With the continued progression of technology, we have more opportunities to automate our decisions than ever before. As our world becomes more complex, we face more decisions and so the extra help of automating SOME of those decisions is a welcomed relief. Often; however, the default option to decisions may end up costing you much more in taxes than you are obligated pay.
Let’s look at three examples that I have seen from working with real estate professionals and business owners for the last twenty years.
- It seems the limited liability company (“LLC”) has become one of the most popular choice of entities when setting up a company in recent history. Their flexible ownership and allocation options, tax classification options and relatively light organization and maintenance requirements (depending on which state you live) helps boost its appeal when starting a new venture. The default tax treatment of an LLC owned by two or more people is to follow partnership tax rules. Without proper tax planning, net income from partnership activities is subject to self-employment tax and reported on the owners’ individual tax return. With proper planning, you could change the tax classification of the LLC and remove the self-employment tax altogether. The default option in this case could result in subjecting your income to a 15.3% tax that is not necessary.
- Even during a year that has been impacted by the pandemic COVID-19 virus, real estate professionals are still driving their vehicles for business purposes. With proper documentation, the IRS allows for a vehicle expense deduction using a default mileage rate set by the IRS. Did you know that using the business use percentage of your actual expenses may result in a greater vehicle expense deduction? Studies have been conducted by AAA that present surveyed operating costs by vehicle type and in just about every class of vehicle, the actual expenses were greater than the default mileage rate provided by the IRS. Tracking vehicle expenses is one area where the use of technology takes the pain out of tedious record retrieval and summary at tax time. There are many “apps for that” and we are happy to share a couple that we have used with our real estate and construction customers.
- Investing in rental real estate is a common activity among our customer base. When we first get introduced, I will review their prior years’ tax returns and seek out opportunities to harvest missed deductions and get a sense of the opportunities for future tax savings. One that comes up almost every time is how general the rental properties are identified for depreciation purposes. The rules state that assets have a “useful life” and the cost must be recovered over the useful life, rather than being simply expensed in the year purchased. The IRS offers examples of useful lives for all sorts of assets in specialized industries and for general use. The useful life of a residential rental property is 27.5 years, a commercial building is 39 years, and land lives forever according to the IRS. I will let them explain that to an environmental engineer who may feel otherwise.
Too often I see the rental activities only broken out between building and land, when in fact, allocating the cost to shorter lived assets like floor covering, cabinets, decorative lighting, sidewalk, appliances, etc. will result in a larger depreciation deduction during the current period, thereby creating greater cash flow for the investor to put to work today. The time value of money leads us to believe a dollar today is worth more than one tomorrow. How much of the cost can be allocated to shorter lived assets depends on the building, but for a reference point example, a generic single-family residence may have about 25% of its cost allocated to shorter lived assets than the 27.5 years. There are other factors to consider when making planning decisions regarding investment real estate and depreciation, but be aware the default option of listing just building and land may be leaving money on the table during the current year.
For more than 20 years, holding various financial leadership positions along the way, I have helped business owners stop overpaying their taxes. Through our proactive tax planning, you may be able to achieve your intended outcomes sooner with money that you would have spent on taxes you do not have to pay. Be purposeful with your decisions, as the default option may be costing you thousands.
To learn more legal, tax-saving strategies for business owners, or get help with an IRS tax problem, contact me at (360) 474-5892 or e-mail me at tate@ensigncpa.com.
Tate Ensign, CPA
T.S. Ensign, CPA & Company, Inc.
P.O. Box 956
Ravensdale, WA 98038
(360) 474-5892
Fax (360) 474-5825
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