Real Estate Agent Tax Guide
This is a pretty comprehensive guide for the new real estate agent. It doesn’t cover everything, but it will get you started in the right direction. I update it at least once a year to keep it up to date.
So you’ve got your real estate agents license and that first commission is finally on the way. No way around it now, you have taxable income. The question is, how much? And, how do you pay as little as possible? This post assumes that you will be paid on a 1099-MISC, as a self-employed Real Estate Agent. If you’re getting a W-2, some of this will be useful, but not all. I’m also assuming that you work for a real estate company, and aren’t completely independent. Much of this advice isn’t gospel, it’s just what I’ve seen and think works best. In some ways, it’s a list of “best practices.” As always, you should use this post as a starting point, and seek professional assistance when it comes to your personal situation. I am also going to assume you have not formed a complex business entity such as an S Corporation or Multi-Member Limited Liability Corporation. There are benefits and disadvantages to these, but you need to talk to a professional to understand them.
Here’s a bit of something you might not want to hear, but it’s actually good news. Here we go: The goal of being a real estate agent is to make tax time SUCK. If you are doing this thing right, you will owe a lot of money, every year, and the amount will go up, every year. The reason is that you are making more money. It’s easy to pay no taxes if you are a crappy agent who can’t make money. The goal is to make a CRAP-TON of money and pay a CRAP-TON of taxes. The key is to make sure you are prepared for the taxes you owe, and to keep the amount to the minimum legally allowed. I tell my clients that if they are doing things right they should hate me.
I’m going to start with some basics, and then get into details. The first big surprise you will have is that nobody’s taking taxes out of your paycheck. You have to pay it all as you go, or at the end of the year when you file your tax return. The second thing is that there’s nobody to pay for Social Security taxes except, well, you. Most people are barely cognizant of the 7.65% that’s taken right off the top of a normal paycheck for Medicare and Social Security taxes. What even the most aware don’t realize is that their employer matches this deduction! As a 1099 recipient (self-employed is the IRS term) you have to pay both the employee and employer portion! This means a 15.3% additional tax! Imagine you’re in the 12% tax bracket – that means you actually pay 27.3% taxes! And this doesn’t even cover state taxes! Also, you don’t want to be in the 12% tax bracket – you want to make more money and end up in the 22% or higher bracket!
The good news is that, unlike a W-2 employee, you only pay these taxes on your ‘net’ income. This means you get to take all “ordinary and necessary” expenses off the top before you pay a dime in taxes. So what is ‘ordinary and necessary’? I like to boil it down into two categories: 1 – things you pretty much have to pay – like licensing, commissions and fees. 2 – things you pay because you expect them to increase your income or make the business run more efficiently. If they meet either of these requirements, they’re pretty much a lock as being deductible.
Knowing the above, it’s important that I give one of my biggest pieces of advice – you pretty much should NEVER do something just because you expect it to help on your taxes. Spend money only if you have to, or because it’s the best idea for your business! This has two benefits: 1 – you don’t waste money on stupid s**t. 2 – chances are the deduction is legitimate.
So now comes the part you’ve been waiting for: What the hell can I deduct? Here’s a non-exhaustive list, with some details, to get you started:
Marketing Expenses: Business cards, website fees, MLS dues, lead generating expenses, posters, signs, sponsorships, commercials, advertising, pretty much anything you do to get someone to call YOU when they want to buy or sell a house. As a non-tax aside, you need to evaluate these carefully and talk to experienced agents to find the best of these. Your commissions are big but come infrequently. You need to understand how much you spend for each commission so you can properly evaluate what works best.
Gifts and Referral Rewards: Gifts to clients are generally limited to $25 per person, per year. (That’s the deductible amount, you can give more.) Be careful of referral fees. You should have received more training on this than me to get your license, but I will simply remind you that there are varying rules from state to state, as well as RESPA requirements that restrict what amounts, how and to whom you may pay a referral fee, so, check with your senior brokers before paying these. If the referral fees are legal, there are ways to deduct them, but talk to your tax professional about them.
A great gift for buyers would be a copy of my tax book. It’s based on life events and has chapters like, I’m Getting Married, I’m Having a Child and, wait for it…I’m Buying a House! Please consider buying a ton and giving them to your new homeowners – they’ll thank you!
Training, Education, and Licensing: Whatever you pay to maintain your ability to be an agent is deductible, as well as things you do to increase your skills, as well as what you are allowed to do in the field. Classes, seminars, books, and certificates mostly all qualify.
Insurance: I’m not talking about homeowners insurance here. I’m talking about ‘oops I screwed up and my client is suing me insurance’; or someone who’s not my client. Sometimes this is called Errors and Omissions Insurance. If your state or agency doesn’t require it, get it anyway! Also, if you pay a rider to your car insurance for business use, the difference between that and regular insurance is deductible. There is also a self-employed health insurance deduction that allows you to deduct your health insurance costs if you have no other insurance source (if you can get insurance through your spouse’s work this is a no-go.)
Entertainment Expenses: Eventually you’ll be with a client, or potential client, and pick up the tab for lunch, or dinner, or a stripper (don’t do that – it’s tacky – and questionable as a deduction). Generally, if you expect the expense to result in a sale that makes you money, either immediately, or in the future (whether it ultimately does or not doesn’t matter, as long as you expect it to) 50% of the meal (and ONLY the meal) is deductible. I recommend writing the name of the client on the receipt, as well as a quick description – “house hunting”, “referral source”, “potential client” or something like that.
Travel Expenses: These are a toughie. People love conflating personal and business travel. If you travel to Maine to visit family and see the lobster festival, and go to dinner with a client that is moving to your area, the trip is primarily personal. You can deduct expenses DIRECTLY RELATED to the meeting with the client, but little else. I recommend keeping business and personal separate. You can visit a friend for dinner on a three day business trip, but don’t do business for an hour on a three day personal trip. Also, avoid what I call BS travel. Flying to Vegas to assess potential real estate markets is transparent vacationing disguised as business travel, especially if you spend 23 out of every 24 hours in the casino! Be reasonable! Go on trips that are going to increase your money-making potential. Stay away from any others. For legitimate travel, you get airfare, rental car, tips, taxis, laundry, internet, and phone, as well as 50% of meals and any other reasonable and necessary expenses. Travel assumes overnight trips away from your home area.
Cell phones, laptops, and tablets: Do yourself a favor, get a business only laptop, cell phone, tablet and/or computer. It is simply too difficult to calculate expenses on a part personal and part business electronic device. Don’t share your business number with friends and family (other than wife and kids). If you keep everything separate, the deductions are easy and legitimate. If you don’t, you have to establish a business use percentage, and worry about listed property rules – which suck!
Vehicle Expenses: Keep a mileage log. Let me say it again, unless you have a vehicle that is 100%, no s**t, total business and no personal use, keep a mileage log. Don’t worry about gas, repairs, oil changes, insurance or any other car expenses (except as discussed above under insurance). There are other ways to track vehicle expenses, but mileage is the best. Do track annual car taxes and finance charges. The easiest mileage log is a notebook where you write the date, the trip purpose and the miles driven. You will also need to know the total miles the vehicle is driven for the year, so write the odometer reading down every January 1st! Mileage will be one of your biggest expenses, so keep track of it religiously! 10,000 miles of properly tracked vehicle mileage can result in $1500 of tax savings! Mile IQ is the absolute BEST way to track this. It is a mobile phone app that AUTOMATICALLY tracks your mileage every time you drive. Then a simple swipe categorizes it as business, personal, medical or charity. You can add notes to each trip and print a report for filing taxes. It even keeps a running total of your deduction amount! It costs a small amount to use (which is deductible) but is a MUST!
Home Office: Set aside a space in your home that is 100% business use. Never used for anything else, and regularly used for business. This is where you keep your business records, your business computer or laptop, make your sales calls from and meet clients. The tax term is regular and exclusive business use. If you do this, you deduct a percentage of the household expenses – rent, interest, taxes, utilities, insurance, repairs, etc, based on the square footage of the office ratioed to the home square footage. Expenses directly related to the office, such as a dedicated phone line; do not have to be ratioed. You can also take a small depreciation deduction for the home losing value (let your tax guy handle this – it’s a b**ch!)
Employer Reported Expenses: In many cases, your employer is going to charge you for a number of different things like marketing and insurance. They will generally track the expenses and then deduct them from your commission check when you make a sale or broker a purchase. Virtually everything they charge you for will be deductible, but they will report the full amount of your commission on the 1099-MISC at the end of the year, and then give you a report of what they charged you. This simplifies things for record keeping, except that you need to make sure not to deduct something from the employer report twice by tracking it in your own records.
Depreciation: Some items that you buy for your business, that have a useful life longer than a year will have to be depreciated over time rather than deducted all at once (examples include computers, digital cameras or office furniture). There are many options for deducting it up front, but be wary of this, there are tripwires that can cost you if you dispose of something before it has passed its useful life. Talk about these items with your tax advisor.
Now let’s cover some more details:
Record Keeping: This is where the rubber meets the road. Good record keeping will save you when it comes to tax time. Your records don’t need to be extensive, but they do need to be accurate and usable. I hate double-entry bookkeeping and would never recommend it as a tool for a Real Estate Agent. I also have found that the various bookkeeping software programs are virtually useless when it comes to taxes. They may help when it comes to managing the business, but they suck for doing taxes. The best and easiest record keeping method I’ve found for Real Estate Agents involves a small notebook, a big notebook and an envelope or box. The small notebook is for mileage, discussed above. The big notebook is for every other expense (except employer reported expenses.) You need simple columns set up: date, expense, and cost. You can add categories, but don’t really need to, if you’re unsure something’s deductible, write it down and let your tax guy tell you if it’s deductible. The box/envelope is for receipts – just throw them in. Really? No sorting, categorizing or organizing? No. Simply put, your odds of ever needing them for an audit are slim to none. Save the box, notebooks and tax returns for 7 years, and then throw it all away. If you ever do get audited, there’s plenty of time to sort through the box and organize it to match the notebooks – but why do it if it’s not necessary. If I’m doing your taxes I’m going to use the notebooks, and remind you that you should have a receipt for everything. You don’t have to prove things to me.
Separate Bank Account: This one might be a little controversial, but I believe it’s the be all end all of successful businesses. Combined with record keeping discussions above, and budgeting discussions below, this will make everything easier. Open a separate bank account for your Real Estate Agent business. It doesn’t have to be in a different name, just separate from your personal account. If you use credit, get a second credit card that is exclusively for business (again, it doesn’t have to actually be a business credit card, just one that you use only for business). Put all Real Estate income in this account, and pay all Real Estate expenses out of it, or with the business credit card. Pay off the business credit card out of this account. The only expenses not paid out of the account are car expenses (especially gas) and home office expenses that will be divided based on square footage as discussed under home office above (utilities would not be paid out of the account, but office supplies and business only cell phone would). The beauty of this method is that it simplifies budgeting as we’ll discuss below, and it allows reconciling of expenses to make sure your notebook covers everything. A good tax expert should be able to compare your account statements with your notebooks and know if you missed something (assuming you don’t intermingle personal and business expenses).
Budgeting and Saving: Now that you have an account that is separate for business, you can start thinking about budgeting. Your income is going to fluctuate wildly, so you can use the business account to pay a “salary” to your personal account. I recommend letting some money build up in the business account until you have a feel for your income level. It will probably start small, but build up over time. Once you have a good feel, you can pay yourself this salary. The salary should be no more than 50% of your gross income or 60% of your net income. You need to play around with it. Start small and raise it if income exceeds expectations, but NEVER pay yourself more than 60% of net income. Having a salary allows you to budget like you had a normal job. Keeping a buffer amount in the account allows you to have a “salary” even during lean months. By paying yourself a salary and saving the rest, if you have a really big month, you end up saving more, which in turn allows you to have the money to pay the tax bill that the big month will generate. When you file your taxes, you should have plenty of money to pay the tax bill, and still have money left to maintain a buffer, and, if you’re lucky, have the ability to pay yourself a bonus to your personal account for a big purchase or vacation!
Estimated Payments: My advice is that you should use the budgeting advice above to pay your taxes. You’ll still need to make estimated tax payments if you’re making good money, but you should pay the minimum required to avoid an underpayment penalty. Your tax advisor will calculate them for you, but to explain simply: you need to pay at least as much as your prior year’s total tax liability in withholding or estimated taxes to avoid a penalty (oversimplified explanation, but really all you need to know). This is an easy calculation for your tax guy and he will set up quarterly payments and provide vouchers for paying them. (The timing is a little weird. You pay 4/15, 6/15, 9/15 and 1/15.) You can also pay varying payments to try to avoid a tax bill, but it gets complicated, and the government won’t pay you interest.
The “Pass-Through” deduction: Your business almost certainly qualifies for this deduction, even if it is a sole-proprietorship and not a fancy S-Corp or LLC. This means you can generally deduct 20% of the profits from your business off of taxable income (but the ~15% self employment tax would still apply). If the taxable income (income after all deductions except this one) is less than (2018 numbers – these go up every year) $157,500 or $315,000 if you are Married Filing Jointly (MFJ), then that’s all there is. If you are above that, you are subject to two limitations, one, because you are a service oriented business (you make money based on your knowledge) the deduction phases out over the next $50,000 of income increase ($100,000 if MFJ). The other limits your deductions based on wages you pay (even to yourself) and things you are depreciating. This is a complicated topic, so see a pro if your situation is complicated. I suspect most software will handle it nicely if you are below the income thresholds discussed above. As you make more money and start approaching the income limits discussed above, it’s imperative that you start seeking advice from a competent EA (Enrolled Agent) or CPA and prepare for the incredible complexities of being a high income real estate agent. There are a lot of things you can do to mitigate taxes at these levels and you WILL need help with them.
I hope you find this advice useful. If you keep good records and separate personal and business expenses you’ll make your tax guy’s job easier, and pay the minimum in taxes. If your tax guy sighs a lot while viewing your records, try harder next year.