Top 3 Strategies Realtors Use to Avoid Overpaying on Income Taxes

Here’s 3 ways you can keep more of your commission income in your wallet, and save money on taxes you don’t have to be paying.

1. Deduct Actual Vehicle Expenses, not the IRS Standard Mileage Rate!

If you’re like most Realtors, you take the Standard IRS Mileage Rate on your tax return because it’s quick and easy. 

Let’s say you claim 10,000 business miles this year. (You probably drive more… in fact the AAA publishes statistics that prove you drive more… but 10,000 miles is an easy number to work with, so let’s go with it for now). 

Take the 2020 IRS standard mileage rate of 57.5 cents per mile, times 10,000 business miles, and even your second-grader can easily calculate the $5,750 tax deduction.

That’s great for the average taxpayer-- but what if the operating costs of the vehicle you drive aren't “average”? 

Example: what if you drive a pickup truck, or an SUV, or (dare I ask) a minivan?  You are losing money every time you put the key in the ignition if you take the IRS mileage rate.

Every year the American Auto Association (AAA) does an operating cost survey. This AAA survey says it costs you 72 cents per mile to operate an SUV. So if you drive your SUV 10,000 business miles, and claim the Standard Mileage Rate, then you’re losing a $1,450 tax deduction every year. (72 cents operating costs minus 57.5 cents per mile IRS mileage rate  X 10,000 miles = $1,450.)

So what do you do, exactly, to claim actual expenses rather than take the standard mileage rate? 

First, to maximize your auto deduction, keep track of all your actual expenses: 

• Gas
• Oil
• Tires
• Repairs
• Insurance
• DMV Registration

Hey, it’s not that hard. You pay for all this stuff electronically these days. There’s a record of it, somewhere, so pull a copy. Or outsource the task to a bookkeeping service, so you can focus on what you do best: sell real estate! 

Now, add to all those out-of-pocket costs something we call depreciation expense.

Depreciation is just a 25-cent word that tax geeks use to account for the wear and tear on your vehicle each year. 

Did you know the average new car purchase price in 2019 was $37,185? 

Take that average, and divide that amount by 5 years (because that’s how long IRS rules say you can write off or ‘depreciate’ a vehicle), and you arrive at a $7,400 auto deduction every year, only for depreciation. 

Note: I took 5 years as a “straight line” depreciation calculation; you can actually use an accelerated depreciation formula to get a bigger deduction in the early years. So $7,400 is actually a conservative deduction total. But I digress…

Add that $7,400 to your out-of-pocket costs for gas ($2,000?) oil ($100?) tires ($400?) repairs ($250-$2,500?) insurance ($1,200) and DMV registration ($75?) and you can see that claiming actual auto expense will give you a bigger tax deduction than the typical $5,750 auto deduction Realtors take using the IRS standard mileage rate. 

Maybe you’ve hesitated to deduct actual vehicle expenses because you know your record-keeping has holes in it. 

If your record-keeping has holes in it, you should be even more hesitant to take the standard mileage rate!

If you are already claiming the mileage deduction, be sure you’ve got a mileage log to document everything. By ‘everything’, I mean don’t forget to track the date, odometer readings, destination,  and the business purpose of each trip on your log. 

Auto mileage is what an IRS auditor will focus on first if your tax return raises an audit flag.

Now let’s move on to a couple other deductions you may not have thought about (yet).

2. Hire Family Members

Hiring your children (or grandchildren) can be a great way to cut taxes on your real estate income. This strategy is what tax advisors refer to as “Income Shifting”. 

Let’s say you have Gross Commission Income (or 1099 income) of $100,000. And let’s also assume you have $25,000 in business expenses, including advertising, auto, association dues, MLS fees, office and broker fees, etc. That leaves you with $75,000 in net income. 

You’re going to pay two taxes on that: 12% federal income tax plus 15% self-employment tax. That adds up to 27%, or 27 cents on every dollar of commission you earned. 

Oh, and unless you live in FL, TX, or one of a handful of other states that don’t have income tax, you’ll have to add another 5% or so for state income tax. But again, I digress...

By hiring your child, you can deduct his or her ‘employee’ expense and move it right out of your taxable income, shifting the tax burden to someone in a much lower tax bracket. 

How much lower? Well, if it’s your dependent child, the first $12,200 of his/her earned income is taxed at zero percent. And the next $9,875 is taxed at just 10%. So you shift income from your 27% federal tax rate downstream to a 0% or 10% tax rate, and save $1000s in taxes in the process.       

What’s the minimum age? Glad you asked! 

Tax courts have ruled the child can be 7 years of age or older. So what can a 7-year old do in your business?  Light office work, filing, cleaning, stamps on envelopes are a few tasks you could include on their job description. 

Heck, they probably can run your social media marketing better than you can!

Anyway, a reasonable wage ($10/hour) for a reasonable work schedule (5 hours/week) for a 7 year old, even if for only 20 weeks out of the year, will yield an additional $1,000 tax deduction. For teenagers, of course, the pay rate, hours worked, and number of work weeks can be much higher, giving you a tax deduction of $5,000 or more.

Keep in mind, all that money doesn’t have to go into their Pizza and XBox fund. You can deposit it directly into a 529 college savings plan.! Or how about a Roth IRA account for years of tax deferred growth?

You can also hire your spouse, and if your entity structure allows it, include him or her in a Medical Employee Reimbursement Plan (MERP), so you can deduct family medical expenses as a business deduction.

But again, I digress... so let's move to strategy number three.

3. Structure Your Business to Pay Less Tax

If you’re like the vast majority of real estate agents, then by default you are operating your real estate business as a sole proprietor. 

Or…  somewhere in the first year or so, you may have registered with your state as an LLC, because a closing attorney or co-worker said it made business sense. 

Either way -- whether you’re a sole proprietor or an LLC -- for tax purposes the Internal Revenue Code treats you as a sole proprietorship. 

What this means to you is that you pay two taxes:

(a.) you pay income tax at whatever your income tax rate is, PLUS 

(b.) you pay 15.3% in self employment tax, which is another label for what is basically social security and medicare tax. (You pay 15.3% on the first $118,500 of your net income, and then 2.90% on all compensation above that threshold.)

But consider what happens when you do what the tax advisers to those ‘rockstar’ million-dollar agents tell them to do ... which is, operate their real estate business as a corporation.

Don’t let the idea of incorporating your business intimidate you. Don’t fool yourself into thinking that only 7 figure income earners can benefit. 

Having their business properly structured can save any real estate agent thousands of dollars in taxes they shouldn’t have to be paying. 

An S Corp, the most popular option for Realtors, can save you thousands in taxes each year, can cost just a few hundred dollars to set up, and be registered with your state and with the IRS before the sun goes down today. 

Think of an S Corp as just a family-owned corporation that’s taxed as a “pass-through” entity. “Pass through” means the net taxable income of your S Corp simply passes through to your Form 1040 Individual Income Tax Return. In other words, the S Corp typically never has a federal income tax balance due, nor a refund.

Here’s why this saves you money, big-time.

Your S corporation allows you to split your income into two parts. First, it pays you reasonable compensation (or salary) for the work you do. Second, you take additional distributions for the net income left in the business after your salary is deducted and paid out to you. 

You’ll pay income tax on both your salary and your distributions, but you’ll only pay the 15.3% tax associated with social security and medicare on the portion that is paid to you as salary or wages. 

Your savings will vary, depending on your commission income. But using the earlier example of $75,000 net income after expenses, you could conservatively expect to save $4,000 per year in tax using this strategy. And this isn’t a one-time savings. You’ll save it every year you work as a real estate agent.

One final note: if you’re already set up a Limited Liability Company (LLC), don’t fret about having to close your LLC and start over again as an S Corp in order to take advantage of this tax strategy. You have a much easier route to take: you can simply elect to have your existing LLC taxed as an S Corp. That way you benefit from S Corp tax advantages. All you have to do is file a one-page IRS form to gain S Corp tax treatment for your LLC.

Anchor on This: 

It’s not what you earn in real estate, it’s what you keep. 

The strategies shared here will help you keep more of your commission income in your wallet, and save you money on taxes you don’t have to be paying.

You can click this link to connect with Jim, or message him on LinkedIn, or give him a call 757-346-1040