Call Duty, Expired Listings and Tax Planning!

It can be tough starting out a professional career in a position where how much you earn depends on how much you sell. I’m a product of a parent who was a professional real estate agent for well over 25 years. I can still picture the Gibson-Pfannenschmidt blue GP logo (before it became Coldwell Banker) on for sale signs and still say she also worked at “Paul” Semonin Realtors. 

I can remember my younger years spending Summer days in her office sitting through Call Duty. I can’t count the number of hours I saw her sit at home in the evenings making calls to homeowners with Expired Listings. There were plenty of times I was with her during house showings and saw her point out to her buyers the good and bad parts of the house. She would show them where there could be a mold issue and would need to have an inspector look at or point out how a wall could be knocked out to create more space. I thought we hit it big the day she had a cellular mobile telephone “installed” in her vehicle and I would get in trouble making calls on it because each minute used cost money. I was proud to flip through the newspaper on Sunday’s and see her listings or read through the multimillion-dollar producer lists and see her picture. 

I’m in the accounting world now. I specialize in working with professionals in the real estate industry. In most cases, those professionals are sole proprietors or have entities formed and taxed as an S-Corporation. It can be intimidating to run a business and keep up with all the tax changes that go on. The 2017 Tax Cuts and Jobs Act was the largest change to the tax code since 1986. I never got involved with my parents’ finances growing up. I don’t know what system was kept by mom for her to submit to her tax advisor or how often she communicated with them to get advice. 

Tax Planning

I do know that there is plenty of factors to be aware of and plan for during the year to help you be in good shape when it comes time to file your tax return. It gets stressful during tax season around the end of March and the first 2 weeks of April. I can recall overhearing a phone conversation early in my tax career where a partner was discussing the tax amount due with his client over the phone. He mentioned to the client the amount owed was several hundred thousand dollars. I heard him repeat it a few more times to the client. Can you imagine needing to pay that amount? It turns out the client was a very successful business owner, but never was willing to tax plan during the year. It seemed every year this business owner would owe a large amount of money and always be surprised. 

It’s understandable that business owners want to save money and tax planning costs money. In a lot of cases spending money on tax planning will save money in the future. You may be deciding on how much you’d like to spend in advertising for the year. Do you put more dollars into building your website or print advertising such as yard signs, mailers or newspapers? Putting too many dollars in newspapers may not be a wise choice if more clients will come from your website. This cost would be more of a variable cost, but you also may have a fixed cost such as the desk fee you pay to hang your license under a national franchise broker. 

It would be a good idea to budget for your tax advisor as well. You may not need to worry about meeting monthly or even quarterly, but tax planning is necessary to help save you from a big tax liability when you file your tax return. I’ll meet with clients at least one time earlier in the year to not only prepare their tax return, but also review the upcoming year. We’ll discuss any tax changes recently made that may affect the real estate industry, adjust quarterly tax estimates, review bookkeeping, discover personal expenses that are not deductible, explain retirement plans and many other topics. These discussions are generally helpful to put into place a good plan for the year and updates will be made as the year goes along depending on whether the agent’s business increases or slows down based on how the housing market is performing.

Quarterly Estimates

If you’re new to a profession that earns income based on commissions, then you may not be familiar with how taxes are collected on the income. Generally, a professional earning a W2 wage has their taxes withheld through the company that employs them. Self-employed professionals earn income and receive a Form 1099 at the end of the year. Generally, no taxes are withheld. Therefore, it’s necessary for the self-employed professional to withhold their own taxes and pay them quarterly.

IRS requires taxes to be paid evenly throughout the year as the income is earned. Professionals earning a W2 wage have their taxes withheld based on tables so that the amount withheld is generally even based on the income earned throughout the year. 

Self-employed individuals are required to withhold and pay their taxes evenly based on 4 quarterly estimates that are generally due April 15th, June 15th, September 15th and January 15th. If payments are not made by the due date of each payment period, a penalty may be charged. 

You may receive quarterly estimate vouchers from your tax preparer each year along with filing your tax return. These estimates are based on your income you earned in the prior tax year. Making these payments is considered a safe harbor because they are based on 100% (110% if your income exceeded a threshold) of your prior year tax liability. But what if your income significantly increases during the current year? You have met the safe harbor of paying your tax estimates but could still have a large tax bill when you file your taxes in April because the estimates you paid throughout the year were not adjusted for an increase in taxable income. Or the housing market may have dropped significantly during the year. You’ve continued to pay the estimates provided on the vouchers and get a huge refund when you file your return in April. Getting a refund is always nice but having the cash when you may have needed it would’ve been better.

Vehicle Expenses

I’ll review a return of a new client and sometimes see they have no expense designated to vehicle expenses. Generally, an agent can take a vehicle expense based on the total business miles they drove during the year. This is known as the standard mileage deduction and the rate fluctuates year to year based on the IRS mileage rate. It is $.575 cents per mile in 2020. 

There is also an option to deduct actual expenses, but the standard mileage rate is required to be taken in the first year the vehicle is placed in service and then you can optimize between standard mileage and actual expenses each year thereafter. If you drove 25,000 total miles in 2020 and 15,000 of those were business miles you would get a deduction of $8,625 using the standard mileage deduction. That might be compared to the $7,000 spent on gas, maintenance, insurance and lease payments using the actual expense deduction.

But what is business mileage? Generally, leaving your home and driving to your office is commuting and cannot be included in the calculation as it is not deductible. Driving from your home to show a house or from your business to go to a closing would be considered business mileage and includable in the calculation to deduct vehicle expenses.

It’s important to maintain a contemporaneous log of the mileage in case you are audited in the future. This is an expense that can be easily abused, and the IRS likes to perform a review of vehicle expense to determine if the amount calculated is reasonable and can be substantiated. There are plenty of apps available you can check out to help you track your mileage. Or you can keep a written log in your calendar. Make sure to record the miles along with the destination, a description of the business purpose and who attended. It will tell a better story during the audit and should keep an IRS agent from digging any deeper.

Meals & Entertainment

Let’s get the elephant in the room out of the way when discussing meals and entertainment as the Tax Cuts and Jobs Act (TCJA) made a major change (temporarily) to deductible costs. Prior to TCJA, business owners could deduct meals and entertainment expenses that were ordinary and necessary, but not lavish. The deductible amount was 50% of the total costs. For example, you would invite one of your clients out to a local sporting event and cover the costs of the ticket, beverages and meals with the total deductible amount being 50% of all costs. 

The TCJA changed the rules so that only meals can be deducted at 50% while any entertainment costs are 100% nondeductible. In addition, if meals are served at an entertainment event they must be separately itemized on a receipt or charged separately for them to be 50% deductible. Otherwise, they are considered costs as part of entertainment expense which is 100% nondeductible.

Let’s consider how that gets recorded on your books as part of your bookkeeping efforts. Generally, you might see an expense called meals and entertainment which generally would’ve captured all the expenses prior to the TCJA passage. If you have not updated your recording methods, you may still be combining the costs which likely is creating an inquiry from your tax accountant so that the proper amounts are reported on your tax return. Or you may be over or understating the amounts. 

Then there is the probability that you’re posting expenses in this account that are 100% deductible. One such cost is the amount you spend on a weekly open house for the general public. If you’re purchasing beverages and food to display at your open houses this amount should be recorded to a separate meals expense account so that it doesn’t get limited to 50% on your tax return. Or worse, it doesn’t get limited to totally being nondeductible because you and your tax advisor overlooked it. 

Also, one last item to consider making sure you don’t lose out on a deduction. Generally, a meal exceeding $75 requires the receipt to be kept with the description of the business purpose and name of the client/prospect attending the meal. Expensing meals is a common expense abused by business owners and can be a popular item to review by IRS agents during an audit. It’s always nice to have your I’s dotted and T’s crossed so that you don’t have an expense disallowed.

Business Use of Home

Some agents may not pay a desk fee to their broker and don’t use a local office. If they use a space in their home (purchased or rented) exclusively for business, they may be entitled to a business use of home deduction. You may have heard of this deduction and are fearful of it because you have heard stories this is a popular audit hot button for the IRS. 

That is somewhat true, but the IRS has recently provided a simplified method of calculating the deduction. The important part is to make sure your office/space is exclusively used for business. You certainly don’t want to have personal items in the same area you’ve designated as the office space. You can’t use your couch if you also use it to watch tv and your kitchen table doesn’t qualify if you also eat your meals there along with the rest of your family.

The deduction is based on a percentage of the square footage used exclusively for business divided by the total square footage of your home. A portion of your mortgage interest/rent payments, insurance, utilities and real estate taxes is eligible to be deducted as indirect expenses. You may also have repairs and maintenance made directly to your office which is eligible as a direct expense.

One important note. I’ve worked with new clients in the past who used the business use of home deduction, but their accountant passed on calculating the allowable depreciation. I highlight allowable because if you sale your home it is eligible for the home sale exclusion where you may be exclude up to $250k ($500k jointly) in gain, but the amount of allowable depreciation from the business use of home is subject to recapture taxes. Therefore, you might as well include the depreciation expense in your deductions.

Dues

It’s important to get out and network with other business professionals. Obtaining a referral from a networking event leads to the next referral so long as you do well with the first. I am involved with the Kentucky Real Estate Investors Association and attend the monthly meetings as often as I can. You also are likely a member of the Greater Louisville Association of Realtors. These are organizations that require monthly or yearly dues for your membership. These dues are tax deductible.

Keep in mind on occasion these organizations use their size to lobby for government legislation. You may decide to contribute to a political action committee, or it is itemized as part of your yearly membership fee. This expense would not be deductible.

I’ve known several business professionals who use a round of golf to entertain their clients or prospects. Generally, they pay membership fees to a local golf club. These expenses are considered entertainment expenses and are not deductible as well. 

Gifts

Who doesn’t like to receive gifts? I can recall a time in my younger days when a relative gave me a Christmas gift that was pink with bunny ears and my mom forced me to try it on and I didn’t want to. Yeah, you’ve probably heard that one before and it really didn’t happen to me, but I did once get a bottle of cheap cologne from a relative that I ended up not using because it made my skin breakout.

Gifts can sometimes be memorable in good and bad ways. Therefore, in your profession you likely put thought into the gifts you give your clients so they will remember you the next time they decide to shop for homes. But you’re limited on the deductibility of the gift you provide to your client and the rules are rather strict.

Gifts can be deducted up to $25 and only one can be given to a client once per year, per person for them to be tax deductible. Incidental costs such as engraving, packing or shipping aren’t included in the $25 limit if they don’t add substantial value to the gift. Also, gifts costing less than $4 that have your business name permanently engraved on the item and which you distribute on a regular basis is fully deductible. 

In Closing

Real estate has been a big part of my life. I can’t count on my fingers and toes the number of homes I lived in growing up. Homes were my parents 401(k). We always had plain white walls because it “would be easier to sell to someone who can then pick their own colors.” I respect the work an agent does having seen the highs and lows my mom went through in her career. I didn’t even mention the double-digit mortgage interest rates many agents faced back in the 70’s and 80’s.  So, think about that for sale sign your putting in the ground the next time you list a home and remember the image of the logo. It will certainly bring back fond memories to you someday down the road.