I bet you know someone who has a regular old job with a regular old salary who's built a large net worth over the years. Conversely, I bet you also know someone who makes tons of money but has no net worth. What's going on here? Well, the obvious answer is: money management (or mismanagement). Money management matters! Our money, whether we have a lot or a little, must be managed.
Make a commitment to yourself to be a good money manager. It requires a bit of study and effort but the rewards are great.
Many people live their entire lives without ever knowing about money, taxes, investments, and such. Let's face it - many people don't even know what they don't even know! Too many believe, I don't have to know any of that stuff, my accountant takes care of it for me. Boloney! It's your money, and nobody cares about your money as much as you should.
Regarding taxes, most people don't have a good tax manager, they have a tax preparer that they see once a year . . . on April 14th when they bring in a shopping bag full of junk and dump it on the accountant's desk and say, How much do I owe? That's not tax management, it's tax preparation. You'll never build any wealth that way.
If this is hitting pretty close to home and sounds a lot like your situation, it's time to change. You need to find a good tax manager who will make suggestions and help guide you, not merely prepare your tax return.
The purpose of this article is to give you ten sample questions to ask when interviewing an accountant to see if they qualify to be your tax manager. The perspective is that of a self-employed REALTOR. These questions are general in nature so be sure to discuss them with your tax manager to see how they fit into your unique situation before you take any action.
Judge your tax manager on their knowledge and ability to communicate.
- Should I use the IRS mileage rate or actual expenses when figuring my auto deductions?
While actual expenses usually provide the largest deduction, many people choose to use the IRS mileage allowance. If you're self-employed and choose to use the IRS mileage rate (54.5 cents per mile - 2018) don't forget you can also deduct the business portion of the interest paid on your car loan.
- Isn't there a special deduction for some vehicles?
If you buy a vehicle for business that has GVW (gross vehicle weight) greater than 6000 pounds, you may qualify for first year bonus depreciation.
- What are the advantages of hiring my child?
If you're self-employed and not hiring your kid, you're nuts. If you're self-employed and you don't have a kid get one! Here's why:
The wages you pay your child for business purposes are deductible on your schedule C. That reduces your state and federal income tax, as well as your self-employment tax. Your child can earn up to $12,000 (in 2018) without paying tax. Your child under 18, working for you, is exempt from social security tax. It's possible for your child to fund a retirement account with the wages you pay. If your daughter starts an IRA when she's 9 years old, contributes $4,000 to it each year, and earns an average return of 10% per year, she'll have approximately $4,500,000 when she's 59.5 years old! What a country!
- Can I buy real estate with my retirement account?
First and foremost: A retirement account (traditional IRA, Roth IRA, SIMPLE IRA, SEP, Keogh, 401k, etc.) is not an investment! It's simply a special account that holds your investments. It can hold many types of investments, such as mutual funds, stocks, bonds, and . . . drum roll, please: real estate.
You might be thinking, "But I asked the company that administers my account if my IRA could own real estate, and they said 'no.'"
Whoa! Instead of merely saying "no," the person you talked with should have added three important words: "not with us."
The problem is that most companies that hold retirement accounts aren't geared up to handle real estate. Therefore, they have no incentive to inform their customers that real estate is an alternative investment choice. That's the main reason for the misconception that real estate can't be held in a retirement account.
- Should I take a deduction for a home office?
If you qualify, absolutely! A home office will save income tax as well as self-employment tax. Plus, it can convert non-deductible commuting miles into deductible business miles. And, because the laws changed in 1999, it's much easier to qualify for a home office deduction than it used to be. By having a home office many household expenses that were formerly not deductible, become deductible!
In addition, you're allowed to depreciate the business portion of your house. Depreciation is a non-cash deduction - you get to deduct it without having to pay it! Here's an important thing to keep in mind: any depreciation you take on the home office after May 6, 1997 is taxable (or recaptured) when you sell. But, think about it --even if you do have to pay back the taxes saved by depreciation - you've had an interest free loan from the government. Plus, you've deducted a percentage of previously undeductible expenses like repairs, insurance, cleaning, etc. and you don't have to pay that back.
Or, here's an alternative. Beginning in 2013, if you meet the requirements for the home office deduction, you're allowed to deduct a flat rate allowance of $5.00 per square foot of qualifying home office space. The maximum allowable space is 300 square feet. Therefore, the safe harbor home office deduction is capped at $1,500.
If you elect to take the safe harbor method you cannot deduct other home office expenses such as utilities, repairs, depreciation, insurance, cleaning, etc.
- Can I qualify for a home office even if my broker also provides an office for me?
Yes! As a result of the 1999 rule changes, you must use your home office regularly and exclusively for business. And, it must be your principal place of business. Your home office is your principal place of business if it meets one of the following three requirements:
- Requirement #1:
If the home office is used for substantial administrative and/or management activities of your business and ... there is no other fixed location where you conduct substantial administrative and/or management activities of your business. Or,
- Requirement #2:
Your home office may still qualify if you meet or deal with clients, or customers in the normal course of your business. Or,
- Requirement #3:
Your office qualifies if it is a separate structure not attached to the home - for instance a detached garage or outbuilding.
- Requirement #1:
- What happens when I sell the house in which I've claimed a home office?
This is a doozy! If you meet certain requirements, the IRS has special "exclusion" rules for the sale of your primary residence which, in most circumstances, make any gain from the sale tax free...up to $250,000 for single people and $500,000 for marrieds. Fabulous!
However, what if you're using 15% of your home for business and taking all the great deductions? Well, the rules used to say that, in a case like that, 15% of the profit from the sale would be taxable. Bummer! But no more! The rules now say that even if you use a portion of your home for business, the entire gain (except for depreciation recapture) is tax free if you meet the primary residence "exclusion" rules. That's outstanding. It means you can treat a portion of your home as a business and get tax breaks while you live there, AND, when you sell, you still get the benefits of the primary residence exclusion. Again, I say, what a country!
Here's a slight curveball that might affect a few people. If your home office is a separate structure - such as a detached garage or outbuilding - the gain on that portion of the sale is not excludable and would be taxed.
- How do I depreciate my rental property?
Be sure to allocate your cost among these four categories: land, personal property, building and land improvements. This is called bifurcation, which means to separate. You should become a lean, mean bifurcating machine!
Don't be one of the typical investors who merely divide their cost between land and building. That's a costly mistake - you'll pay more tax than necessary.
- How do I know the cost of the four categories when I bifurcate?
The best way to bifurcate is to negotiate the cost of each category on the purchase contract. These costs are important to both the buyer and the seller. From the buyer's standpoint, the categories are depreciated over different periods: land (not depreciated), personal property (5 years), building (27.5 or 39 years) and land improvements (15 years).
And from the seller's standpoint, each of the categories is taxed at different rates upon sale.
- I've invested for years and never heard of land improvements. What are they?
If you own rental property be sure to depreciate your land improvements (driveways, parking lots, fences, landscaping, etc) separately from the building. Land improvements are depreciated over 15 years as opposed to a building's 27.5 or 39 year schedule. Most people don't even know about land improvements and miss out on this important deduction.
Ok, those are ten good questions for your tax manager. But before closing I've got a question for you. Ever asked yourself, How come I earn so much income, but never seem to have any money? If that sounds like you, do yourself a favor and commit to a goal of being a better money manager. Here's hoping this article helps you, and your good tax manager, meet that goal.
This material is designed to provide information in regard to the subject matter covered. It is understood that Tom Lundstedt, is not engaged in rendering legal, accounting or other professional services. Everyone's situation is unique, so – before you, or your clients take any real world action – be sure to check with the proper professionals.