The Tax Code has gown in complexity the last few years. Finding a qualified tax professional who understands the nuances of taxes is harder than ever. Without proper vetting you can overpay for service and end up with subpar results.
The growing complexity of the Tax Code has more tax professionals specializing. This is a good news/bad news situation. The good news is that when you find the best tax professional for your situation you should achieve maximum results. The bad news is that prep fees reflect the higher competence level.
And if you are going to pay more you want to make sure you are getting the best value.
All tax professionals are required to work outside their area of specialty. An accountant focusing on investment properties still has to complete the remainder of the tax return. You need a tax professional who understands how decisions made with investments affects the remainder of the return.
The meat of the value when hiring a tax pro is finding one specializing in the most difficult or complex area of your return or the portion causing the most tax.
For example, income properties are a part of many tax returns. Those looking to retire early may use rentals to supplement their income. Income properties can also supplement part-time income. The tax professional you need should understand the basics of an individual tax return. The accountant should also understand the fundamentals of the various retirement accounts and the implications of using each for your situation. But most important of all, you need a tax pro focused on the rules surrounding income property.
Desperation is a bad guide. Just because an accountant accepts you as a client doesn’t mean it’s a good fit. You need to vet your choice before signing the engagement letter and committing to her services.
Today we will focus on how you can vet a tax professional (enrolled agent, CPA, attorney or other tax professionals) to handle your investment properties. Asking the right questions is vital. Knowing what answer you should get is even more important.
Vetting a Tax Professional
Each situation requires a different set of questions. We will focus on a individual with income properties. Small business owners will have different questions. You will need to do some research to prepare a list of questions specific to your needs before visiting the accountant.
The answers the accountant gives is less important than how they handle the questions. First, you probably don’t know all the details of taxes surrounding your situation. Therefore, you may not know the accuracy of the answers given.
You don’t want a know-it-all tax professional. It is okay for her to say she doesn’t know the answer and will need to look it up. This is normal! If the candidate never needs to research they are either a prodigy or an idiot and I’m not betting on prodigy.
You also want the accountant to add something to the mix. Your questions and situation should jar some additional ideas from the tax professional you didn’t think of. That is why you are hiring her!
The accountant should care and be interested. Smart isn’t good enough. This is a long-term (we should hope) relationship. As the accountant knows you better she can provide better and better service. Her value should grow each year.
I’m putting a lot of weight on the accountant. I fully expect the tax professional to charge accordingly. No one should work for less than the value they provide. You should be willing to pay more if you expect more.
Expect more. It’s a better deal.
Let’s run down the vetting process and questions you should ask a tax professional if you own or plan on owning income property.
Should I have an LLC?
LLCs are organized on the state level. I can’t think of a state where have income properties in an LLC would cause an issue. The accountant’s answer is important here. You may need an attorney to set up the LLC if their are issues.
Under no circumstances should you hold real estate in a regular or S corporation or LLC electing as such! There is no added benefit to doing so and many, many problems associated with it.
The accountant should point out that the income properties held by the LLC will have no tax effect as you will be treated as a “disregarded entity” for tax purposes. This means if you own the property/s solely you will report on Schedule E of your personal tax return and if there are two or more owners the LLC defaults to a partnership. For income properties, the LLC value is for legal purposes only.
If the accountant wants to deviate from my answers they had better have a really good reason. There are not many and I have never seen a qualified tax professional or attorney recommend putting real estate inside an S corporation.
This is a warning to all the DIYers setting up their LLC. Too many think they save money by putting the properties in an S corporation and it really only causes problems.
Next you should ask how the accountant want your records. This is a personal preference. As long as your are comfortable presenting your data in the format asked for the relationship should run smooth.
This is also the time to discuss bookkeeping services if you need help in this area. If you know you’ll struggle with the recommended bookkeeping process requested by the accountant consider spending a few extra dollars for a quality bookkeeper. As hard as it is to believe, good books save you money, reduce audit risk and lower your taxes.
Deductions and Other Tax Advantages.
Now we turn to a variety of unique tax deductions and benefits owners of income property enjoy. The normal deductions should be obvious: property taxes, mortgage interest, depreciation, supplies, repairs, advertising . . .
I want you to ask difficult questions on unique issues when vetting a tax pro candidate. The accountant should understand these issues or be willing to research them.
This list is not exhaustive. The issues I want you to ask about I see constantly so you want an accountant versed in these issues. It is where the tax savings reside.
Ask about mileage. The accountant should explain what is allowed. She should also explain if the standard mileage rate or actual expense is better.
Other non-cash deductions
I consider the mileage deduction a non-cash deduction. There are a few others worth noting.
First, you can use a per diem when you travel. If you attend a real estate investing seminar you can deduct the hotel, airfare (or miles if driving), the cost of the seminar and a meal and incidental expense allowance (M&IE).
Hotels and other travel expenses require a receipt for substantiation (in case you get audited). However, meals are a different story.
You can deduct actual meal expenses if you want or you can use the M&IE per diem rate. You can use a chart to deduct based on the city you are visiting or the hi-low rate. You must use the same method within each business trip. However, you can switch between different business trips, using actual expense on one and the per diem on another within the same tax year.
Second, if you use actual expense when traveling you do NOT need to keep a receipt for meals under $75, including tip. Your accounting records of the meal expense along with the business purpose of the meal and who you were with is sufficient for a tax deduction.
You can not use the per diem for non-travel business meals. However, the $75 receipt rule still applies.
Tangible property rules
Some things are deducted and some need to be capitalized (depreciated over a period of time). Not long ago this was a real pain for income property owners because asset expensing (Section 179) is not allowed on income real estate and its components (appliances, for example).
Under the new tangible property rules all items $2,500 or less can be deducted regardless. That means most appliances are now deducted versus depreciating over 5 years. Curtains, carpet and other minor items are also currently deducted.
An election is required so ask to assure the accountant you are vetting understands this.
Improvements have always been a serious issue. Improvements are depreciated over 27.5 years for residential property and 39 years for commercial. You still pay the expense up front.
Improvements are defined as increasing the value of the property. Many improvements therefore are really deductible repairs under regulations.
For example, flooring is usually not an improvement since it only restores the property to its original value. Roof replacement can also be considered a repair, even if it is really expensive. Cost does not automatically cause a deductible repair to become a capitalized improvement!
Generally (and this is why a detailed conversation with your tax pro candidate is so important), if flooring is replaced with the same type it is a repair as long as floor boards are not replaced or reworked. The same applies to roofing. If the same roofing material is used to replace an old roof it probably qualifies as a deductible repair as long as roof board are not replaced.
However, the previous paragraph (flooring/roofing/other repairs) only qualifies for a deduction if you own the property as an income property for 5 or more years. It is assumed by the IRS that if you owned the property for a shorter time period the property didn’t have enough time to deteriorate so the repairs are actually improvements. Planning with your accountant is vital.
There is still one more really big out. If you have an improvement of $10,000 or less you can elect to deduct the improvement as a repair expense.
There is some gray area here. The $10,000 repair reg rule is per building, kind of. If you remodel a kitchen and bathroom in the same apartment it must be $10,000 or less combined to use the repair reg election.
The same probably applies in multi-unit buildings. Tax professionals differ here. Many tax professionals consider all improvements in a duplex. This means all improvements in both apartments must be $10,000 or less to qualify under the repair regs.
But in larger multi-unit buildings it gets more complicated. Do you count all bathroom remodels , et cetera in a 20 unit complex? This accountant looks at each situation before making a judgement call. (I also research this a lot based on facts and circumstances when it comes up.)
You need a serious discussion on this issue when vetting an accountant because it is only a matter of time before it comes up in real life.
Cost segregation studies
Sometimes you can super-charge your depreciation with income properties. Cost segregation studies can generate ~ $400,000 in extra deductions the first year on a $1 million property, depending on the facts and circumstances. Costs segregation studies work on properties as low as $300,000.
You can read more about this powerful tax strategy here.
Sometimes it is advantageous to group certain properties/activities together to maximize tax benefits. Grouping is less common so many tax professionals need to review the facts and circumstances before committing to an answer.
Qualified Business Income Deduction (199A)
This new deduction created by the Tax Cuts and Jobs Act of late 2017 is complicated. To make matters worse the IRS has issued several batches of regulations as it relates to income property and several issues remain unresolved.
You can read more about the QBID and how it relates to income properties here.
Be sure to discuss any recent changes with your tax professional. Again, they can pass the vetting process with less than perfect answers because perfect answers don’t exist. But they need to understand what has been clarified and have good reasons to take the position they do in unclarified areas.
There are other questions you will want to ask.
Finding a qualified tax professional takes time and work. It is all worth it in the end. The best tax professionals are selective in who they take on as clients so you will be vetted at the same time you are vetting. This is a good thing as you want a good fit for all parties involved because it is your investment and money is on the line.
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Thursday 11th of July 2019
Why is it a bad idea to have an LLC taxed as an S corp? We are getting opposite advice and would like some information on this subject.
Thursday 11th of July 2019
Laura, once RE is in a S corp or LLC treated as such the RE cannot be transferred back to you without triggering a sale and subsequent taxes. If the S corp has even a single dollar of accumulated earning and 25% or more of revenue is passive (RE is passive income) all profits are taxed at the highest individual tax rate for ordinary income at the S corp level.
There is no tax advantage ever to put RE in an LLC and elect S corp status, but plenty that can go wrong. In most cases: no harm, no foul. And since there is no reason to put RE in an S corp and a possibility (even a small one) of great harm, it is best avoided.
Therefore, in most cases, RE is best held in an LLC treated as a disregarded entity.
Tuesday 2nd of July 2019
Good article, as always. One quick question - I was told you can't hold an investment property in an LLC if there is a loan attached to the property. Apparently there is language in the loan documents with certain lenders that the loan could be called if you purchase the property yourself and then transfer it to the LLC. Is this true or is it state/loan dependent?
Side note - Thanks for the post and the advice relating to a cost segregation study. I had one conducted on our small single family unit ($325,000 purchase price) and it was extremely helpful this past tax season. For those of you thinking of having a cost segregation study, I would highly recommend the contact Keith has in his article. Very professional and knowledgeable.
Tuesday 2nd of July 2019
This is not an issue in my state (Wisconsin), BK. That is why I recommend an attorney to make sure there are no state-specific issues to address. It also might be a lender issue.
I agree. Randy is awesome at cost segregation studies. I hope he never quits.
Monday 1st of July 2019
Keith - thanks for the info... I’m confused on one point though. The LLC, assuming single member and being considered disregarded tax entity, DO you or do you NOT recommend the LLC?
From what I understood the LLC is the way to go from a liability perspective as long as you avoid partnership status and “double taxation”. Thanks for the clarification!
Monday 1st of July 2019
Other bloggers quote me wrong on this all the time. I recommend an LLC for your income properties. You get the LLC legal protections without any negative tax consequences because you are a disregarded entity for tax purposes only. Hence, the tax return looks exactly the same; no additional prep fees (unless you need to file as a partnership).
Cathleen Cooks Stuff
Monday 1st of July 2019
Thank you! I've been grappling with the problems of how to find a tax adviser that would be able to handle us having multiple (hopefully) investment properties. Asking these questions are a good start.
Monday 1st of July 2019
Cathleen - Yes, this would be a good place to start, along with some of Keith's other writings on the topic. In addition, I would probably also look to see if there are any FIRE or RE investment groups in your area and ask members of those groups.
Mr. Hobo Millionaire
Monday 1st of July 2019
>>You are probably the first person to complain I was too brief.
Laura, you are proving Keith's point in this post. As a long time reader, I can promise Keith is very leery to give specific tax answers in his posts. He's very good at giving a lot of general topics to be aware of, though.