your salary and distributions is the ultimate in tax planning.

I’ll tell you why.

If you take all of your profits via payroll, you are paying more in payroll taxes than really required.

Let’s pretend you made $100,000 in net income (before payroll) last year.  Your net take home pay in this example would be around $71,500.  I used California as the state.  A Digital Nomad (i.e. no state return filed) would end up with about $76,500.

Optimizing payroll for S Corp owners involves finding the right balance between salary and distributions. Understanding the advantages of each and utilizing business deductions are essential for minimizing taxable income and maximizing tax efficiency.

If you determined your salary should be $50k (instead of $100k), you would be right at a 50/50 split between salary and distributions.  This would save (in payroll taxes) about $4,000.

See.  Tax planning.

You Must Comply With IRS Requirements

Congress recently passed legislation which increased the IRS budget by $79.4 billion over the next 10 years (this is in addition to the annual budget given for operations).

One of the things they will use this money for is audits of S Corps, specifically as it relates to shareholder payroll.  This is low hanging fruit and can generate billions in payroll taxes and the related penalties and interest involved.

I have started seeing these audits and the IRS is taking a position that ALL of your net income should be paid out using payroll.  The best course of action is to pay yourself with a nominal salary.  You can pay yourself a bonus periodically to increase your pay to reflect at least 50% of net income.

I don’t advise simply paying yourself a small salary each month, taking the rest in distributions.  You are in no better of a situation if your pay balance is 10/90% (payroll/distributions) vs 45/55%.  You’ll mitigate penalties and interest, but this will be a minor expense related to the actual payroll taxes. 

Employee Benefits for S Corp Owners

If you are an S Corp shareholder, the only legal way for you to receive benefits would be via payroll.

Without a paycheck, you can’t contribute to a Solo 401K or SEP plan. 

If you’re not on payroll, you can’t get an auto supplement.

Without a paycheck, you won’t be able to deduct your health insurance.

If you pay yourself via payroll, you open up the world of benefits you can receive as an employee of your own corporation.

Without a paycheck, your corporation cannot pay for benefits on your behalf.  If you do, you must 1099 yourself for the amount paid out.  You will report this income on your personal income tax return as self employment income.

Should You Hire an Expert?

There are two parts to this question:

1  Determine a salary amount which you can show is “reasonable”

2  Run your S Corp’s payroll at least monthly (this is the legal minimum).

You should be able to determine a reasonable salary by using one of the salary sites I referenced above.  Be sure to save your research in the event the IRS questions the amount of salary you give yourself.  You will need a persuasive argument when dealing with the IRS.

Where you should consider an expert is in the preparation of payroll.  While the actual calculation is easy (heck, there are hundreds of web pages to calculate your payroll).  The important part is tracking and reporting your payroll each quarter.  I advise your payroll reports be prepared by an expert.

I haven’t had many clients in my career who were able to properly calculate AND report payroll.  Payroll tax issues are also one of the most prevalent issues small business owners experience.  Let a pro handle this aspect of your business.  This also frees you to make more money.

A Simple Case Study

You will see the benefits of this even with a simple situation.  In this example, it’s just me.  Not as a licensed tax professional, but as a guitar player.

I’m an ok player and have a few set gigs a week, with the occasional event.  I’ve been around a while and have made $100,000 each year for the past 5 years (just to make the math easier).

Earlier, we noted that a $100k salary would give you about $71,500 after taxes were withheld.  Cutting your salary in half saves about $4k in payroll taxes.

It really is that simple.  The complication is figuring out what your MINIMUM salary can be.  The balance between compliance and savings.  This is a personal calculation.  If you can prove your salary amount is reasonable, the rest can be taken as a distribution saving payroll taxes from being paid out.

Conclusion

Figuring this out is the easiest way to save real money with tax planning.

You must comply with S Corp payroll requirements for active shareholder participants.  This fancy talk for “pay yourself what you’d pay someone else to do your job”.

Your salary should be AT LEAST 50% of what your net earnings are for any given period.  I’ve spoken with auditors who use a 75/25 split to start.  I would negotiate this down to be closer to the 50/50 split.

The easiest way to do this is to set yourself up with a nominal salary to be paid every month. Give yourself a bonus every quarter that increases your pay to the 50% figure we aim for.

You must pay yourself as an employee if you work for your S Corp.  You may as well do it right and save a little money!

That’s it for now.  Hit me up if you have questions.  Until then, stay cool.

JKC

Find Out From An Expert What Legal Fees Are Tax Deductible.

Should you know what kind of legal fees are tax deductible?

Not all legal fees are tax deductible. After you read this article, you will know when and where your legal fees are deductible.

I’ll break down the different ways you can deduct legal fees you pay in the coming article.  We’ll go over several scenarios and explain the proper method of deducting your attorney fees and how the deduction will affect your tax liability.

Deducting legal fees isn’t as straight forward as it appears.  Taxes, as I’ve stated for much of my career, are not born out of logic.  Tax law and how they come to be are a political process.  This process is a political tool that means we need to understand the different ways these legal fees can be treated. They will not always make sense.

One more big issue. At this time, most personal legal fee deductions are suspended.  This info will be viable for your state, and certain legal fees not affected by the TCJA.

Here goes!

The deductibility of legal and attorney fees as an individual are generally only allowed if they were for one of two topics.  Taxes and income protection.  An inconsistency of this rule is legal fees paid for estate planning are typically NOT tax deductible.  In my mind, estate planning covers both taxes and income protection.

See.  Political.  Not logical in many ways.  And this makes it more complex and confusing than it need be.

  • Just Your Regular Old Legal Fees

For the most part, legal fees paid for things like estate planning, divorce, child custody or accidents are not tax deductible. Sometimes there is a way to get a partial deduction and I’ll explain this when appropriate.

  • Dedectible Personal Legal Fees

Do You Have a Rental Property?

The IRS looks are real estate rentals as a passive activity.  I know.  Cleaning up after messy tenants or repairing plugged toilets isn’t exactly passive.

If you incurred legal expenses due to tenant issues, or any contractual issue relating to the rental property, this would be 100% deductible as a business expense.  You’d deduct these legal fees on Schedule E.

Include legal fees paid for renovation or building planning process in the basis of the improvement or property and amortized.

Do You Have Your Own Business or Side Hustle?

Legal fees paid with regard to a business or side hustle (I know.  They’re technically the same thing.  My distinction is between a full-time gig and a part time thing).

Regardless, money spent on legal fees for a business or side hustle are generally fully deductible.  There must be a direct connection between the business and the why of the legal fee.

Suing someone who owes the business money would be 100% deductible.

As an example, you use your car 50% for work and 50% personally.  An elephant from the local circus damaged your car.

You sue the circus and they pay to fix your car.  Since the car was used personally 50% of the time, 50% of your legal fees would be deductible as a business deduction.

Take a legal fees deduction on your personal tax return under the TCJA as follows:

  • Deduct legal fees paid for your rental property on Schedule E.  Schedule E discloses your activity on a specific rental unit or site.
  • Deduct legal fees paid in relation to your business or side hustle on Schedule C. Schedule C discloses your activity on you business or side hustle..
  • Allocate legal fees which had a personal element to them. If a personal element exists, you can only deduct the amount which pertained to the business or rental property.
  • I suggest you ask your attorney for two invoices.  One to your business, one to you personally.
  • For legal fees deducted before 2018 and after 2026 you were limited by a 2% “haircut” The amount was 2% of your adjusted gross income.
  • You can’t deduct legal fees on Schedule A until 2026.
  • If your lawsuit was due to your being discriminated against, the legal fees are NOT deductible on Schedule A.  These fees are an Above The Line deduction and should be reported on Schedule 3.  This is really important!
  • What if you were discriminated against?

This little hitch in the tax code is a real benefit.

Tax deductible legal fees as an itemized deduction isn’t a 100% deduction.  Items deducted as Miscellaneous Itemized Deductions get a 2% haircut.

This means you lose part of the deduction equaling 2% of your Adjusted Gross Income.

  • Mary sued her employer for $1mil because they discriminated against her due to her age when giving out promotions.  She won her case.  Her attorney’s kept 40% of the total proceeds.  Mary’s adjusted gross income for the year was $1,100,000 ($100k salary + $1mil settlement).
  • Since this was a discrimination suit, the legal fees are deductible as an above the line deduction.  You don’t lose the 2% like a Misc Itemized Deduction.  This gave her a $22,000 larger legal fee deduction.
  • “If” these legal fees were for a non-discriminatory suit, the legal fees would be a state deduction subject to the 2% haircut.  Legal fees deducted would be $378k in this case.
  • The lawsuit is based on a discrimination charge so she takes the entire $400k paid to the attorney as a deduction on Schedule 3.
  • Claim the income on the return.  Nothing special about how to report this income.  You’ll probably receive a 1099-Misc form.
  • Deduct your legal fees on Schedule 3 as an Other Deduction.  Label the deduction as Unlawful Discrimination Case.

Since this is a direct deduction without any limits, you will see a better result than if it were deducted as an itemized deduction (this will be back in 2026).

The best part of this is if you aren’t typically itemizing, you’ll still get the Standard Deduction.  More tax savings.

How About If I’m a Federal Whistleblower???

Deduct legal fees associated with being a whistleblower on Schedule 3, just like you did when discriminated against.

If you were a state level whistleblower you need to check your state specific rules.  If you are a state level whistleblower who brought an employment suit, your legal fees are treated the same as any other discrimination suits fees.

Government whistleblowers will get some relief on their taxes.  Issues as specific as these usually need some specialized research.  Remember to ask questions if you find yourself in this kind of situation.

  • Contracts… 

If you’re in business, you will always have some sort of contractual agreement with someone.  It’s smart to put your agreements to paper as a protective measure.  It’s for your protection as well as the other party.

Legal fees paid to draft, review and finalize a contract are fully deductible on your Schedule C.

  • …Broken Contracts

Does someone owe you money?  Is someone refusing to comply with a signed contract?  How about someone who did work for you, but it wasn’t to your specifications or was it some really bad work?

If you take them to court, arbitration or mediation, the fees will be deductible.

Renter doesn’t pay?  Sue and deduct the legal fees.

How about a legal fight with the City about some improvements you want to make?  These expenses you would add to your basis and depreciate over time.

How about the cost of writing up a special contract between a prospective tenant and you?  Heck yeah.  Fully deductible.

Most of these legal fees will continue to be deductible on your state return.  Check and see if your state complies with the TCJA of 2017.  Your state may comply with parts of the TCJA but not all.

Any fees paid for financial advisory services and support are deductible on your state return.  These fees are lumped in with the fees paid to manage your portfolio or subscriptions to finance based newsletters and the such. 

I lump these costs in with your tax prep cost.  Allocate part of your fee to Schedule C and E. Any fee allocated to your itemized deductions will be deductible on your state return.

How I’ve read the statute as it relates to this topic, I would add the fees to basis and not deduct in the current year.

VI. Deduction Limits and Other Weird Things to Consider

Most states will allow a deduction for legal fees as an itemized deduction.  The TCJA suspended legal fee deductions made on Schedule A until 2026.

Fees paid for discrimination suits, or as a government whistleblower are handled differently than other legal fees paid.  These fees are deducted above the line and give a much better deduction.

Just because a legal fee isn’t deductible on your federal return doesn’t mean you won’t benefit from the deduction on your state return.

Conclusion

Knowing the types of legal fees that are deductible can save you a lot of money.

Generally, the Tax Cuts and Jobs Act of 2017 suspended the deduction of many legal fees on your individual (1040) return as personal deductions.

If your lawsuit was about discrimination, or you acted as a whistleblower at the federal level, the deduction is an above the line deduction.  The above-the-line deduction refers to taking a deduction directly after your Adjusted Gross Income has been calculated.

State level whistleblowers may be able to deduct legal fees.  Most states comply with federal rules, but every state is different.

Above the Line deductions are dollar for dollar deductions which will reduce taxable income by the entire legal fee expense paid.

Legal fees paid for a rental property or business dispute will be 100% deductible.

Solo 401(k) or SEP IRA: What are the differences! Two Big Reasons A Solo 401(k) Is Better.

I’ll admit.  This retirement stuff can be confusing.  I mean really confusing.

401K’s, IRA’s, wait…there are more than one kind of IRA?  SEP IRA?  ROTH IRA?  ROTH 401K??  What are they trying to do to you!?! How do they compare? Why are there so many plans!? Is there really a difference in a Solo 401(k) or a SEP IRA?

To keep the confusion to a minimum, let’s look at two available options and how they would fit into your retirement plans.

Let’s compare a Solo 401(k) or SEP IRA.

Let’s lay the foundation.  We’ll be looking at Tom & Steph.  Steph is an orthopedic surgeon and Tom manages Steph’s medical practice.  They have no employees currently but that could change.  Steph does well and brings in around $600k per year.  They have very little in the way of overhead expenses.  Let’s say 10% of receipts.

I’ll also be comparing the Solo 401(k) or SEP IRA plans with the business in a corporation, and as a sole proprietor.

I. Solo 401(k)

This plan is a combination of a 401(K) plan and a SEP IRA.  The first part is a 401k, similar to what you may participate in working at a larger company.  2023 401k contributions are limited to $22.5k with a catch-up provision of $7,500 for those over 50.  The company can then match up to 25% of W2 wages as a SEP Contribution.  With the catch-up contribution, you are limited to $73.5k in total contributions.

  1. A. Eligibility and contribution limits: Solo 401(k) plans are often referred to as a Married 401k since you must be self-employed with no full-time employees other than your spouse. Limits for the Solo 401(k) are higher than other retirement plans due to the dual nature of the plan types. For 2023, the maximum contribution limit is $62,500 ($73,500 if you’re age 50 or older).
  2. B. Employee and employer contributions: One of the advantages of a Solo 401(k) is that it allows both employee and employer contributions. As an employee, you can contribute up to $22,500 ($26,000 if age 50 or older) in 2023. Additionally, you can make employer contributions of up to 25% of your net self-employment income.
  3. C. Tax advantages: Contributions through payroll and profit sharing (SEP) reduce taxable income in the corporation.  With a maximum tax rate of 21%, you can expect to save at least 21% on your contributions.
  4. If you are a Sole Proprietor, contributions are deductible against all income but the calculation is based on net self employment income.  Since the max tax rate for an individual is 37%, you could conceivably save up to 37% on your contributions.
  5. D. 401K and borrowing against your balance: As with regular 401k plans, you can “borrow” from your balance.  You must pay this back just like you would if you borrowed from a bank.  Most of my exposure to people borrowing against their 401k were taxpayer borrowing the funds as a down payment on a new home.
  6. E. Sole Prop vs Corp: Here’s where they differ the most.  If the business is in a corporation as shareholders you must be on payroll.  The contribution is determined by how much you were paid through payroll.  Since many S Corp owners also take distributions (which are not part of the calculation), the amount you can contribute may affect total payroll taxes.

If your business is a Sole Proprietorship, the calculation is based on your net income.  This may allow you to contribute more vs. a corporation, but you won’t get the employment tax savings if contributed via payroll.

Now let’s take a look at the SEP IRA part of our 401(k) vs SEP IRA comparison

II. SEP IRA

This is the “not 401k” part of a Solo 401k plan with different limits.  A Simplified Employee Pension Individual Retirement Arrangement (SEP IRA) is another retirement savings option generally for self-employed individuals.  The total contribution limits are the same as a Solo 401k.

  1. A. Eligibility and contribution limits: The biggest difference between the two plans is the ability to have employees other than your spouse on payroll. The contribution calculation as a sole proprietor is 20% od net self employment income.

    The biggest difference is calculating as an employee of your own corp.  The calculation is still 25% of your W2 wages.  To contribute the max SEP in a corp, you must have $264k of wages.  Compared to a Solo 401k,, your W2 wages need to be $174k (after the Solo 401k employee contribution) for a total of $204k in wages.
  2. B. Employer contributions: A SEP IRA is a fully employer based contribution.  There are no catch-up provisions with a SEP so the max contribution allowed is $7,500 less (the catch-up provision allowed with e 401k contribution).
  3. C. Tax advantages: Contributions made to a SEP IRA are tax-deductible for the employer. For the employee, the contributions grow tax-deferred until retirement, similar to the Solo 401(k).  Tax savings as a percentage are the same as for a Solo 401k.  Possible savings are lower due to the lower contributions allowed.
  4. D. You can’t borrow against your SEP IRA balance.  Keep this in mind when choosing your plan.  The ability to borrow against your retirement funds is a nice feature to have in your back pocket.
  5. E. Sole Prop vs. Corp:  Due to the disparate difference in tax rates, you would most likely save more as a Sole Proprietor (37% max vs 21% max).  

III. Now Let’s Compare the Two: When should you use a Solo 401(k) vs a SEP IRA?

Solo 401kSEP IRA
Eligibility and contributionsCan only be used for Sole Proprietors with no employees other than a spouse. Solo 401k’s are expressly forbidden if you have employee’s other than a spouse.SEP IRA’s are available to any business with or without employees.
Employee and Employer ContributionsSolo 401k’s are a combination of a 401k and a SEP IRA. The employer contribution component is still the SEP. There is no employer match of the 401k contribution.SEP IRA’s have no povision for employee contributions. 100% of the SEP contribution will come from the employer. If you have employees, they must be allowed to participate if they qualify.
Tax AdvantagesAll contributions are deductible as an expense directly on your corporate return. Contributions are also deductions on your individual return, except it doesn’t reduce Self Employment income so it doesn’t affect your individual self employment tax. Contributions made by the employee is a reduction of taxable income on their return as well.All contributions are deductible as an expense directly on your corporate return. Contributions are also deductions on your individual return, except it doesn’t reduce Self Employment income so it doesn’t affect your individual self employment tax. Since there are no employee contributions, SEP contributions do not affect the employees taxes.
Borrowing?You can borrow against the balance in your 401k. Generally you have 5 years to pay the loan off unless you are buying your principal residence. If borrowing to by a home, you have upwards of 25 years to pay the loan back.You cannot borrow against your SEP IRA account.
Sole Prop vs CorpThe method of calculating your contribution as a corp is dependent on wages paid on your W2. Calculating your contribution as a Sole Proprietor uses the Net Self Employment figure, but does not reduce self employment tax.The method of calculating your contribution as a corp is dependent on wages paid on your W2. Calculating your contribution as a Sole Proprietor uses the Net Self Employment figure, but does not reduce self employment tax. Since there is no employee contribution the employee doesn’t get any tax relief.

IV. Now that you have all this great info in your head, which one is right? Solo 401(k) or SEP IRA

  1. A. Employees?: If you don’t have employees and are married, the Solo 401(k) is probably the better choice. However, if you have employees or anticipate hiring in the future, the SEP IRA allows you to make contributions for yourself and your employees.

    But.  There is no reason you can’t start with the plan that best serves your needs at that moment and move to a different plan at a later time that suits your needs better at that time.
  2. B. Contributions?: A Solo 401k has higher contribution limits, so if that’s your goal a Solo 401k plan is the one for you.  I also believe there is no other plan better suited for a married couple working on their business.

    A SEP is a lot easier to fund, but you have a lower contribution limit and if you have employees, they must be included and receive a share of any contribution.
  3. C. Loans and Accessibility: Being able to borrow against the balance in your 401k can be a life saver.  With no ability to access funds, other than through a distribution you will likely pay a penalty on, as well as tax, a SEP gets a big thumbs down here.

V. Conclusion: Solo 401(k) vs. SEP IRA Final Say!

With the level of complexity associated with most retirement plans it’s no wonder people panic and are anxious when having to make a decision as big as “What Plan Is Best?”.

They look at their current situation, and also envision how the company will look in1, 2, 5 or 10 years.  With the invariable “Will this plan work for me in 10 years?”  questions on the fringe of your thinking.

So what to do?

Husband or Husband/Wife teams would almost always benefit from utilizing a Solo 401k plan.  With the ability to sock away $73,500 each in 2023 (and the max contribution amount goes up almost every year), a Solo 401k plan can be a great conduit to saving for retirement.

If you have employees, the best of the best is a SEP plan.  You can contribute the most of any of the other plans (minus the above Solo 401k plan and a Defined Benefi plan, which we will discuss later).  The big negative for most small businesses would be the requirement to fund your employees accounts as well as yours.

If circumstances change, like the wife has a baby and they decide the husband will stay home and raise the kids, you can change plans.

Watch for future comparisons between the most popular plans.  I’ll be comparing between the following plans:

Traditional IRA
ROTH IRA
Defined Benefit Plans
Defines Contribution Plans
SIMPLE IRA Plans
ROTH 401k Plans

Until next time, thanks for reading and stay cool!

JKC

Using a Self-Directed IRA for The Ultimate Private Placement.

Or, how to use a Private Placement in Your Self Directed IRA to fund your business with retirement savings and pay no tax!

You’ve worked at a job for the past 15 years and want more from your career. Starting your own business is typically the next step. How would you fund this? By using a self-directed IRA and a Private Placement.

Saving for retirement is something we all think about on some level.  I felt time was on my side when I was young.  Now that I’m in my 60’s, I realize how misguided (politically correct phrase for stupid) I was in my thinking.

Another benefit of saving for retirement is

So what’s the deal with Self-Directed IRA Plans?

I. What’s a Self-Directed IRAs and Why Do I Care?:

The primary difference between a Traditional IRA and a Self-Directed IRA is the custodian of your account.

The “Big Guys” like JP Morgan, Schwab or Smith Barney can all house Traditional  IRA’s for you but you are only allowed to buy the investments they offer.  The IRS has a short list of the type of investment you can hold in your IRA.

The IRS must approve your financial institution to act as a custodian for self-directed IRA’s.

The list of investment options is much larger with a self directed IRA.  It can also be a source of funding to invest in or start a business (this is considered for private placement since the investment is offered privately and not through a public offering)..

II. What Really is a Private Placement Investment:

Generally, private placement is a sale of securities to a preselected set of individuals (or institutions, but that doesn’t matter for the purpose of this article).

Private placements generally have much less government oversight or regulation to be concerned with.

I perform due diligence when I’m in a private placement not of my own doing (i.e. starting my own business or investing in one I have knowledge of).  This is really important at this level since you can’t rely on the custodian of your IRA to do ANY due diligence for you.

Private placements have recently taken the place of IPO’s due to all the hoops the issuing company needs to hop through.  These startups look at private placements as an IPO lite, or pre-IPO.  A great way to get funding without dealing with all of the red herring laws associated with even a small IPO or offering to accredited investors.

III. What are the Nuts and Bolts of this Craziness!?:

Not every brokerage firm can offer you custodianship of a self-directed IRA or allow private placements.  Investment firms which offer Self-Directed IRA tend to be more of a niche firm.  They may offer other services, but they’d be more of the niche variety as well.  Think precious metals or commodities.

A custodian of a Self-Directed IRA must be approved by the IRS and follow the same rules as other brokerage firms, plus additional regulations related to the types of trusts needed to hold your investments.

The custodian has a lot less liability exposure compared to custodians of traditional IRA’s.  Self-Directed IRA custodians are only responsible for the administration and holding of the assets.  They don’t have any responsibility as to the virtue of the investment.  You will solely be responsible for any due diligence relating to the investments.

IV. This Is Where I Usually Tell You About Doing Your Due Diligence:

But not today.  You don’t need due diligence if you’re trying to find financing to expand your own business, or buy a business. A Private Placement can be your business’ financing arm.

The simple explanation to using your IRA to finance your business is as follows:

Create a new corporation for the business.  There will be special tax considerations if you’re moving assets from one corporation to another.  This is done to maintain an arms length.  Self dealing is prohibited.

Create a Self-Directed 401k plan for the business (I’d advise using a different custodian for the self-directed IRA).  You will be an employee. 

Initiate a rollover from your current IRA account(s) to your Self-Directed 401k account.  Your self directed 401k account now has cash that you as the trustee can invest how you wish.

As trustee, you would have the ability to purchase stock in your new corporation.  You would initiate a transfer from your self directed IRA account to the corporation checking account to purchase stock of the corporation.  The corporation will then issue you stock shares which you will give turn over to your self directed 401k custodian.

V. If You Also Want To Invest in Private Placement Investments:

Since you are acting as trustee for your self directed IRA/401k, you have the option of making other private placement investments than your business.  Other allowable investments are:

Real Estate (no mortgage)
Cryptocurrency
Private Investment (non listed)
REIT’s
Convertible Notes
Hedge Funds

Again, do your due diligence.  Your custodian will have the paperwork and a checklist of items needed.

Holding private placements in a self directed IRA are like the wild west of investing.  Treat this as such.  I don’t think you’ll get scammed. But I do want you to understand that these are going to be much riskier investments with much less oversight than a publicly listed investment.  

VI. Potential Tax Implications and Considerations:

Since you are administering your IRA, you are also responsible for observing and obeying all tax laws and FINRA/SEC regulations.

Since Private Placement investments are different beasts and run in different crowds, they are also less regulated.  You need to be aware of things like Unrelated Business Tax Income, Unrelated Debt Financed Income, Required Minimum Distributions, and avoiding prohibited transactions.

Self-dealing is prohibited. You can’t rent “office space” that you own in a Self-Directed IRA to your business.  You can’t enter into financial deals with disqualified people such as beneficiaries or the IRA, family members or yourself

VII. Conclusion:

Using a self directed IRA for private placement opens up a lot more available options regarding the types of investments you can hold in your IRA.

Since you will be self-directing your investments you need to be aware that the company acting as your custodian will not be giving you investment advice.

You must take care not to trigger a distribution by making a prohibited transaction or dealing with a prohibited person.  If this happens, the IRS goes back to the year of the improper transaction and deems the entire balance of the account as a distribution.

A self-Directed IRA can be a source of funding for you to start or invest in a business.  Since there are rules against self-dealing in the IRS code, a C Corporation is formed and a 401k plan started for the corporation.

A self-Directed IRA can also be used to hold real estate, precious metals, closely held corporations and other non standard investments.

How To Save BIG With These Auto Deductions for Self-Employed Individuals

We all drive.  Almost everyone who is self employed will have to use their car for business.  How do you write off your car?  Let’s take a look at what you can and cannot deduct when it comes to your vehicles.

When it comes to auto deductions for self employed taxpayers, I haven’t met one self-employed individual who doesn’t try to write off 100% of their vehicle expenses, even if they use the vehicle personally as well. This isn’t really their fault though.  I’ve seen ads and heard people talk about how their CPA lets them write off everything.  I had a client ask about writing off an Audi R8.  He didn’t qualify but the fact that someone is asking about writing off a $200,000 supercar on their taxes (and thought he could) tells you how much bad information there is out there.

The reality is it’s pretty easy to figure out what you can deduct and what’s off limits.  Let’s take a look and see what’s best for you.

I. What Do You Mean I Can’t Write Everything Off?:

To determine the portion of your auto deductions for self employed that can be deducted, it’s essential to calculate the business use percentage. This percentage represents the portion of time you use your vehicle for business purposes versus personal use.

The personal use of your vehicle IS NOT deductible.

If we’re talking about a work truck or van (like a contractor would use) that has storage boxes or shelve installed (in the case of a van), you are more than likely writing off everything.  This will be an issue if you don’t have another vehicle to drive during off hours.

II. What’s Legit Deductible?:

If you’re self-employed, then you can write off most auto deductions associated with your vehicle, including:

  • Depreciation
  • Lease payments or loan interest
  • Gas, oil and other fluids expenses
  • Insurance premiums
  • Repairs and maintenance costs
  • Licensing and registration
  • Tolls and parking fees
  • Upgrades to the vehicle (like the example above).  Sometimes theres a way to write off expenses that seemingly don’t belong.  The next example shows one way.

I had a shifter cart business get into the manufacturing of body kits and other go-fast parts for the Nissan GTR series, and started selling them on his website.  He actually bought a GTR to “test” the parts for these cars.  The bHe offered everything for sale on his website and actually made a profit on sales of bodykits and suspension components).

He took the car to shows and became known for his GTR support.  He got to write off a $120,000 car because he actually used it 100% for his business.  This just shows you that a little creativity may be required to get the best legit deduction.

III. Huh?  Why Do You Care If I Have A Home Office?:

Isn’t this an article about Auto Deductions for Self Employed taxpayers? Why does a home office matter?  Part of your mileage deduction relates to your actual miles driven.  The IRS wants you to break it out between business usage, personal usage and commuting miles driven.  If you take a home office deduction, you shouldn’t have commuting mileage.

Commuting mileage is specifically excluded in the IRS code.  Here’s how I explain this to my clients.

The first trip of the day to your first destination is a commute, regardless of you taking a home office deduction or not.

The last trip of the day driving home after your last destination is also a commute.

So the first AND last trip of the day will not be deductible.  Sounds easy, right?  Wrong.

I had a client who lived about 2 hours away from his biggest client.  He made this trip 5 days a week, first thing in the morning.  His old tax person wouldn’t let him write off the mileage driven (about 240 miles a day) since it was his first AND last trip of the day.

The workaround I came up with was so simple, I was shocked his old tax preparer missed it.

I had him establish appointments near his home first thing in the morning.  That trip became his commute.

I had him set up appointments on his way home too.  So now his commute home wasn’t 120 miles, but closer to 20.  This alone saved him close to $2,500 in tax the first full year he implemented this, and it’s perfectly legal.

IV. Record-Keeping and Documentation:

Tracking your auto deductions as a self-employed individual can be divided into two sections.

Mileage

The starting point is to track the miles driven.  The easiest way is via an app on your phone.  I use MileIQ but there are many others available.  QuickBooks online has one built into their package and another one I’ve heard good things about is Everlance.  The point is, you must track your miles to determine that percentage was driven for business.

Actual Costs

This is the second part of the calculation.  It’s also the easiest part as long as you ALWAYS use your debit or credit card when you pay.  Don’t pay for things with cash.  It makes it a lot harder to capture in your books, and it makes it harder to prove to the IRS unless you have the receipt.

To calculate your auto deduction you calculate your mileage deduction first.  Let’s say the IRS gives you $0.60 per mile driven.

If you drove 10,000 total miles with 7,500 being for business, you would have a mileage deduction of $4,500 (7,500 miles x $0.60=$4,500).

Now we’ll take a look at your actual expenses.  In this example lets say your total qualified auto expenses (gas, repairs, maintenance, licensing,  insurance,  lease payments if a lease, interest expense if a purchase, depreciation if a purchase) was $9,000.  Since your business use was 75%  (7,500 of a total 10,000 miles driven), 75% of $9,000 would be $6,750.  You would get a $6,750 deduction for your business auto use.

V. Anything Else You Need To Know?:

  • Personal use needs to be tracked.  If you personally use your car, but don’t track anything the IRS will disallow 100% of your vehicle expenses.
  • There are rules for high dollar vehicle limitations (think Porsche or BMW).  The max cost allowed is $58,000 and limits depreciation, bonus depreciation and section 179 deductions on “Luxury Vehicles”.
  • Your depreciation expense is directly affected if you buy a vehicle defined as a luxury vehicle per the IRS code.  Your tax preparer should know these rules.

VII. Anything I Should Worry About In My State?:

Not really.  This is one area the states have chosen to conform to IRS regulations.  I haven’t found a state that doesn’t conform to the IRS mileage rate ($0.655/mile for 2023)  One difference I do see is reimbursing your employee’s for mileage driven on their personal vehicles.  This calculation changes based on the state.  Since it’s too involved to go over here, my suggestion is to ask your tax preparer for guidance.

VIII. Who Can Help Me The Most?:

When it comes to writing off your self-employed auto deductions you really need to go to a licensed tax preparer.  The IRS takes a look at around 8% of all filed returns.  And the two categories they check the most are Meals and Entertainment, and Auto expenses.

Deducting your auto as a business expense is one of the most abused deductions available, and the IRS knows this.  Stay out of their crosshairs by having a professional prepare your return.

While having a tax pro prepare your return is not a guarantee that they won’t call you out, the reality is most of that 8% referenced above is people who self prepare their return.  Many years ago an IRS Revenue Officer told me that only about 2-5% of returns audited were prepared by CPA’s.

The IRS is a business unto itself.  They will go after the low hanging fruit (self prepared returns) first, before going after someone who has competent representation (that would be the CPA).

Conclusion to Auto Deductions for the Self-Employed:

The key to maximizing your auto deductions is simple.  You must track your mileage.  I us MileIQ to track my driving and the beauty is, it only cost $60/year.  Go to their website every week or month and designate which trips are business related and which are personal.

The reason for this is it will allow you to allocate your auto expenses on a pro rata basis.

As an example, Mary drove 10,000 total miles in 2022 split evenly between months.  She tracked all her driving in Mile IQ and this revealed she drove 5,500 miles for business and 4,500 miles personally.

Mary also tallied all of her vehicle expenses (not including loan payments, but including the interest paid on the loan).  This total came to $12,000.

Her mileage deduction calculation would look like this:

5,500 miles @ $0.585 = $3,217.50

4,500 miles @ $0.625 = $2,812.50

Total mileage deduction would be $6,030.00

Based on miles driven, total business cost is $6,600 (5500/5500+4500= 55% times $12,000)

Since the actual costs pro rated is more than the mileage deduction, you would take the actual costs as a deduction on your taxes.

And that’s how to calculate your auto deductions for self employed taxpayers.

How To Deduct Travel Expenses as a Real Estate Investor and save $1,000’s!

I’ve had a lot of clients who were real estate investors and they all want to write off their travel expenses to visit a property or check a prospective property they may purchase.

Can you deduct travel expenses? For the most part (remember later that I said “most part”) you can deduct your costs of traveling, lodging, meals and incidentals.  Let’s take a look at a thoroughly confusing topic and shine a little light into the fog.

I. Two types of investors:

Before I tell you how to deduct your real estate travel expenses, we need to categorize your business activity. You’re either a Real Estate Professional (REP) or you’re not.  At least for tax purposes.  Being an REP is definitely preferential for tax purposes, but qualifying is not easy.  Here’s what you need to do:

  • First, you need to spend more than 50% of your total time working in a real property trade or business.
  • That total must be more than 750 total hours.  No part timers allowed.
  • Lastly, you must “materially participate” in each rental activity.

To have “materially participated” is a facts and circumstances kind of thing.  Hiring a management company to manage your rental properties would absolutely disqualify you.  Being the guy up on the ladder at 10pm painting the interior 2 days before the new tenant moves in would lead me to believe that you are materially participating.

Not many will qualify.  The material participation rule is pretty easy.  It’s the first qualification that gets most people.  I’ve had clients with a dozen rentals who did all the work and more than likely spent 750 hours during the year, but they had a full time non-realty gig (2000 hours) so they failed the first test.

Here’s a couple of examples:

Melanie:

Melanie worked at a stained glass shop full time.  Over the course of the year she worked 1,900 hours making stained glass windows.  She also owned three rental properties and did all the work on them.  She will not qualify unless she can prove that she worked at least 1,900 hours in real estate, materially participating in all aspects of managing her properties.

Steve:

Steve worked part time preparing taxes for H&R Block during the busy season.  He works 980 hours.  Like Melanie, he also owned three rental properties and did all the work on them.  He worked 1,200 hours managing and maintaining his rental properties.  Steve would qualify as a Real Estate Professional.

II. Which one do you want?:

I just made a big deal of the requirements to qualify as a Real Estate Professional, so that one is obviously the most preferential.  As an REP you aren’t limited in how much loss you can take from your rental activities.  As a non REP (regular taxpayer with rental property who doesn’t satisfy the tests above) you will be subject to Passive Activity Loss rules and limited to a maximum of $25,000 in losses annually. Your ability to deduct for real estate travel is tied directly to this classification.

Passive Activity Loss rules don’t make tons of sense in this example because a passive activity by definition means you aren’t materially participating.  But most owners of rental property are in charge of getting renters, repairing things and are 100% responsible fore everything.

The biggest negative in my mind regarding the Passive rules is the loss amount available.  There’s a maximum $25,000 available, but your income affects the ultimate deduction.  The $25,000 available is reduced dollar for dollar once our income hits $125,000, with no deduction available once your income exceeds $150,000.

Maybe the most important benefit is not having to pony up for that lousy 3.8% Net Investment Income tax on investment income over $250k for a Married Filing Joint taxpayer.  With real estate in many states selling for over $1,000,000, being classified as a Real Estate Professional has real benefits.

An example:

Nick and Dianne are not Real Estate Professionals.  They sold a rental home and netted a $1,000,000 capital gain.  They would pay an additional $28,500 in Net Investment Income tax due to the sale.

In this example, Nick is a Real Estate Professional.  Nick is an REP and isn’t required to pay this tax.

What about the other guys?

Well, you get the previously mentioned $25,000 passive activity loss you can use.

As mentioned above, you still have a rather large potential deduction at your disposal.  In regards to travel, the potential big deduction you will lose is the ability to write off travel to visit prospective purchases.  Add the travel costs to basis once you purchase the property.  If you don’t buy there is no deduction.

III. Eligibility Criteria for Deducting Travel Expenses:

What’s the relationship of the expense to your real estate activity?  If there is a direct relationship, i.e. traveled to make repairs or meet with contractor to go over improvements?  Fully deductible.

Where it gets sketchy is when you commingle work with vacation.  Take a week and visit your rental in Lake Tahoe?  Ski 5 of 7 days and work on the property the other 2?  You must allocate the expense between business and personal enjoyment. 

IV. Travel Expenses for Property Acquisition and Management:

If you are a Real Estate Professional, you get a travel and meals deduction for travel to visit prospective properties.  Even if you don’t buy.  Since you are in the “business” of real estate, checking on available properties out of your tax area is likely.  It would be the same if you were in manufacturing and had to visit a prospective vendor of a raw material used in making your product.  Its necessary to the success of your business.

If not an REP, then no deduction.  In the eyes of the IRS, if you can’t qualify as a Real Estate Professional, you aren’t in the real estate “business”.  It’s a passive activity, almost like its nothing more than an investment in Microsoft stock.  Even though you’re doing all the work, they still categorize it as a Passive Activity and you have to abide by the passive rules.

V. Travel Expenses for Rental Property Visits:

Buy that condo on Maui or in the Bahamas.  Deduct your travel expenses to inspect or work on your rental property will be deductible.  But be careful with this.  You actually have to work on the property to get any kind of deduction.  Take a 2 week trip and work 1 week on your property?  You can take 50% as a tax deduction.

VI. Track your information better:

If you’re a Real Estate Professional, you need to maintain a set of books.  It’s your business.  I’m a fan of QuickBooks Online since it’s relatively easy to learn and being online allows you (or anyone else who works on your books) to access from anywhere there’s WiFi.

Not maintaining good records can ultimately cost you.

I had a client many years ago who was ok, but not great at her recordkeeping.  She would pay for a lot of expenses with cash and not put it in her books.  Every year she would tell be she spent “a couple hundred” with cash for me to add to her return.

One year I bet her the cost of her return that if she just saved all her cash receipts for the year, it would be over $1,000 instead of the “couple hundred” she always told me.

The next year she brought her stuff in with an extra envelope full of cash receipts.  She averaged over $500/mo.  $6,000 in additional deduction that saved her around $2,400 in tax.

Do your books people.

VII. Make sure your tax person knows these rules:

Get someone who knows who can deduct travel expenses. Since real estate is one of the biggest industries in the US, the tax code is filled with rules specific to the industry.  With a cost of entry low enough that almost 7% of taxpayers own residential rental property, it makes sense that this is a spot Congress can look at when forging policy (not to mention the fact that Real Estate is on of the four largest industries in the USA).

With the majority of people who own rental property not classified as a Real Estate Professional, you will need someone who knows the rules, and more importantly, knows how you specifically are classified as a taxpayer and how best to utilize those rules to your benefit.

Conclusion:

You want to deduct travel expenses? As a Real Estate Professional, the IRS sees you as primarily in the real estate industry.

As a Real Estate Professional, you will be able to deduct travel to and from anything related to your real estate world.  This includes travel to see perspective properties to purchase.  This deduction is not available for passive properties.

A real Estate Professionals primary focus is making money through buying, selling, renting and renovating real estate.  Travel may be an integral part of business.  Travel is a direct cost so it’s a deductible expense.

If you don’t qualify as a Real Estate Professional you will be limited to a max $25,000 loss in a tax year.  Your rental activity is considered a passive activity for tax purposes.

Someone who has a passive activity however is limited to deducting travel for visits to already existing properties.  If you have a property on Maui, you could conceivably visit every year to inspect and make any repairs or upgrades, and your trip would mostly be deductible.  If you take  a one week trip to visit your property and spend 4 days working on the property and 3 enjoying the island, you can deduct 4/7 of your travel.

On the other hand, if you are visit Maui with an intention of buying a property, but ultimately don’t?  No deduction.  Not even with t

5 Money Saving Tax Deductions for Successful Real Estate Agents

Hey All.  Today I’m going to talk about 5 types of tax deductions every real estate agent should know about.

As a real estate agent, you will have the “normal” kinds of expenses available (like office supplies and meals) but there are a few other kinds of expenses that need a little deeper look.

Understanding these types of tax deductions is also a great way to open up your mind when it comes to other expenses.  As an example let’s look at your meals deduction.

If you take a client or referral source out to lunch and get sandwiches, you can deduct the cost of the meal and tip on your return, but tax law only allows you to take 50% of the total spent.

Now let’s pretend instead of taking a client out for sandwiches, you bought a bunch of sandwiches to serve at an open house.  Same exact expenditure, but you now get to deduct the entire amount.

The tax code is full of little weirdnesses like that.  So without further stalling, here are 5 tax deductions for realtors.

1. Open House Expenses:

A. Advertising:

  • Website Development and Maintenance: Costs related to creating and maintaining a professional website are deductible.  Don’t forget costs of SEO (search engine optimization) and other organic traffic costs.
  • Print and Digital Advertisements: Expenses for designing and publishing advertisements in newspapers, magazines, online platforms, and social media can be deducted.
  • Business Cards and Promotional Materials: The cost of printing business cards, brochures, and other promotional materials are deductible.

B. Staging Expenses:

  • Hiring a staging company is a big expense.  This is fully deductible.
  • Some agents actually do their own staging.  The money spent is classified in two ways:
    • Items that have a useful life of longer than a year (like tables, chairs, beds) should be depreciated over 7 years.  Don’t worry.  If you have sufficient income or just need to take the whole expense, you can take advantage of either bonus depreciation or Section 179 and take the whole shebang as a deduction in the current year.
    • Knick knacks, little things, stuff that might give the home a “homier” feel I advise taking as staging supplies.  This stuff generally isn’t used over the course of multiple years and is fully written off in the year you bought it.
  • What about storage of these items?  It’s not weird to rent a storage site and move your staging materials in and out as needed.  But what if you store your stuff at home?  That would be a home office deduction and we’ll talk about that later on in this article.
  • Staging can be a huge tax deduction for realtors, so make sure to keep good records.

C. Catering, snacks, other food and drink:

  • Anything you buy to serve to visitors and prospects is deductible in full.
  • What if you make cookies and pastries at home?  Unfortunately you can’t “pay” yourself for all the baking, and the home office for the kitchen isn’t available since a requirement for the use of a home office is the office must be used exclusively and primarily for your business.  The kitchen won’t qualify since you don’t use it exclusively for your business.

2. Transportation and Travel Expenses:

As a real estate agent, you are constantly on the road for one reason or another.  But there are some things to watch:

A. Vehicle Expenses:

  • To write off your car, it must be used for your business by more than 50%.  The only way you will know the actual usage percentage is by tracking your mileage.  If you use QuickBooks online to track your business books, they offer an app to load on your phone that uses GPS info to track your movements.
  • I actually recommend an app called MileIQ.  It costs $60/year and it’s totally worth it.  I suggest to my clients that they go online every week (to the mileiq.com site) and allocate the trips captured during the week to either business or personal.  That way you’ll have detail of all your driving and we can properly figure your auto expense.
  • Fuel, Repairs, and Maintenance: Costs for fuel, oil changes, repairs, and maintenance for your vehicle used in business activities can be deductible.  By tracking your mileage, we can determine if taking your actual allocated costs or taking the mileage deduction ($0.655 per mile for 2023), whichever is higher.
  • Insurance and registration fees are treated the same as repairs, gas, etc…  Signage for your car would be fully deductible as advertising.

B. Travel Expenses:

  • As a tax deduction for realtors, travel for seminars and classes are fully deductible.  This includes flights, hotels, weird airport fees (everyone has their hand out), Uber/car rentals and tipping to name a few.  Meals are still generally deducted at 50%.
  • Travel to “find” property.  The only way to write off travel expenses to look for investment property is if you actually buy a property where you traveled.
  • If you are traveling to find investment property for a client, I would take this as an expense even if the client doesn’t buy based on the trip findings.  The client can’t deduct the costs.

3. Home Office Deductions:

This one is really on an individual basis.  Not everyone who has a home office is qualified to take the deduction.:

A. Qualifying for a Home Office Deduction:

  • Exclusive and Regular Use: To qualify, your home office must be used exclusively and regularly for your real estate business.
  • Principal Place of Business: The home office should be your primary place of business where you meet clients and conduct administrative tasks.
  • Because a lot of brokers have desks for their agents to work from, you may not qualify because it won’t be your primary place of business.  Some brokers may even charge you a “desk fee”.  Depending on this fee and your actual housing costs, it might not be a bad thing since this fee is fully deductible.

B. Deductible Expenses for a Home Office:

  • If you take a Home Office deduction, you must track all of your home occupancy costs in full.  We then calculate the expense based on the square footage of the house and the square footage of your office area.  So if you have a 1,000 sq ft home and your “office” is 100 sq ft, you would get to expense 10% of your total occupancy costs.
  • So what do you track?  The basics are:
    • Mortgage interest or rent.
    • Property taxes (if paid)
    • Fire or renters insurance
    • Utilities which include gas and electric, garbage, sewage, telephone/internet.
    • If you meet clients at home and have someone come clean every week, that’s a deduction.  If they only clean your office, that’s fully deductible.  If they clean the whole house we allocate based on square footage.
  • What about a gardener or repairs?  If you meet clients regularly at home, gardening will be allocated as above.  Otherwise no.  Repairs are categorized as either direct or indirect.  Direct would be something in the actual office.  Indirect would be repairs to the house, but these might not be deductible at all.  These would be a case by case issue to be discussed with your tax preparer.  Business purpose will be the deciding factor.
  • Home Office Equipment and Supplies: Deductible expenses include furniture, computers, printers, and other supplies necessary for your home office. These expenses would be fully deductible as if you had an office elsewhere.
  • If your broker gives you desk space in their office, this would not be a tax deduction many realtors could take.

4. Education and Business Coaches

This is a tax deduction in which successful realtors invest heavily. 

A. Seminars and conferences:

  • These are fun AND deductible.  And they don’t necessarily have to be strictly about selling real estate.  Learning business knowledge is your line.  Marketing, writing skills, presentation skills…I’d even toss things like self improvement seminars (think Tony Robbins) and the like are generally taken to improve their ability to get business.  All deductible.
  • Continuing education is fully deductible.  This is required to keep your license so there is no question as to its deductibility.
  • Travel and such is all deductible as outlined above.  But you can’t expense travel for your family if they go along for the ride.  If your significant other also works in the business there may be an avenue to deduct their costs if they attend the conference or seminar with you.

B. Coaching, Courses and Mastermind Groups:

  • This stuff is expensive and also fully deductible.  Once again, it doesn’t have to be specifically related to real estate and a lot of times, doesn’t sound even related to business.  But your mindset has a big effect on your success (again, think Tony Robbins)
  • If you buy a product at a seminar, webinar or any kind of conference, chances are good that this can be deducted.  Educating ourselves to be better at business can look like a lot of things.  If a course helps you in business, take the deduction.
  • Mastermind groups cover a lot of info, but generally they are groups you can run thoughts and plans by a bunch of other people and get feedback.  They are moderated and led by someone with a lot of knowledge in the groups reason of being.  Mastermind groups start at $5k and I’ve seen invitation only groups that cost $100k a year.

5. Technology and Recordkeeping Costs:

This is kind of a catch-all category.  Both are essential to success yet both are forgotten and relegated to the “Ask My Accountant” category in QuickBooks.:

A. You Gotta Do Your Bookkeeping:

Keeping detailed records of your expenses and receipts is crucial for substantiating your deductions during tax audits.  I suggest QuickBooks Online.  Their starting plan would be be more than enough, and there is always some sort of discount available.

Get one of those accordion folders that’s divided up by the months.  That way you can simply put any receipts or other paperwork in the appropriate month so you can find it later when you are doing your books.  .

B. Utilizing Technology for Efficient Record-Keeping:

QuickBooks Online has all kinds of real estate based apps that you can use to integrate with your QuickBooks records.  From CRM (Customer Relationship Managers) software to access to MLS or appraisal apps (not Zillow, but similar).  Depending on your needs, there is bound to be something that will make your life a little easier.

Conclusion To Tax Deductions for Realtors:

I’ve never met anyone who likes to pay taxes.  The best way to ensure that you aren’t paying any more than you are legally responsible for is to spend time each week going over what you spent, what it was spent on, your auto mileage, your meals out…and it usually won’t take much more than an hour or so.  Probably less.

This is the stuff that people tend to avoid.  The fear of the unknown, the fear of doing something wrong.  Just fear.  What if I’m not doing well?  Then what?  What if I’m doing better than I thought and I’m now going to have a big tax bill?  Holy crap1  The horrors!

It’s not horrible and you can do it.  Look at it this way.  You passed the Real Estate Agent test and that took time to learn the rules and regulations you have to abide by.  Tracking your expenses and mileage will be a piece of cake compared to that.

You got this!