Real estate investments can be very complex, especially when it comes to tax reporting. However, there are general tax implications for common scenarios. Here, we will discuss some of these benefits:
Who is responsible for payroll taxes? CEO David King and Lead Tax Attorney Philip Hwang discuss everything you need to know regarding payroll taxes, including tips on what to do if you find yourself in trouble with the IRS.
The desire or need for extra income has become increasingly prevalent. Side gigs have been a popular method of supplementing earnings but with this comes more reporting during tax time. When is a side business treated as a business in the tax world, and when is it treated as a hobby?
Real estate has long been considered one of the greatest long-term investments. Further, with the trend of minimalist living, many are turning their primary residences into rental properties. While turning your home to a rental property comes with passive income and tax benefits, it’s important to note the tax implications as well.
With the recent passing of The Inflation Reduction Act, individuals who have unfiled tax years or unpaid tax debt may now expect an increase in IRS collection enforcement. Optima CEO David King and Lead Tax Attorney Philip Hwang explain how the Inflation Reduction Act can directly affect taxpayers and how to get compliant with the IRS.
While there is no guaranteed method of avoiding audits, there are things to steer clear of that could trigger an IRS audit. The Senate recently approved nearly $80 billion in IRS funding, with $45.6 billion for enforcement, which could lead to more audits. Here are some things that the IRS has historically viewed as “red flags,” which could increase the chances of an audit for taxpayers.
Reporting a Business Loss
The IRS will surely be more inclined to audit a taxpayer who reports a net business loss, even if the loss is small. Reporting losses year after year will only increase IRS interest in your tax returns. Remember, it is mandatory to report all earnings in a tax year. However, it might be helpful to reconsider which expenses should be deducted from your tax return. Reporting even a small profit could reduce the chance of being audited by the IRS.
Being Vague About Expenses
When it comes to expenses, the more detail the better. This is especially true when categorizing them on your return. Try to avoid listing expenses under “Other Expenses” as this will lead to more scrutiny from the IRS. It may even be helpful to provide supplemental documentation explaining why certain expenses drastically increased or decreased for that year. Doing so can give potential auditors a valid explanation for such occurrences and possibly avoid a tax audit. Additionally, rounding dollar amounts are red flags for the IRS. You should always use exact dollar amounts on your tax return.
Filing Late
Some taxpayers believe that filing late can actually decrease the risk of being audited. However, filing on time, as well as paying on time, can help establish a history of IRS compliance. This will be far more beneficial in the long run.
Claiming Excessive Deductions
It is best to avoid any excessive expenses. For example, deducting the cost of your breakfast and lunch each workday may not be acceptable to the IRS. Excessive deductions for your donations to charitable organizations can also increase the chances of being audited. Inflating business expenses can result in being audited, especially if you try to claim large amounts for business entertainment or claim a vehicle that is used for business purposes 100 percent of the time. Also, remember to only claim the home office deduction for the portion of your home that is used exclusively for business purposes. When claiming this deduction, you will need to figure out how much square footage in your home is dedicated to your business. For tax year 2023, the rate for the simplified square footage calculation is $5 per square foot, with a maximum of 300 square feet or $1,500.
Keeping Poor Records
Even the simplest tax situations require adequate records. If your finances are more complicated, then detailed records are necessary. Some taxpayers may feel inclined to estimate their expenses because they did not save receipts or documents. Unfortunately, the IRS views this as a red flag. It’s important to make sure you have detailed records for the past three tax years at minimum. Having items like your previous tax returns, medical bills, business receipts, real estate documents, and investment statements can help substantiate your claims and avoid an IRS audit.
Choosing the Wrong Filing Status
Your filing status (single, married filing jointly, married filing separately or head of household) determines how you treat many tax decisions. it affects what forms you’ll fill out, which deductions and credits you’ll take. It ultimately determines how much you will pay (or save) in taxes. Select the wrong status, and it will trigger a cascade of mistakes–maybe even an audit. On top of that, if you decide to file jointly with your spouse, this means you’re responsible for their errors. This includes deliberate falsehoods on your partner’s return, so make sure that you’re comfortable with what it says.
Tax Relief for Those Being Audited
The chances of being audited are low, but those chances increase when the IRS notices red flags. The audit process can be very stressful. It is a tedious process that requires collecting information regarding your income, expenses, and itemized deductions. Failing an audit can result in a huge, unexpected tax bill. It’s best to seek assistance from experts who can help you avoid an IRS audit. Our team of qualified and dedicated tax professionals can help.
Real estate investments and tax implications can be very complex. However, there are general tax implications for common scenarios. Here, we will discuss some of these benefits.
Real Estate Tax Write-Offs
The most obvious tax implication for real estate investments are the write-offs that can help reduce rental income. Typically, you can deduct any expense directly related to managing and maintaining the property. This can include:
Property insurance and taxes
Mortgage insurance
Property management expenses
Expenses for maintenance and repairs
Advertising fees
Office space
Equipment used for operating your real estate business
Legal fees
Travel expenses
Accurate and detailed records should be kept in case the IRS requires substantiation.
Real Estate Depreciation
Like many physical assets, real estate investments assume normal wear and tear. You can deduct the cost of depreciation on your taxes each year, which will allow you to lower your tax liability. According to the IRS, the standard expected life of a property is 27.5 years for residential properties and 39 years for commercial properties. This means you can take the value of the property, less the value of the land it resides on, and divide it by the expected life term to calculate the amount of depreciation cost per year.
Capital Gains
Many real estate investors purchase properties with the expectations of eventually selling them later. Being aware of the tax implications that result from the sale of a property is just as important as those that result from owning one. A capital gains tax can have drastic effects on your tax liability.
For example, you can realize a short-term capital gain if you earn a profit on an asset within a year of owning it. The gain is considered regular income. If the profit is large enough, it can move into the next tax bracket, creating a larger tax bill.
On the other hand, you can realize a long-term capital gain if you earn a profit on the sale of property held for one year or more. These gains have much lower tax rates than standard income tax rates, which means you will get to keep more of the profit. Additionally, if your income is low enough, you may not be required to pay any taxes on the profit.
Tax Help for Real Estate Investors
It’s always best to get the advice of a reliable tax preparer or professional during tax time, especially if you have complex investments like real estate. Not knowing the correct way to report income, losses or deductions can result in IRS auditing, penalties and fees. Our team of qualified and dedicated tax professionals can help.
The IRS recently announced that it will be providing penalty relief to help struggling taxpayers affected by the pandemic. Optima CEO David King and Lead Tax Attorney Philip Hwang provide insight on what penalty relief is and how individuals can qualify for it if they are still dealing with an ongoing tax burden.
