Real estate investors will benefit from year-end tax planning and utilizing these 5 year-end tax planning strategies to minimize your tax liability.
These tax strategies for real estate investors are provided to Rentec Direct by Amanda Han, Managing Director of Keystone CPA, Inc. Amanda is a CPA and real estate investor and the author of the highly-rated book Tax Strategies for the Savvy Real Estate Investor.
Tax Saving Strategies for Real Estate Investors
Contrary to popular belief, tax savings does not happen in April each year. Planning is not done when you take your tax forms to your tax preparer. By April, all you are doing is report what did (or didn’t happen) last year. To get true tax savings, we need to be involved in proactive tax planning. This means working proactively during the year to put the right strategies in place so that by next April, you are able to legitimately save on taxes.
Tax planning is when we take a look toward the future and take the right steps to ensure we are legitimately using the tax code to our advantage. Believe it or not, one of the best times to do tax planning is actually at year-end. Why? Similar to a sports game where the scores may go up or down during the game. The winner though, is determined by who has the most points at the end of the game, when the clock counts down to zero. Tax Savings works the same way. Where your numbers stand on 12/31 will determine, for the most part, how much in taxes you pay or save.
Simply put, year-end tax planning is the process of reviewing your financial situation at the end of each calendar year and strategizing ways to minimize your tax liability for that year. This is especially important for real estate investors because there are so many tax incentives for us.
Here are the top 5 year-end tax planning strategies for real estate investors.
1. Maintain Accurate Financial Records
An essential part of successful year-end tax planning for real estate investors lies in maintaining accurate and thorough financial records. Proper bookkeeping is more than just recording numbers—it’s a strategic tool for tax planning.
By keeping a clear record of all financial transactions, including income, expenses, property purchases, and sales, investors can ensure they are capturing and maximizing their allowable deductions and credits. This not only provides a clear picture of your financial health but also lays the groundwork for potential tax savings.
Comprehensive and up-to-date financials make it easier to identify tax planning opportunities and enable more accurate forecasting for tax liabilities.
In short, good bookkeeping gives real estate investors the insights needed to strategically plan when it comes to year-end. With all the systems and automation that areis now available, make sure you have your books and records set up for success. And if you do not have it set-up, year-end is the best time to get all of that buttoned up.
Not only will this help you with year-end tax planning, but it can also help a ton to alleviate tax-time stress next April.
2. Defer Income into Next Year
Another effective year-end tax planning strategy for real estate investors is to defer income into the next year.
This strategy might involve delaying the closing of a property sale until January of the next year. If the sale closes in January, the income from that sale won’t be taxable until you file your tax return for the following year, effectively delaying the tax bill. A deferral of income by even one day (from 12/31 to 1/1) can result in an entire year of tax deferral. This also allows you to have an additional year to plan for ways to offset that income.
Another method involves holding off on chasing overdue rent until the New Year. Remember, in the world of taxes, it’s not what you earn but what you keep. So, by strategically deferring income, you can manage your annual tax liability more effectively. But consider this strategy carefully, as it may not be advantageous if you expect to be in a higher tax bracket next year.
3. Accelerate Expenses
Another year-end tax planning strategy for real estate investors is accelerating expenses. This involves making deductible business purchases before the year ends to reduce your taxable income for the current year.
For landlords, these expenditures may include repairs and maintenance on rental properties, prepayment of insurance or property taxes, or purchasing equipment or supplies needed for property management.
If you foresee a repair or a significant purchase early next year, consider if it would be beneficial to make it this year instead. By doing so, you’re essentially shifting next year’s tax deductions into this year, reducing this year’s tax liability.
Be cautious of what you prepay to avoid any issues. For example, you may not want to prepay a large amount to a new contractor with whom you have never worked. Make sure that what you prepay will have a minimal risk of loss or forfeiture.
4. Shift Property Management Income into a C Corporation
Shifting property management income into a C Corporation is another strategic move in year-end tax planning for real estate investors.
Establishing a C Corporation for managing your properties can potentially lower your tax rate. The C Corporation tax rate is a flat 21%, which is lower than the top individual federal tax rate. If your personal tax rate is higher than 21%, it might be beneficial to shift some of your income to the C Corporation.
By doing so, the income derived from property management is taxed at the corporate rate rather than your potentially higher individual rate. However, it’s essential to remember that this strategy has its complexities. The corporation needs to be a real, operating business providing bona fide services.
Also, keep in mind the potential for double taxation; the C Corporation pays corporate income tax, and shareholders also pay taxes on dividends received. As with most things in the tax world, there is not a one size fits all solution.
5. Manage Capital Gains and Losses
Proper management of capital gains and losses is yet another crucial component of year-end tax planning for real estate investors. If you had a significant gain this year and did not do a 1031 exchange, consider using offset strategies before year-end to alleviate that tax bite.
For example, did you have other rentals that are expected to create tax losses this year? Maybe tax losses can be created strategically through cost segregation studies. Alternatively, you may be interested in purchasing more rentals by year-end to strategically create some rental losses to offset that gain.
Time is of the Essence
As you can see, year-end tax planning for real estate investors is crucial. Now is the time to take action. It is important to begin to tackle it before the holiday season kicks in. The reason is twofold.
First, the holidays are traditionally a busy time, and you may not have the mental bandwidth to give your finances the attention they deserve. By starting early, you ensure you have enough time to evaluate your portfolio, meet with your tax advisor, and make necessary adjustments.
Second, many tax strategies, such as deferring income or accelerating expenses, require time to implement effectively. They are not last-minute decisions but require careful planning and strategizing. Starting your tax planning before the holiday season ensures that you have plenty of time to implement these strategies and maximize your tax savings.