The Importance of Accounting and Taxation for Business Owners & Real Estate Owners and Investors Simplified
REAL ESTATE HAS LONG BEEN A HIGH-PERFORMING AND GREAT INVESTMENT OPTION
Real estate has long been a high-performing and great investment option. Real estate investors make money through rental income and appreciation of value over time. Here we discuss the importance of proper recordkeeping to further maximize your income, deductions and business performance that successful business and real estate owners, small and large, should understand at least at a basic level. This information was digested, simplified, and explained by an experienced, New York licensed real estate CPA. Through our years in corporate America and understanding the simple and savvy business and tax strategy employed by the real estate giants in the U.S, we wanted to bring similar in-depth knowledge and business acumen to our clients - like you - individuals, small and medium businesses, especially real estate operators, in our communities; With this in mind J. WARDE CPA LLC was birthed.
Let us dive in. The A - Z process of buying and renting real estate is to (1) select and purchase the property (2) select suitable tenants (3) deposit monthly rents (4) pay mortgage (5) pay real estate taxes (6) pay other operating and maintenance costs. Each step mentioned here creates an accounting transaction that should be recorded in your financial records. On top of this, one huge expense that business owners often ignore until year end is to estimate income taxes on the rental profits. Taxes are the single largest expense for most businesses, representing about 30% of the business income for a lot of taxpayers. That means, for every $1000 profit you make, you should expect to pay about $300 in taxes; going further, for every $100K you make, you pay about $30,000 in taxes; one more step, for every $1M you make, you pay about $300,000 in taxes. You can plan for this and legally plan to reduce your overall tax burden if you gain a thorough, yet basic understanding of real estate taxation and accounting. Knowledge is power. One of our core values at J. WARDE CPA LLC is that we place a high value on teaching and education and do not miss opportunities to educate our existing and new clients. This writing you are reading here is one of those opportunities - an overview of real estate taxation and accounting for landlords, investors, and owners.
IMPORTANCE OF RECORDKEEPING TO REDUCE TAX BURDEN ON BUSINESS AND RENTAL PROFITS
IMPORTANCE OF RECORDKEEPING TO REDUCE TAX BURDEN ON BUSINESS AND RENTAL PROFITS
Well, let us take it from the horse's mouth directly - the IRS. The IRS states that you MUST always keep your business records available for inspection by the IRS. If the IRS examines any of your tax returns, you may be asked to explain the items reported in more detail and a complete set of records will speed up the examination. The IRS chooses tax returns for examination randomly. If the IRS rejects or denies one or more of your expense deductions for lack of proper records to support your claim, the result will be that you now owe more in taxes than you previously thought you owed and budget for. The IRS offers a clear and fair solution. Here it is: the IRS states that every business should keep good records to monitor the business performance and to prepare monthly and annual financial statements for the business. The IRS will generally accept these same business records and financial statements that you should have already prepared for the business to support items of income, expenses, and credits you report on your tax returns. You cannot escape proper financial recordkeeping. It is not just an additional business expense. It is a business need. Like how you need a map to navigate a ship. Proper financial records are your map to navigate your business.
ACCOUNTING AND BOOKKEEPING IS NOT JUST AN ADDITIONAL BUSINESS EXPENSE. IT IS A BUSINESS NEED!
ACCOUNTING AND BOOKKEEPING IS NOT JUST AN ADDITIONAL BUSINESS EXPENSE. IT IS A BUSINESS NEED.
We understand taking on a CPA may seem like an additional business expense. It is not and it does not have to feel that way. Here is the simple truth: No business, small or large, can succeed without organized and accurate financial data. A business manager or owner will find it difficult to make informed business decisions without good financial records available. Businesses who fail to maintain proper financial records always find themselves scrambling at the last minute to filter through tons of paper receipts and bank statements to compile records when an opportunity is on the table or a request for financial statements is made by a bank or government authority (like IRS or State tax department). This results in lots of missed expenses, mixing up of personal and business transactions, and understatement or overstatement of revenues. Any experienced CPA or business professional would tell you this is the recipe for business failure and mistrust.
RECORDING DAY-TO-DAY MANAGEMENT AND OPERATING EXPENSES
RECORDING DAY-TO-DAY MANAGEMENT AND OPERATING EXPENSES
A well-managed business will incur management and operating expenses throughout the month. Some of the common expenses incurred by real estate managers are travelling expenses, reimbursable meals and entertainment, hotel and lodging, etc. These expenses are usually incurred when real estate managers seek out new investment properties in different U.S. states and even overseas. Other operating real estate expenses are property taxes, repair and maintenance, common area utilities, and purchase of small tools, etc. Under U.S tax laws, a tax deduction is allowed for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. All such expenses can be deducted from the rents received from tenants to determine the net rental profits which are taxable at both the Federal and state level. As mentioned earlier, taxes are the single largest expense for all businesses including real estate businesses and are estimated at about 30%of your net profits. To capitalize on these tax deductions, you must maintain the financial records or can risk your deductions being denied or reduced by the IRS. A simple example of the importance of proper accounting records relates to meals and entertainment expenses. Before the passing of the tax reform act of 2017, meals and entertainment expenses were lumped together as one grand expense and 50% of this total could have been taken as a deduction for tax purposes. However, the tax reform act of 2017 eliminated the deduction for all expenses related to the entertainment piece. Because entertainment and meals are often closely intertwined when purchased in a business context, taxpayers may have difficulty distinguishing deductible meal expenses from nondeductible entertainment expenses. This change in the tax deduction rules for meals and entertainment expenses requires a detailed analysis and tracking to determine the proper tax treatment to these now two separate and distinct types of expenses.
IRS RESTATEMENTS AND THE DOMINO EFFECT
IRS RESTATEMENTS AND THE DOMINO EFFECT
Our CPA office is usually called in for help when the dominos are already tipping over. As an experienced CPA, I have watched this scene played out many times. It sometimes starts with an IRS notice claiming an understatement of income for previous years. After diving into the details, the fact pattern is usually the same – missed IRS Form 1099 income. This often occurs when the business scrambles at year end to put together financial records and hands it over to the tax preparer who does their best to make sense of the records provided to them and file the tax return by the due date. An understatement of income (unrecorded revenue) is an easy check on the IRS part. A computer runs this check by matching the income you reported on the tax return to the income the business or person who paid you the money (the payer) reported to the IRS. As you should know, an exact copy of any IRS Form 1099 that you receive each year is also filed with the IRS by the payer the exact same time. The payer is required to do this by the IRS and does not need your consent. Income for you is a tax deduction for the payer and it is in the payer’s best interest to secure this tax deduction for themselves to reduce their own tax liability. This means the IRS already knows how much gross income was reported to you on Forms 1099 before you even file your tax return or extension. This type of underreporting of income can easily be avoided if the business maintains its own financial records and prepares financial statements on an ongoing basis.
The domino begins tipping at this point because your business will now be required to amend (correct) the original filed Federal tax return to now include the missed income and pay the additional tax, interest, and penalties for underreporting your income. The domino effect tips again to the State tax department because Federal and States agencies have information sharing agreements where the Federal government passes on their discoveries to the respective state tax department (like New York or New Jersey) who then will come knocking for their additional piece of tax, interest and penalties for the income you underreported (even if it’s unintentional). The ‘domino’ continues to slide to other interested parties, like banks and investors because on your tax return there is a question asking if your tax return has been restated in a previous year which you will then be required to answer yes. You may then be required to reissue the correct tax returns for the amended years to these interested parties who may have their own line of questioning about the integrity of your overall financial statements and internal controls. This is what CPAs and business professionals call the recipe for business failure and mistrust – inaccurate and unreliable financial records. So as said earlier, accounting and bookkeeping is not just an additional business expense - It is a business need.
THE END FOR NOW
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There is a lot to unravel for business owners and real estate business. We are a team of professional CPAs always ready and available to support our clients as you navigate the business world. You know the goals you have set for your business - We want to help you get there!
If you have any questions, please feel free to email us at Ask@WardeCPA.com, call us at (973) 295-5153 or you can easily schedule an appointment directly on our website at www.WardeCPA.com/bookappointment
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