Get More from Your Money: CPA Tax Tips for Real Estate Agents

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About This Episode

Income tax season is right around the corner, and whether you’re a solo agent or leader of a team, there are specific tax strategies that can benefit you simply because of your real estate professional status. This week on The Walkthrough™, a CPA specializing in real estate shares the keys to maximizing your real estate income using expert tax strategies.

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Links and Show Notes

• ryan.carriere@hallcpallc.com
• Contact Ryan to inquire about tax services
• Ryan on LinkedIn
• List of vehicles over 6,000 lbs.
• Join our Facebook mastermind for The Walkthrough™ listeners
• HomeLight’s Agent Resource Center
• Follow and listen to The Walkthrough™: Apple Podcasts/iTunes | Spotify | YouTube

Full Transcript

(SPEAKER: Lisa Johnson Smith, Host)

Lisa: It’s that time of year again. Income tax season is right around the corner. Whether you’re filing through a CPA or daring to tackle your taxes on your own, one thing’s for sure. You want to maximize your profits.

Ryan: If it were me and I was a Realtor®, I would be taking advantage of the Real Estate Professional Status (REPS) tax strategy.

Lisa: That’s the voice of this week’s guest, Ryan Carriere. He’s a CPA and senior tax advisor specializing in real estate. And he’s going to break down exactly what that Real Estate Professional Status could mean for you to help you get more out of your money every tax season. This is The Walkthrough™.

(INTRO MUSIC)

Hey there, I’m Lisa Johnson Smith. Welcome to The Walkthrough™. This is a weekly show. New episodes come out every Monday. This is the show where you learn what’s working right now from the best real estate agents and industry experts in the country. At HomeLight, we believe in real estate agents. We’re here to explore how great agents grow their business, stand out from the crowd, and become irreplaceable.

Today, we’re talking CPA tax tips for real estate agents. Now, this episode is a little longer than usual, but trust me. It’s packed with information that could help you save some money on your taxes and take advantage of some tax strategies that are unique to real estate professionals. So, you might want to take some notes.

Today, you’ll hear us talk about how your Real Estate Professional Status can save you tens or even hundreds of thousands of dollars every year, what type of entity will give you the best tax advantage, whether you’re a sole agent, owner, or a team leader, a review of your deductible and nondeductible expenses, and the best way to keep track of your expenses with less hassle, and some changes in tax laws that will directly affect you.

Here’s my conversation with Ryan Carriere.

(BEGIN CONVERSATION)

So, I wanted to have you on today because, as a real estate agent myself and always talking to real estate agents, there are always so many questions when tax season comes around. And we want to talk about how agents can make sure they’re getting every tax benefit possible.

We want to talk about strategies that they can have that help their businesses to reap the most tax benefits, changes to tax laws, and maybe some additional strategies that only apply specifically to agents where they can benefit. Let’s start with talking about businesses: the type of business that you think best benefits solo agents.

Ryan: Yeah, I’d say most agents are probably going to be some sort of a sole proprietorship or a single-member LLC to start. That’s kind of a default if they’re going to have any sort of entity structure. I’m not an attorney, so this is not legal advice. But certainly, as we think about creating an entity, it is primarily at first a asset protection purpose that we’re kind of creating these LLCs and things like that.

But a lot of people, if they’re making more substantial net income, for example, and depending on their states and various other things, having an S-corp in place can help them save on a FICA tax that we have. That’s made up of Social Security tax and Medicare tax, that 15.3% or self-employment tax, kind of all synonymous with one another. But essentially, if you have a significant amount of net income from your Realtor® business…

Lisa: Like what? What would you say is significant?

Ryan: Probably somewhere north of probably $80,000- $100,000. Somewhere north of that, more than that. And again, each state, depending on which state you’re in…specifically, I know your audience is nationwide, so depending on the state that you’re in, it might be a little less beneficial. For example, Tennessee: sometimes they have a little more on the business tax than the benefit of the FICA tax savings. So, be careful there with that.

But basically, with the S-corp, essentially…yeah, in short, basically what you’re doing is saying, “Hey, instead of a single-member LLC Realtor®, all of my income is subject to not only ordinary income tax but also that FICA tax, all of the net income.” But rather now as an S-corp, I’m going to say, “Hey, maybe I have $100,000 and I’m going to say only $50,000 is my wages.” Right? And so, only the wage portion is subject to that FICA or self-employment tax.

Rather than, let’s say, I’m a single-member LLC. If that’s all you were and you still had $100,000 of net income, then all $100,000 is subject to that 15.3% FICA tax. So, with that example, basically, you’re cutting the FICA tax in half if you’re able to properly use that S-corp.

But just keep in mind, you’ve got the FICA tax savings, but you need to be careful with, “Hey, having an S-corp, you have some additional administrative costs that go along with that.” For example, you’re going to have to file an S-corp tax return. Depending on your preparer and their costs, that could be a few hundred or a few thousand dollars, depending on the complexity. Right?

You also are going to have to file payroll taxes. So, keep that in mind. That’s just a couple to think about. You’ve got, “Okay, great. It sounds like awesome. I can get this additional tax savings. But what about the additional costs that come with that?” So, that’s why we come up with kind of a $80,000 kind of break-even point, just kind of a back-of-the-napkin math that we’ve done. So, think through those things first before you just say, “Hey, I’ve got some net income, therefore, I should be an S-corp.” So, be careful with that.

Lisa: Is that for solo agents, as well as agents who have their own brokerages or agents who are part of a brokerage but have a team?

Ryan: Yep. So, if you’re a 1099 employee…again, be careful with some states, also, don’t allow basically payments to go to LLCs or S-corps, for example. So, you have to be careful about whether your state even allows you to do this. Again, I think Tennessee, again, I keep mentioning Tennessee, but I think Tennessee is another one of those states that basically you can’t receive payments if you’re an LLC or an S-corp. You basically have to be earning them in your personal name. So, be careful, again, with that.

But yeah, basically, that would work for…as long as you’re a 1099 employee. If you can create your own entity, that’s fine. If you are an employee, this is not an option, right? So, if you’re an employee for someone, this is totally different. You don’t have your own entity set up. But if you are, yeah, a broker or Realtor® on a team, you own the team kind of a thing, whatever, that’s all relevant for you. Yes.

Lisa: I know real estate agents; we can take advantage of a lot of write-offs and expenses. Before we get to what those are, what’s the best way, do you think, to organize those expenses throughout the year?

Ryan: If you’re not going to kind of invest in some sort of a software, maybe just something like an Excel spreadsheet to make sure that you’re keeping track of those. We prefer, as an accountant and a CPA, some sort of a software to help you get kind of the basics in. Right? It’s going to pull them…

Lisa: Give us an example.

Ryan: So, QuickBooks is a popular one. I use QuickBooks personally. So, QuickBooks, if you link it to your bank accounts, checking, savings, whatever, it’s going to pull in the transactions automatically from your bank, and it’s going to pull in the basic information: the date, the description, the amount, was it in, was it money out, things like that. And then, all you need to do is just simply click on the button, click the dropdown, and figure out what expense is this?

That’s going to make it pretty simple for you, rather than going through, “Okay, I have this receipt over here. I’ve got this over here.” And you’ve got to kind of manually put in everything and then figure out what are your expenses?

If you use something like QuickBooks, then it’s basically…at the end of the day, you can pull up your reports, pull up your profit and loss statement, your P&L, and it’s going to show you, “Hey, here’s all your commission income, here’s all of your expenses for vehicle deductions, subscriptions, mileage.” All those things it’s going to have in there nicely summarized for you compared to just a spreadsheet where you’re going to have to manually put that in.

Lisa: Okay. And do you recommend every agent separate have a business account and a personal account?

Ryan: I would…it’s primarily from a simplicity of bookkeeping perspective. If there is an entity structure in there, we also are going to have to be considering, “Hey, are we kind of mixing personal and business funds in there?” So, it’s one from a good kind of clean accounting perspective to separate personal and business.

And then two, it’s, “Hey, is there a legal discussion or a consideration?” of, “Hey, we’re kind of having personal expenses go through our business account, or business transactions or expenses going through our personal,” and it can just get really convoluted doing it that way. So, yes, I highly recommend having two separate ones.

Lisa: Okay, so let’s talk about expenses. What are some of the expenses and deductions that agents should make sure they’re taking advantage of?

Ryan: I think most agents are driving around places. We’re going to be talking about a vehicle deduction. We’ve got two different types of methods that we can use for the vehicle deduction. You’ve got kind of a standard mileage method that’s like $0.60 or so per mile, and then we’ve got the actual expense method.

So, we’ve got two ways to basically calculate it given to us by the IRS. But because you guys are driving so much compared to a lot of maybe other white collar jobs, like me as an accountant, CPA, I’m generally not driving around, and I can do my job from a laptop. Right? So, I don’t have a lot of hours, or even if I was my own business owner, I don’t have a lot of hours driving to and from places.

But when you’re doing showings, or you’re meeting a new client, or you’re networking, or whatever, all those things could be vehicle deductions. Although at the end of the day, it might be a few hundred or a few thousand dollars, depending on how much you are driving, that could be more substantial as far as tax savings.

So, that is a one specifically to Realtors® that I find, “Hey, you guys should be capturing this.” And you could use something to help you. Could be like MileIQ. That’s a software out there that helps you kind of track your miles. There’s all sorts of other ways you can do it. If you want to use some sort of a spreadsheet, that’s completely fine. But capturing those vehicle deductions would be one.

Lisa: What kind of car? Because I know about Range Rovers, or a certain vehicles, or SUVs over a certain weight have more of a deduction or complete write-off versus others. Talk a little bit about that.

Ryan: Yeah. So, the rule is the gross vehicle weight of over 6,000 pounds generally are eligible for bonus depreciation. So if you’re looking back and preparing your 2022 tax return and you had a vehicle placed in service and used for business in 2022, then, theoretically, if it meets the over 6,000 pounds gross vehicle weights, then hey, that can be eligible for bonus depreciation.

And what’s unique about 2022 is that that was the last year for 100% bonus depreciation. So theoretically, here’s what clients could be doing or listeners could be doing. If they bought a vehicle that meets this 6,000 pound rule, then if they had used it, let’s say, drove it for 500 miles and that was the…all the mileage was just for business, driving to and from showings or to and from different places or whatever, all for business? And let’s say they bought a $75,000 vehicle, right? If it is 100% used for business and it’s eligible for 100% bonus depreciation, theoretically, they could take a $75,000 deduction against their Realtor® commission account.

Lisa: Wow.

Ryan: Yeah. So, that is using the actual expense method. Remember, I kind of mentioned the two methods.

Lisa: Yeah.

Ryan: That is basically using that actual expense method. And we’re just saying, “Hey, the vehicle was used 100% for business. It’s eligible for a bonus depreciation.” Again, 100% in 2022.

Here’s the catch that a lot of people miss. The catch if you’re going to do that is that you need to use that vehicle for the next five years for more than 50% of the time for business. So, if you thought with me…you’re kind of listening to what I just said. If you thought, “Oh, Ryan’s basically saying that I can then, in year two, just use it for 100% personal.”

That is not what I’m saying. There is this kind of dark side of depreciation called depreciation recapture. And that’s basically if you use it less than 50% with the vehicle context, then we actually have to recapture that $75,000 deduction we were just talking about. But there’s basically a calculation to figure out, “Hey, you were supposed to use this for the next five years for more than 50%. You didn’t meet that. So, we have to recapture that $75,000 of depreciation you took from this vehicle.”

So, be careful on that. There’s kind of a catch there. So, just be careful.

Lisa: Does it matter whether you have leased the vehicle or purchased it outright?

Ryan: I think if it’s leased, it’s a different situation. That’s primarily for when you buy it. But if you buy it in cash, or if you buy it with a loan for the vehicle, then you can take advantage of that. I personally think owning it is a little better personally. If you can get the full 100% bonus depreciation by buying it…again, all cash or with a loan, right?

So, theoretically, you could put down $0, you could 100% finance a vehicle, but you could still get a $75,000 tax deduction. Right? So, that doesn’t matter in this equation of bonus depreciation, that doesn’t matter. So, I personally like the idea of just acquiring it, or 100% debt, just to make sure that you’re getting that.

Lisa: But that’s only for 2022. You can’t…you’re saying, moving forward, there’s no longer a 100% depreciation value. Right? So, now what is it going to be moving forward?

Ryan: Yeah. So, for the next several years, starting in 2023, we basically step down that bonus depreciation percent by 20%. So, 100% for 2022. 2023 is going to be 80%. 2024 is going to be 60%. And it keeps going down until we get to 0% in 2027.

So, kind of the next couple of years here, this year and I’d say next year, are still going to be pretty advantageous. I’d say once we get to the 40% 20%, 0%, it might be a little less. But hey, if you’re not putting any money down, and you can still get 40% of that deduction, the value of that vehicle, that’s still really awesome.

Lisa: So, Ryan, clarify something for me. Okay, are we talking about only…so, 100% for that first year, for that over-6,000-pound vehicle you’re talking about. Have the rules changed for 2023, meaning you can only take advantage of an 80% benefit, or are you talking about those five years from the 2022 on from the purchase of the one vehicle?

Ryan: Yeah. So, the rules kind of changed with this whole bonus depreciation stepping down, if you want to call it that. That came from the Tax Cuts and Jobs Act in 2017. This basically brought back the 100% bonus depreciation. So, essentially, we’ve had 100% bonus depreciation from effectively 2018 to 2022, to keep it simple. They added a little bit at the end of 2017.

But essentially, we’ve had 100% all of 2018 to 2022. But in order for our lawmakers to pass that, basically, they had to say, “Okay, to make this kind of…” I think it’s net neutral or something. They basically had to step it down the last several years because it’s kind of a 10-year window that they have to evaluate these kind of new laws and things. So, they said, “Okay, it goes into effect here, but we have to start phasing it down to zero towards the back half to make this net neutral.”

Lisa: Okay, so that’s across the board?

Ryan: Right.

Lisa: Okay. What about for vehicles that are not 6,000 pounds or over?

Ryan: So, you can still take the actual expense, or you can still take the standard mileage method. You could still do, I think, if it’s less than that 6000, I think you can still get an amount of…what is it, $18,000 or $19,000? Don’t quote me on that. A lot less common for me to deal with that because most of my clients are driving that 6,000 pounds.

But you can still get kind of a substantial amount even if it’s under that 6,000 pounds. But again, you can still…that’s kind of using the actual expense method compared to the standard mileage method. Yeah, you still get some benefits, even if it’s under 6,000.

Lisa: Let’s talk about other expenses besides mileage, the car itself. What other expenses should real estate agents be making sure they take advantage of? I know meals is huge.

Ryan: Meals are good, as long as they’re business related, with the clients or something. That can be good. The reason I’m less excited about meals is because it’s usually 50% deductible compared to, let’s say, making sure that you capture using your, let’s say, cell phone. We could talk about a home office deduction. That’s sometimes a good one.

(SHORT MUSIC TRANSITION)

Lisa: Hi, this is Lisa Johnson Smith. HomeLight Settlement provides modern title and escrow services to simplify your closing. Our dedicated escrow officers ensure your clients have a seamless closing every time. Contact your HomeLight agent experience team, or go to homelight.com/agents. After you sign up to use our Settlement services, HomeLight rep will be in touch to help get you started. HomeLight Settlement is currently available in select states, and will expand to more states in the future.

Well, let’s talk about home office.

Ryan: Yeah, so similar to vehicles, we have kind of two different methods again. So, we’ve got kind of the safe harbor method, or standard method if you want to kind of relate it to what I was just saying for the vehicles. That’s going to be $5 per square foot.

And basically, you can do up to 300 square feet, so a $1,500 deduction. That basically says, “Hey, here’s the square footage of my little space of my office.” Bam, that’s your home office deduction.

If we use the actual expense method, which usually can yield a little higher of a deduction, basically what we’re saying, instead of just, “Hey, here’s my square footage times $5.” Now we’re saying, “Hey, my whole home,” for example, let’s say is 2,000 square feet, right? Of the 2,000 square feet, let’s just say for easy math, “My home office is 200 square feet.” Tight? So, 10% of your home is then used for home office. Okay, that’s great.

So, 10% times all of these other kind of home office deductible expenses. I think it’s utilities, interest, insurance, right? There’s a whole list, depreciation. All of those things can actually be deducted as your home office expense or deduction.

So, usually, it yields a little more. There’s a little more time to kind of get those things pulled together and figure that out. But the downside to home office deductions is that basically, it can’t further a loss. And the reason I’m bringing that up is because as we just talked about, that vehicle deduction, if you have, let’s say, for short example, $50,000 as commissions. And then you were actually able to take that $75,000 deduction from the vehicle. You’re basically looking at a negative net income of -$25,000, right? Using that.

So, home office deduction, at that point, basically has no value in the current year because it can’t further a loss. Basically, it’s like, “Hey, you’re already at a loss here -$25,000.” The home office deduction doesn’t do anything. But with the actual expense method… I’m getting into a lot of details, so we can just move past this if you want.

Lisa: No. It’s okay.

Ryan: But for the actual expense method, basically any amount that’s not used, because you’re at that -$25,000, that can then get carried forward to a future year to get used. So, it’s not completely lost. But if I was using that standard method, that kind of $500 per square foot method, that’s essentially just lost, and you kind of lose out.

Lisa: Okay. And then, of course, for office we’re talking about printer, or fax if anybody still uses it. All of your equipment, CRMs. What about furniture for office setup? All of those things are expenses that you can write off for deduction, correct?

Ryan: Yeah. If it’s specifically for the home office space itself, then we could take 100% of that.

Lisa: What if you use more of your house? A lot of people have open-concept homes. What if you use more than just an office space to work? Maybe you move from your…the front of your house to the kitchen area. I mean, is that fair if you really are doing that?

Ryan: So, if the IRS came knocking, they’re going to say, “Hey, tell me where your office space is.” And if you’re like, “Hey, it’s here, and it’s here, and it’s here, and it’s here,” they’re going to be like, “You don’t have a home office then. You’re just kind of using this personal space for your office, and you don’t have a home office.”

So, you want to have a dedicated space that is regularly and exclusively used for business to justify you taking a deduction on your tax return and saying to the IRS, “I have a home office.” Oftentimes, we will actually advise clients to take a picture and do a floor map to say, “This is how big it is.”

Lisa: Really?

Ryan: Especially that’s helpful if they move, right? If you move and you get audited, they’re going to say, “Prove to us that you had this home office deduction.” Right? If you move, you can’t…how are you going to get back into that home?

Are you going to knock on the person you sold it to, say, “Hey, I need to come in here? The IRS agent wants to come.” They’ll be like, “No, no, no, they’re not coming in.” So, just be careful trying to take it too far. And as always, good documentation is really key for any sort of deduction that you take.

Lisa: Okay, that’s good advice. So, let’s get to meals because I’ve been on a couple tax webinars. And one thing that stood out to me was, especially for agents, because agents are kind of…we’re always doing business, no matter what.

So, one of the things that this particular webinar had pointed out to me, and you tell me what you think, is that pretty much almost any of your meals can be looked at as a deductible expense. Because if you are sitting there and you’re talking to…you’re going out to lunch with a neighbor, but you’re talking about…asking them about whether they plan on selling their house soon, or the topic of real estate, or who sold in the neighborhood, what the neighborhood homes are going for. That can count as a real estate expense.

Talk to me about what you think about that and where you draw the line.

Ryan: I think that’s fine. I think, just realistically, that’s not going to be the case. A lot of people, and I won’t mention any names because I respect them, but you can basically say, “Hey, even going out for a meal with my wife can be business deductible.” That’s true. It totally could be true.

If you’re a Realtor® and you’re with your spouse over dinner, and you guys, 100% of the time, or let’s just say more than 50% of the time, the majority of your conversation is just talking about the business, or real estate, or whatever? Great, that’s awesome. So, sure, it’s possible. Do I think it’s always realistic? No. So, I guess just be careful taking it too far.

Lisa: Okay, besides meals, what other…what about entertainment?

Ryan: Entertainment is now 0% deductible.

Lisa: Really?

Ryan: So, it’s just meals now. Yeah. So, be careful.

Lisa: Wait a minute. Even if you’re entertaining clients?

Ryan: Yeah. Unless you’re putting on an event for them, right? But if you’re going to something like, “Hey, we’re going to go to the Derby,” or, “Hey, we’re going to go to a basketball game.” Right? That’s 100% entertainment.

If you instead wanted to maybe host a client’s event, maybe you could call it that and say, “Hey, we’re hosting this for our clients that we like. It’s at our office or something, or it’s at my home.” Maybe you could justify that a little bit more. But anything considered just purely entertainment is not going to be deductible anymore.

Lisa: Wow. And that’s starting 2023?

Ryan: I forget what year that started. That was just a couple of years ago. Yeah. I can’t remember what year it was.

Lisa: What if it was looked at as a gift? You had a client who closed on a home, and you bought them two tickets to a Clippers game?

Ryan: That could work. I don’t know if the entertainment kind of definition is about you’re spending the money to have an entertaining time with the client. I can’t remember the definition of what exactly they define as entertainment. But it used to be just meals and entertainment. They were kind of grouped together under the tax code. And now they’ve kind of separated them and said, “Hey, you can still take 50% of meals.

But anything that would be categorized as entertainment is now 0% deductible.” So, be careful with that. Anything that when I see on a client’s, or anyone’s, really, anything that says an expense that’s like a client gift or something like that, I kind of assume that’s like a bottle of wine or, “Hey, I bought you this really nice knife,” or something special as a welcome home or something. That to me, feels like that’s a legitimate cost of doing business.

But if it’s like, “Hey, I went to a Miami Heat game with my client.” Well, okay, that’s obviously entertainment with them, compared to, “I’m just giving them a gift.” So, be careful on that. Again, I can’t remember the actual definition of entertainment, but I would be careful on that.

Lisa: Okay, that’s good to know. What other expenses that maybe some agents don’t really think about?

Ryan: I’d say a small one that people will normally forget is cell phone cost unless they’ve already captured that through kind of their business checking account. Maybe they’re like, “Hey, all I do is kind of use this phone for business.” If they’re really that busy, maybe they’re already capturing that.

But a lot of people, they’re like, “Hey, I use my phone maybe 50% of the time for business.” But they’re having that run through kind of their personal bank accounts. And so, it’s like, “Hey, let’s take…” maybe it is 50% used, “Then let’s take 50% of the cost of the cell phone over here against your business income.” Right? So, things like that that maybe it’s kind of used for both business and personal. It can be hard to make sure you kind of calculate that and get it captured in the correct spaces at the correct percentages, let’s say. It can be hard to do that.

Lisa: Okay, anything else?

Ryan: Any other subscriptions that you might be able to say you could justify that, “Hey, I use this.” Again, it might be small, it might be hard, not a lot of tax savings if you don’t want to go through the headache of that. But maybe some subscriptions that you’re using kind of for both could be an example.

Lisa: What about, now that everyone’s so big on social media, what about Facebook ads that you might take out for your business or ads on other social media?

Ryan: Yep. I’d say advertising is a key one. If you’re spending money to grow your business specifically as a Realtor®, yeah, definitely would include that as a business expense.

Lisa: All right. Let’s talk about some of the benefits specific to real estate agents that aren’t necessarily expenses but something that you say, “Wait, this is something I would do all day long as an agent,” that a lot of agents aren’t taking advantage of.

Ryan: If it were me and I was a Realtor®, I would be taking advantage of the Real Estate Professional Status tax strategy.

Lisa: And what is that?

Ryan: The Real Estate Professional Status, we call it just REPS kind of in-house and on social media, if you’re watching me or following me.

Basically, this Real Estate Professional Status came about. I think it was the early ’90s, essentially from this 1986 Tax Reform Act. Congress kind of said, “Hey, we are going to split taxpayers’ income between now passive bucket and this non-passive bucket.” So, now we’ve got two. And essentially, what they said is rental real estate are over here, right? So, Realtors® are over here, kind of this non-passive income you’ve got. But then they said, “Hey if you’ve got a rental real estate, we’re actually going to make that passive,” right?

So, agents that can invest…actually work as Realtors® over here, and they own rental properties over here if they meet Real Estate Professional Status, and I’ll get to what the tests are here in a second, but basically what they can do is say, “Hey, I don’t have this divide anymore. Now I can take my rental property losses.” Right? Losses usually come from rental properties through things like depreciation, right?

So, now what I can do, if I meet REPS, I can pull that into my non-passive loss bucket over here. And now that can actually offset my Realtor® income as well. So, if you combine that with a cost segregation study with kind of juicing your losses with this new rental property loss, and it’s now non-passive, that really can significantly reduce your Realtor® income taxable income, really.

So, basically, the test in order to kind of do this whole transition from passive to non-passive, meeting Real Estate Professional Status is kind of made up of two steps. The first step basically says you work in real estate 750 hours during the year. For Realtors®, real estate agents, whatever, that’s easy peasy, right? So, you might be working 2000 hours as a Realtor®.

So, then that test, to me, for most Realtors® is easy, especially for full-time brokers. The Part B of that is…so, it’s not only 750, but it’s also more than 50% of your working time. So, again, for people in real estate, full-time real estate agents, that’s also not a concern. But guess what? For people like me, that’s impossible, right? For most of Americans, 98% of Americans, this is going to be basically impossible because of that more than 50% test.

Because if you’re working 2,000 hours as an employee, you also need to work 2,000 hours in real estate alone. That’s just not realistic. So, what do you need to do next? So, basically, step two is material participation in your long-term rental properties. So, basically, it’s different because we’ve got your hours up here being a Realtor®, let’s just say, 2,000 hours. But then you basically have the second step that says you also need to participate in your rental properties, right? Two different businesses, being a Realtor® and kind of managing your rentals. Two different things.

So, basically, the IRS says, “If you can meet one of the material participation tests in your long-term rentals, now you will have met Real Estate Professional Status. And now those long-term rentals that you have, any losses they generate can actually now offset your Realtor® income over here.”

So, going back to the second step, what are those tests? So, ultimately, there’s seven separate tests within material participation. But kind of the three most common that we see our clients trying to use, the first one is substantially all.

So, if you do substantially all of the work in that long-term rental or long-term rentals, right? That would mean you’re the property manager. You’re the repair person. You’re the cleaning person. You’re all of those things. Of what I’m about to say, that’s probably the least used. So, then we go to the second one.

So, the second one under the material participation test umbrella is you get to 100 hours and more than any other individual person. So, what does that mean? So, let’s say you got 250 hours doing things within your long-term rentals. You’re managing it. Maybe you’re doing some of the renovations yourself. You’re doing the turns yourself, right? All of those things.

If you got 250 hours, and then let’s say you had a handy person that got 175 hours, right, you would then still need material participation because you got your 100 hours, and it was more than the next closest person, which in my example is going to be that handy person. So, that would work.

But we’ve got this third test of 500 hours. So, we’ve got substantially all, 100 hours, and more than any other individual person, and 500 hours. So, if you do the 500-hour test, you don’t have to compare your time to anyone else.

So, to me, that’s kind of the golden ticket, if you want to call it that, because as long as I get to 500, I can have a property manager work 2000 hours in my rentals, and that doesn’t matter. So, it actually opens up a lot of opportunities for you if you can actually meet the 500-hour test.

Lisa: Oh, really?

Ryan: For another example, basically, if you met that 500-hour test, and you met the other kind of REPS test that we’ve mentioned earlier, then if you were to actually go and invest, let’s say, $50,000 into, let’s say, an apartment real estate syndication. What they’re going to do is send you a K-1 at the end of the year to say, “Hey, here’s your income or losses for the year with your new investment.”

Usually, the sponsor, the syndicator, the GP is going to have a cost segregation study done on that property, on this new property that you just put money into. So, what does that mean? That means that that K-1 that you receive is going to show a huge negative. It’s going to show a huge, let’s just say, -$40,000.

Lisa: Ryan, I’m going to stop you for one second. Just hold that thought. I just want you to break it down in layman’s terms, the type of investment that you just mentioned.

Ryan: Basically, you’re a limited partner in a, let’s say, 250-unit apartment building. So, maybe you own 1% of that apartment. Right? So, you’re basically just a passive investor, limited partner, just putting some money in. And you’re just kind of getting those monthly, quarterly, annual distributions.

Lisa: Okay, got it.

Ryan: So, when they send you that K-1, again, it’s going to, let’s say, be -$40,000. That -$40,000 if you meet Real Estate Professional Status and you met the 500-hour material participation test. Now, even though you didn’t spend a single hour working in this syndication, that negative $40,000 can come back to you and offset your Realtor® income.

Lisa: Well, how can you meet the 500-hour if you didn’t spend a single hour with that particular investment?

Ryan: That is a fantastic question. So, basically, the short answer is initially, you have to meet one of those material participation tests for each individual property that you own. However, the IRS has given us a grouping election under 469-9, where you can actually group your long-term rental properties together. And now, it can be seen as one activity.

So, now you can say, “Hey, I got my 500 hours over,” let’s just say, “three long-term rentals over here that I manage, and I did a bunch of renovation. Now if I just add in one more long-term rental, I didn’t need a single hour, but I can still group that because it’s a long-term rental syndication investment.”

Lisa: So, those 500 hours are cumulative.

Ryan: Yes.

Lisa: Oh, okay. All right.

Ryan: So, it is a extremely powerful strategy. And that’s why I think anyone who is a Realtor® looking to save taxes, you can do the S-corp thing. But if you’re looking to really significantly, basically put in no additional hours depending on how many hours you’ve already put in to your long-term rentals, and managing those, and taking care of those, you could theoretically put in no hours, but get a $40,000 offset against your Realtor® income.

Lisa: Wow. That is great.

Ryan: So, it’s very powerful.

Lisa: But where do you go to find these?

Ryan: I mean, there are websites that you can look into. Some of the websites, they ask that you are a accredited investor. Go on social media, and you will see kind of syndicators, sponsors, whatever you want to call them, putting together these deals. And essentially, yeah, you might need to meet some of their criteria or have a minimum investment, things like that.

But oftentimes, they are looking for new investors. So, as long as you meet that and you can connect with one, you review the proforma. Make sure you’re comfortable with the investment itself. This is not financial advice, huge disclaimer, but review that proforma, make sure it’s good. And then, if you want to invest in that, that’s great. And they can kick back to you a significant loss.

Lisa: I was going to say. But that’s if you’re looking for a loss. If you’re really trying to make money off of your investment, I mean, is that still like…does it kind of balance out?

Ryan: So, here’s the thing. That -$40,000 was not $40,000 that that entity spent, that the syndication spends. It is purely a tax deduction, a tax kind of paper loss. That is very different than the distributions you received.

For example, the one that I’ve done: we invested, I think, $25,000 or something. We got, I think, something like a $20,000 negative a loss sent to us, but we still received, I think it was $1,000 of distributions. So, I received money. I received $1,000, but I actually showed on my tax return like -$20,000.

So, the tax in the cash flow and the operations are two completely separate things. Why? Because of depreciation. Depreciation is not a cash expense. It is purely a tax deduction that we receive.

So, how do you get this kind of massive loss given to you? Essentially it’s that sponsor getting a cost segregation study completed. So, before you invest, oftentimes, what clients are going to do, and what I would do is make sure you know whether that sponsor is going to do a cost segregation study.

If you just invest in something, and you think they’re going to do it, or expect 100% of the time and assume that they’re going to do it, but they don’t, you’re going to be very upset. You’re going to have your expectations not met. So, make sure that you ask beforehand before investing, so you actually know if you’re going to get this loss.

And if you’re really banking on that loss, then you might pivot and say, “Hey, actually, I’m not going to invest in this because they’re not going to do a cost segregation study.” So, it might actually impact where you invest depending on what you actually hear and find out.

Lisa: Okay. And that type of investment is clearly for a long-term investment if you’re getting that type of return.

Ryan: Yeah, it’s usually a little longer. I’d say, at shortest, it’s probably going to be a two to three-year hold, depending on what the syndicator expects to do. It could be five, six, seven, eight, nine, ten years that they’re going to hold that, and then they’re going to sell it depending on the market. Basically, pay back their investors.

(SHORT MUSIC TRANSITION)

Lisa: Hey, this is Lisa Johnson Smith. Before new clients contact you, many will go online to check out your reviews. Guess what? The same thing happens in podcasting. Before an agent decides to listen to The Walkthrough™, many will check out the reviews from current listeners.

So, I have a favor to ask. If you enjoy and get value from The Walkthrough™, please rate and review us in whatever app you use to listen. And whether that’s Apple Podcasts, or Spotify, or any other app, it’s easy to do. And you’ll be helping us and helping other agents at the same time. That’s what we call a win-win.

Before we get to tax law changes, if there are…an issue for a lot of agents, because they are self-employed, is retirement and how to strategize tax-wise for retirement. Let’s talk about that.

Ryan: Yeah, so you have…some of the most common are going to be SEP-IRAs. I think that stands for Self-employed Pension Plan IRA. Anyway, it’s a self-employed option IRA, basically. And then you have the solo 401(k). Just like IRAs, 401(k)s, we’re pretty familiar with that.

Essentially what you’re doing here as a self-employed individual is you’re saying, “Hey, I’m going to set up kind of my own IRA, or my own 401(k), and then I’m going to contribute my side as an employee. And then I’m going to have my company match at some amount,” again, depending on the numbers. Also, match that on the 401(k) side as well. Right? So, you’ve got these different options. Again, they’re calculated a little differently. Evaluate that with your tax preparer. But those are kind of the common ones that I’ve seen with my clients.

Lisa: And specifically, the solo agent would set up the SEP-IRA versus… Okay.

Ryan: Yep. Well, they actually could do solo 401(k). And I’ll say that a lot of my clients actually like the solo 401(k) option a little more. And again, I can’t remember the actual numbers around that, but part of the reason is…this might be a little too tax technical for this audience of yours, but basically…

Lisa: Try us.

Ryan: Okay. When you invest into, let’s say…you put money into a solo 401(k). Right? One of the advantages to that, depending on the actual plan itself, is that you can then self-direct the investments. Right? The contrary to that is, for example, “Hey, I put my money into a 401(k) with my employer. My employer has already designated, ‘Hey, these are the various funds that you can invest in, and that’s it.’”

Whereas, like a solo 401(k) or maybe a self-directed IRA, kind of the similar things here, there are differences, but kind of grouping them together for the sake of simplicity. Basically, you can self-direct where you invest those dollars, your contributions in. So, theoretically, you could actually say, “Hey of my,” let’s pretend, “$100,000 that I’ve put into my solo 401(k), I’m actually going to take that $100,000 and put that into for a new investment property. $100,000 as my down payment for a new rental.”

Then if you like that more, and you’ve put now more money into real estate because you believe in real estate as an asset is better than, let’s just say, the stock market. Then, “Hey, now you’ve actually used your retirement contributions to put into more rental properties, which you believe, again, is going to appreciate more, higher cash flow, you like the leverage, all of those things.” That’s great. Right? You had the option now to self-direct where that went. You had more flexibility.

Lisa: But what would be the tax implications for taking out of that fund or that IRA?

Ryan: So, similar to taking it out of…yeah, it would be kind of similar to taking it out of any other IRA or 401(k). Just like you could say, “Hey…for every year, you can only put in so much into a 401(k) as an employee, or as a solo, or a self-employed individual.”

It’s kind of a similar concept that the IRS is using. But basically…yeah, you could put that money in. And then if you’re trying to liquidate it out, and take it out, let’s say, as cash, it’s, again, kind of that similar concept where if you were trying to take money out of your employer’s 401(k), it’d be taxed kind of the same way. It’s kind of a similar concept.

Lisa: Okay. Even though you’re investing somewhere else, it’s still going to be taxed the same way. It’s just it’s a withdrawal period.

Ryan: Right. Yeah. And so, the solo 401(k), just to finish this thought and we can move on, is that the solo 401(k), when you invest with debt…so you buy a new property, it’s pretty common. So, you have 70%, 80% loan to value. So, you’ve got a mortgage on this property. Basically, with a solo 401(k) option, you can actually go…you don’t have to run through this whole UDFI and UBIT calculation. We don’t need to get into the details of that.

But basically, you can actually save yourself some pretty significant tax by using a solo 401(k) if you’re going to specifically invest in real estate. Compared to using that SEP-IRA, basically, we have to basically say, “Okay, how much did we leverage?” And then we have tax on that. We have to pay UDFI and UBIT with a self-directed IRA. So, be careful of that. If you know going in that you’re going to use your retirement to invest in more rental properties, then you probably more than likely are going to go with the solo 401(k) to avoid the UDFI and the UBIT tax.

Lisa: Oh, wow. Well, that’s some great, great advice there. I definitely didn’t know about that. Are there any tax law changes that we need to be aware of, specifically for agents or otherwise?

Ryan: I guess we did talk about the 0% entertainment change. But the other ones are kind of the annual adjustments that we get for vehicle amounts for that kind of standard mileage. And 2022 is kind of unique with all the inflation. They actually had, partway through 2022, adjusted the mileage rate. I think it was like 58.5 cents, and they bump it up to, I think, 62.5 cents or something like that halfway through. They very rarely ever do that.

Usually, they set a mileage rate for the year, and then they say, “That’s it for the whole year.” But because of the inflation concern, they basically were trying to give business owners a benefit and said, “Hey, actually, you can take more of a deduction because cost of gas has gone up significantly.”

And basically, last year we had, I don’t know where you are, but $4-something per…yeah, it was a lot. And so, basically, they were like, “Hey, we need to give our business owners more of a deduction for this.” So, that’s one thing that’s always going to change pretty much every year.

Lisa: Right. So, is that for 2023 as you’re doing your taxes, or 2022, you can take advantage for inflation for half the year? Are you saying they bumped it up to apply to the whole 2022?

Ryan: It’s kind of split in half. So, the first…

Lisa: It is. Okay.

Ryan: Yeah. So, it’s kind of unique. It’s going to be hard for people to do this year, in my opinion. Because from January 1st to, I think, it was right in the middle of the year, June 30th, basically you get…let’s just pretend it was 58.5 cents. But then any mileage you had on July 1st to December 31st, then that mileage specifically was 62.5 cents, let’s say. And I can’t remember if that was exactly the rate. But basically, yeah, they split it in a half during the year, depending on when your miles actually occurred.

Lisa: Okay. Wow. And one thing I just thought about was health care. A lot of agents, because they are self-employed… Let’s talk about those types of deductions.

Ryan: There is self-employed health insurance deduction out there. There are some small nuances where it depends if you have an option to get health insurance in another place, for example, like your spouse. So, if your spouse…let’s say, you’re the Realtor® and your spouse is a W2 employee, I think the rule says that if you have an option to go with their health plan, and you pay for your own, you can’t take the self-employed health insurance deduction because you have the option of actually going with your spouse.

Lisa: And what about if you don’t?

Ryan: If you don’t, then you can actually take the cost of that health insurance deduction against your income. You can absolutely do that.

Lisa: Any final thoughts or advice?

Ryan: My final thoughts are that if you are a Realtor® who is even considering getting into rental real estate, I would start looking into that now. Why? Because you are most of the way through that Real Estate Professional Status test, you are in such a unique position, in my opinion, very exclusive position to being able to meet Real Estate Professional Status. Right? So if you are considering that, or maybe you’ve got one property, but, “Hey, I don’t know if my current tax preparer, if I’m self-preparing this correctly.” You might not be. Or they might not be.

Make sure that you understand the rules, first and foremost, and that actually might drive your decision because it might not require a substantial amount of additional hours to get significant tax savings. Think that through, right? Think through, “Hey, am I really focused on tax savings because I’m in the 37% tax rate?” Hey, maybe putting in a few more hours and understanding how to meet Real Estate Professional Status could save you tens or hundreds of thousands of dollars in taxes every year.

So that, from a tax strategist perspective, which is what I’m doing for my clients, that is such a significant area that we like to focus on because just dollar-per-effort or dollar-per-time–whatever you want to kind of calculate it–personally, it can be so substantial.

Like the leverage that you can pull on a few more hours in doing more rental properties or putting more assets into rental properties maybe than, say, the stock market—the tax savings can be very significant.

(SHORT MUSIC TRANSITION)

Lisa: All right. Thank you, Ryan. I know that was a lot of information, but I hope this will help you get geared up for tax season. Of course, none of this should be considered legal advice, so please consult your own tax advisor, depending upon where you reside or do business.

If you’d like to connect with Ryan on social media or contact him with tax questions, I’ll leave links to his contact info in the show notes.

Now, let’s do our takeaways segment. Here’s what stood out to me from Episode 114, “Get More from Your Money: CPA Tax Tips for Real Estate Agents.”

Takeaway number one: Decide what type of business structure is more tax-beneficial for you. A sole proprietorship, S-corp, or an LLC. For example, Ryan says that as an S-corp, only the wage portion of your income is subject to the FICA or self-employment net tax. But as an LLC, all of your net income is subject to ordinary income tax and FICA tax.

Takeaway number two: If you understand the requirements for Real Estate Professional Status, you’re able to take advantage of major tax benefits if investing in real estate. And most full-time agents already meet those requirements. And now, there are two main qualifiers. One, you must work in real estate 750 hours during the year or more than 50% of your working time. And number two, you must have material participation in your long-term rental properties. And there are several tests that determine that which we discuss in detail in the episode. And if you do invest in real estate with a group, make sure they do a cost segregation study for a loss. Otherwise, you could be missing out on your tax benefit.

Takeaway number three: Consider using some type of software, like QuickBooks, to keep track of your expenses throughout the year. This makes it much easier to remember and categorize your expenses. And be careful about deducting those entertainment expenses. Ryan says there is a fine line.

And Takeaway number four: You spend a lot of time in your car, so why not take advantage of tax benefits available for certain types of vehicles, if you can? If your new or used vehicle has a gross vehicle weight that’s greater than 6,000 pounds, then you can write off 100% of your business cost with bonus depreciation. And that’s if you both bought it and placed it in service on or before December 31st, 2022. However, that amount will decrease by 20% each year moving forward. And there’s a whole list of vehicles that are over 6,000 pounds. And I’ll include a link to that list in the show notes as well.

I hope these tips were helpful, but make sure you consult your own tax professional before filing. And those are your takeaways for this week.

Well, that about does it. If you have any questions or feedback, you can send an email to walkthrough[at]homelight.com. You can also find me in our Facebook Mastermind group. Just search “HomeLight Walkthrough™.”

Oh, and one last thing. Please rate and review us on Apple Podcasts or wherever you listen, and hit that follow button, so you get all of our future shows automatically. Thanks again to Ryan Carriere for joining me, and thank you for listening.

My name’s Lisa Johnson Smith, and you’ve been listening to The Walkthrough™. At HomeLight, we believe in real estate agents. We’re here to explore how great agents grow their business, stand out from the crowd, and become irreplaceable. Now, go out there and make some moves. I’ll talk to you again next week.

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