Over the years, I have come across thousands of real estate owners and small business owners across the U.S. and have unfortunately witnessed many mistakes that are costing thousands of dollars in over paid taxes.
What a shame that so much money just going to waste and in Uncle Sam's pocket!
Let's take some time to look at these mistakes that we should avoid:
1. Personal funds used for business and real estate expenses are nondeductible
Most real estate or business start-up often needs cash support from the owner to cover operational expenses. If you use your personal funds to pay for business or real estate related expenses it is very important to make sure you are clearly tracking the expenses. Any expenses that are incurred for the business or for real estate are generally deductible, even if you use your personal money.
2. Tipping the IRS will make me "Audit Proof"
If you over pay and tip the IRS, they do not care. What they do care about is if you under pay your taxes or cannot substantiate your deductions. So if you "tip" the IRS in one area, it doesn't necessarily mean the IRS won't make you pay penalties if you underpay in another area. To be on the safe side, it is always better to pay exactly what you owe, that is the best way to "audit proof" yourself. Make sure to track everything correctly and have the right documentation. Also make sure you are working with a knowledgeable advisor that can help ensure you are tracking and deducting everything correctly.
3. You are allowed more deductions by being incorporated
Forming a legal entity does not necessarily mean that you get more tax deduction. As indicated in #1 above, real estate or business related expenses may be deductible regardless of where it is paid from. If you do happen to have a legal entity that you operate your real estate business from, make sure to use it correctly. A mistake I often see if someone who has an S Corporation formed to reduce taxes but all income is still being paid to their personal name. If this describes what you are doing, you may want to make the change quickly to that your income is actually being paid to your legal entity.
4. Taking the home office deduction is a huge red flag to get audited.
The above statement used to be true, but those days are long gone. Because of so many people now able to work from home, the IRS cannot possibly audit all tax returns claiming home office deduction. As long as you keep excellent records to satisfy their requirements, you are fine. There is no need to fear an audit. You do not want to miss out on the benefits to taking the home office deduction.
5. If you don't take the home office deduction, business and real estate expenses are not deductible.
If you do not take the home office deduction, all is not lost you can still claim many deductions for your real estate. You are still allowed to take deductions for your real estate maintenance supplies, business-related phone bills, travel expenses, wages paid to contract workers for property improvements, depreciation of equipment used, and other expenses related to running a home-based business,. These may still be legitimate tax write offs even if you don't take the home office deduction.
6. Filing an extension gives you an extension to pay any taxes owed.
Filing an extension only allows you to extend the filing date of your tax return. It does not extend the time you have to pay the tax due. You may be charged penalties and interests from the date your taxes are due if they are not submitted on time.
7. Can't Deduct General Expenses
Most real estate investors are great at deducting property specific expenses such as mortgage interest, management fees, property taxes, and insurance. What a lot of people miss out on are the general and overhead expenses that a lot of real estate investors have. Examples include car or travel expenses, marketing expenses, cell phones, and meals to name a few. As long as the general and overhead expenses are related to your real estate business, they are generally tax deductible items even though they are not specific to one particular property.
These are just a few of the mistakes I often see especially from newer investors. Educating yourself is the key to avoid overpaying taxes! There are many ways you can significantly reduce your tax bill ... all it takes is knowing how.
Take advantage of this little-known tax "loophole"
Recent tax increases have affected nearly every American taxpayer. But with the right planning, you can take steps to take control of your taxes and potentially even lower your tax bill. In our brand-new special report "The IRS Is Daring You to Make This Investment Now!," you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.
The article: 7 Common Tax Mistakes of New Real Estate Investors is Copyright 2014 BiggerPockets, Inc
Amanda Han of Keystone CPA is a tax strategist who specializes in creating cutting-edge tax saving strategies for real estate investors. As a real estate investor herself, Amanda has an in-depth understanding of the various aspects of investing including taxation, self-directed investing, entity structuring, and money-raising.
Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.