Speaker - Paul Hodge CPA
I. Introduction: My name is Paul Hodge
A. Qualifications: I am a Certified Public Account with degrees in Accounting and Finance from the University of Texas a&M.
B. Experience: I have worked as a Controller and CFO for over twelve years at a variety of companies. I started my CPA practice eight years ago and I have grown it into a successful business operating in both Houston and Dallas. I am a real estate investor with twenty five single family properties. I own a real estate management company, a hard money lending company, and a real estate flipping company.
C. Subject Matter – My top ten tax deductions for real estate and small business
II. Main Topic – Top ten tax deductions
A. Depreciation: If you are a real estate investor and have a number of properties this will be your largest deduction.
1. Determining the basis of your property: Basis is the depreciable value of a particular property you own. The basis includes
a) Purchase Price
b) Abstract Fees
c) Installation of utilities
d) Legal Fees
e) Recording Fees
g) Transfer Taxes
h) Title Insurance
i) The payment of any outstanding bills of prior owners
2. “Cost Segregation” - Segregating the value of your property into different categories will maximize your current depreciation. If you have a CPA that does not want to do cost segregation then fire him or her.
Cost segregation studies, such as those performed by O’Connor and Associates, for apartment complexes can more than double your depreciation expense in the first five years. They are also essential in any exit strategy by reducing your tax liability by as much as 10%.
a) Land – 0 Depreciation (Bad) Try and reduce this by finding the cheapest value of the land. This can be done on HCAD or by using a calculated basis.
b) Residential rental building – 27.5 years (Good)
c) Building Improvements – 27.5 years (Good
(1) Replace roof
(2) Replace siding
(3) Replace air conditioning
d) Land Improvements – 15 years (Better)
(5) Water wells
e) Personal Property – 5 years (Great)
(6) Moveable sheds
The idea is to shift the basis value from the land and building to categories that are depreciated over a shorter time period...
Example: Residential property – Price $100,000
Abstract Fees $ 125
Lawyers Fees $ 500
Title Ins. $ 300
Outstanding HOA $ 250
Outstanding Taxes $ 2,000
Categories Amount 1st Year Depreciation Categories
Land $ 20,000 $ 0.00
Building $ 83,175 $ 3,024.54
Total $103,175 $ 3,024.54
Categories Amount 1st Year Depreciation
Land $ 14,000 $ 0.00
Building $ 79,925 $ 2,906.36
Landscape $ 2,000 $ 133.33
Sidewalk $ 2,000 $ 133.33
Sprinkler Systems $ 2,000 $ 133.33
Personal Property $ 3,250 $ 650.00
Total $103,175 $ 3,956.35
This is more than a 30% increase in you depreciation expense in the first year. The second year of depreciation is more ($4,956.34) due to the MACRS accelerated depreciation schedule.
B. Repairs: The difference between a repair and a capital improvement: Repairs do not materially improve the value of the property or extend its useful life.
1. Roofing : Fix a hole in the roof
2. Windows : Fix a broken window
3. Walls : Sheetrock work on holes
4. Air-conditioning : service and repair
5. Painting is always a repair, not an improvement
C. Auto Expenses: The operation of your car is very expensive. The percentage that you use the vehicle for business is tax deductible. It is important to establish your business address at your home to maximize business use of the vehicle. The IRS loves DOCUMENTATION so keep a notebook in your vehicle to track mileage.
1. Mileage vs. Depreciation & Expenses
a) Mileage : Actual miles times $.50
20,000 miles * .555 = $11,100 deduction
Must use mileage in the first year of business to use in any other year. You can switch back and forth.
b) Depreciation & Expenses: You can take the depreciation of your vehicle and all related expenses;
(1) Gas & oil
(2) Repairs and maintenance
(3) Car repair tools
(4) License fees
(7) Car washing
(8) Interest on loan
(9) Auto club dues
Vehicle Cost $40,000/5 year depreciation = $8,000
Repairs (avg. over $20,000) = $ 500
Insurance ($125 a month) = $1,500
Interest (27,000 loan @ 7%) = $1,890
Gas (800 gal @ $2.50) = $2,000
Total $ 13,890
2. Leasing vs. buying: If you have to have a new car every three years or less and do not drive more than 15,000 miles per year then leasing is a good option.
3. Section 179 Election for your auto: This is a special deduction that allows you to take a larger amount in the year the vehicle is placed in service for business. There are limits depending on the type of vehicle you drive. Please consult your tax professional (CPA) about the maximum amount you can take if it is available for your vehicle.
D. Travel, meals and entertainment
1. What can I legally expense? Business travel is 100% deductible
Meals are the only exception. You can only deduct 50% of your meals while traveling on business. If not traveling you can deduct 50% of your meals if you take a client or business associate with you and discuss business. KEEP YOUR RECEIPTS
2. How do I combine business with pleasure? The easiest way is to make sure that both you and your spouse are active in the business of real estate.
a) Locate and talk to real estate agents in the areas you want to visit. Do that every day of the trip, it does not matter how long you are conducting business.
b) DOCUMENT EVERYTHING There is a new rule that states that you do not need receipts for expenses under $46. This does not mean that you do not document.
(1) Business cards of agents
(2) Brochures of real estate properties
(3) Property listings
(4) Appointment schedules
(5) Clearly define purpose of trip (Looking for real estate investments)
Example: Clients of mine love going to Las Vegas, NV on vacation. They have also thought of purchasing property in Las Vegas. It does not take much documentation for a vacation to turn into a search for investment property. Now they take business trips to Las Vegas. DOCUMENTATION IS THE KEY
3. Travel Overseas
a) Less than 7 days
(1) All transportation expenses are deductible
(2) Deduct all destination expense on days that are business
(3) Can have more personal days than business
b) More than 7 days
(1) Need to spend more than 75% of your time on business to get 100% deduction
(2) Need to spend more than 50% of your time on business to get any deduction
E. Employ a minor child
1. It is not against the law if they are your family: The child labor laws do not apply to parents
2. Rules for employing children:
a) Age limitations: Your child must be between the ages of 7 and 18.
b) Ordinary and necessary: You must be able to show that the salary is an ordinary and necessary expense directly connected with the business.
c) Services Provided: You must document that the services were actually provided. Timesheets are good for this proof.
d) Paid or incurred: You must pay the compensation or incur the expense during the tax year. Get your children separate bank accounts.
3. Tax benefits and maximizing with a Traditional IRA contribution: You can pay your child up to $10,450 without the child paying taxes by;
a) Keeping good records of the work they do and the amounts they are paid
b) Provide your child with a W-2 form at the end of the year
c) Contribute $5,000 of the $9,850 earned to a traditional IRA. This can be self-directed and invested in real estate.
Your savings for each child you employ and pay up to $10,450 is $5,048
$10,450 @ 33% Income Tax = $3,449
$10,450 @ 15.3% Self Emp.Tax = $1,599
4. Let your child pay taxes at their lower rate, instead of at your rate. As long as they earn the money the “Kiddie Tax” rule does not apply.
|Tax Bracket||Single||Married Filing Jointly|
|15%||$7,826 - $31,850||$15,561 - $63,700|
|25%||$31,851 - $77,100||$63,701 - $128,500|
|28%||$77,101 - $160,850||$128,501 - $195,850|
|33%||$160,851 - $349,700||$195,851 - $349,700|
F. Interest expense & Insurance: All the interest and insurance related to your business is deductible including
1. Real estate interest
2. Auto and Equipment loan interest
3. Credit card interest
4. Liability and umbrella policies
5. Property Insurance
G. Office Furniture, Equipment & Supplies: You do not have to claim a home office to deduct your office expenses
1. What can I expense? You can deduct the furniture that you buy for your office at home.
e) 60” Plasma TV (How nice do you want your office?)
g) Printers, copiers, faxes, scanners
j) Phones, cell phones, IPads
k) Any other equipment you use in your business
2. What are your office supplies?
a) Pens & paper
b) Ink cartridges
c) Light bulbs
f) Many other standard household items
g) Also keep a nice selection of scotch, bourbon and fine cigars on hand
3. Keep your receipts: DOCUMENTATION IS IMPORTANT
4. Section 179 or 5 year depreciation: A section 179 election allows you to deduct most if not all these items in the first year they are put into service. The limitation is $139,000 per year in deductions. If you exceed this limit then the other items will be depreciated over 5 years.
H. Legal, Accounting and Professional Fees: All of those outrageous fees to lawyers and the more reasonable fees (more like sensible investments) to CPAs are fully deductible. DOCUMENTATION is still very necessary to determine the nature of the expense.
I. Telephone and Internet
1. Have separate lines just for business, or separate phones, land line and cell phone: This is the best way to deduct your telephone.
2. Keep track of phone calls and usage: If you do not have a second line then you must track your usage on each bill. You are not allowed to deduct the regulatory fees & taxes on a common phone line.
3. Declare that the internet is used primarily for business purposes: It is up to you to determine the % of business use and personal use.
J. Training and Startup Costs
1. Entity setup for LLCs and S-Corporations
2. Member fees to real estate organizations
3. Expenses for training DVDs, seminars, books
4. Cost in setting up your team of advisors
A. Tax laws are always changing and they rarely ever make any logical sense. It is not necessary to understand why the tax laws are in place, just how the system works.
B. A practical rule in deciding whether or not to take a tax deduction is the LAUGH TEST. The rules is this; if you can claim an expense for business without LAUGHING about putting one over on the IRS then you are probably OK. If the deduction passes this test and your accountant tells you you’re just being greedy, fire your accountant. You would not be here if you were not greedy and that is not a bad thing.
C. Always consult a Tax Professional (CPA) for advice about your own tax situation. Everyone’s tax circumstances are different and a good CPA will pay for them selves in saving you time and money. Plan for your taxes and keep more of what you make, because it’s not what you make, but what you keep that matters.