In the flipping business, deductions are crucial. Unless you have a handle on your expenses, and can accurately deduct them, the Internal Revenue Service can only tax you on your gross. If your record keeping is slovenly or you aren’t alert to the deductions you can take, even getting 90 percent of your deductions right is enough to murder you. That’s because when you are leveraged, just 10 percent of your gross receipts is enough to eat all your profits. If you aren’t claiming the deductions that accurately and fairly represent your business expenses, you’re going to wind up with little or no profit at the end of the day after taxes, and wind up quitting in frustration – even if your real estate investment decisions are sound.

As a flipper, you need both: excellent real estate investment and deal-making skills, and rock-solid record keeping.

First, a word before I begin, ahem, itemizing some often-overlooked tax deductions for flippers. You have to be very aware of the differences between a renovation or improvement on one hand, and a repair on the other.  You should also be exquisitely aware of the difference between taking an immediate first-year deduction on one hand and capitalizing an expense and amortizing it over a period of two or more years.

I’m going to concentrate on deductions you can take in your first year, unless otherwise noted.

I’m also going to concentrate on the self-employed investor. So, season to taste if you are the owner/employee of your own corporation.

Business use of your home. That’s the fancy-pants term for the “home office deduction.” It’s not just for offices, though. You can also deduct for space you devote to storage. So if you have a garage full of construction supplies that you use for flipping all year, you can deduct a corresponding percentage (measured by square footage) of your home expenses, including utilities. Remember: No mixed use. To take the deduction, the area has to be exclusively for business use. For instance, the dining room table doesn’t count if your family uses it to eat on! For more information, see IRS Publication 587.

To take the deduction, use IRS Form 8829.

Business use of your car. You can deduct the standard mileage amount for every mile you drive in support of your flipping and real estate endeavors (or any other self-employment context). However, to claim the standard mileage rate (56.5 cents per mile in 2013), you must also meet the following criteria:

• You must not operate five or more cars at the same time, as in a fleet operation.
• You must not have claimed a depreciation deduction for the car using any method other than straight-line.
• You must not have claimed a Section 179 deduction on the car.
• You must not have claimed the special depreciation allowance on the car.

Alternatively, you can deduct your actual expenses. I believe that unless your are flipping within a few blocks of your home and drive few miles, or unless you have some big repairs, most people are better off taking the mileage deduction for most years. Note: If you lease a car, and you want to use the mileage, you have to use the mileage rate for the entire period of the lease.

You can also deduct parking fees and tolls you pay, except for fees and tolls to your normal office (if you have one) or parking fees at your home office.

Note: If you took the standard mileage deduction, you can’t also deduct auto insurance premiums.

For more information, see IRS Publication 463.

Retirement Contributions. If your income is low enough, you can deduct any contributions you make to IRAs and solo/individual 401(k)s or SEPs (Simplified Employee Pension Plans) you create for yourself and any employees. This is a good way to shelter assets from taxes, at least until retirement (at which time you’ll pay income taxes on amounts withdrawn), while diversifying away from real estate at the same time. Limits vary depending on your income and the type of plan. See IRS Publication 590, Individual Retirement Arrangements, for more information.

Assets converted to business use. Did you have a computer, a set of office furniture, a vehicle or anything else you owned for personal use before committing it entirely to supporting your business? You may be able to deduct the lesser of cost or fair market value at the time it was converted. You can’t take the deduction all at once, though. You will have to depreciate them over the useful life of the property or equipment.

Health insurance. If you’re self-employed, you can deduct health insurance premiums for yourself and your family members – as long as your deduction doesn’t exceed your income for the year. The main or primary insured on the policy must be the self-employed individual. This is true for owners of corporations, partnership interests and LLC owners. Note: This applies to major medical only. Disability insurance is not normally deductible unless purchased by the corporation as an employee benefit. Note: You can only deduct health insurance premiums against income for income tax purposes. It’s not normally deductible for the purposes of calculating self-employment taxes. Congress occasionally “patches” this one with short-term extensions and amendments, though, so check with your tax advisor for the latest.

Answering services. If you have trouble picking up the phone when you’re out wheeling and dealing, or you work a day job in addition to your flipping practice, this may be a worthwhile expense. It’s deductible.

Business gifts. Up to $25 per recipient per year is deductible. This doesn’t include meals, which are normally only 50 percent deductible.

Casualty losses. These are any losses due to such things as theft, vandalism, fire and flooding. Any loss you took that is not covered by insurance is deductible. To maximize your deduction, though, start with a good inventory.

Property insurance. Insurance premiums on investment properties are usually deductible. Title insurance premiums, though, are not.

Cell phone bills. You can deduct a prorated amount of your cell phone bill, based on the average percentage of phone time you used for business rather than personal use.

Contract preparation: Deduct. However, points you pay on a mortgage that are considered “prepaid interest” have to be amortized over the life of the loan.

Dues. Are you a member of a community service organization like Lion’s Club or Kiwanis? If so, dues you pay are tax deductible.

Net operating losses. Did you lose money on paper in 2012? Then you should be able to carry those losses forward on your 2013 tax returns. This is how companies can show billions of dollars in profits in one year, yet have no income tax due that year. They are simply recouping losses from prior years.

Education and seminars. Generally deductible if they are related to your current industry and will help you advance within it, and if the coursework or seminar will not qualify you for a new line of work. However… rules are more liberal for employee benefits. So if you are an owner-employee of your own corporation, your corporation can grant educational benefits to you and your other employees, up to $5,250 per worker, as of press time. See IRS Publication 570, Tax Benefits for Education.

Finders’ Fees. Did you pay someone to bring an investment idea to you? That’s a finder’s fee and it’s deductible. Commissions are deductible, too.

Long-term care insurance. This is deductible, up to a certain dollar amount, based on your age. It covers nursing homes, rehab facilities, skilled care facilities, and even hospice care (not normally covered by major medical insurance or even Medicare).

Purchases on Credit. If you purchased items for your business using  a credit card in December 2013, you can deduct that full amount on your 2013 taxes.

Brand new IRA contributions. The law allows you to deduct contributions to your 2013 IRA accounts made right up to April 15. So if you didn’t get around to contributing to your IRA last year, it’s not too late. Remember, you can only deduct traditional IRA contributions – not Roth IRA contributions – and then only up to certain limits, depending on your income and marital status. Again, see IRS Publication 590 for more details.

Interest Expense. Have a business credit card you only use for flipping? You can deduct interest on business expenses. You can also do this on a personal credit card but it’s much trickier as the burden will be on you in the event of an audit. However, you can only deduct interest on construction loans incurred before or after construction actually begins. Any amounts accruing during construction are added to basis and amortized, not deducted in the current year. You also can’t deduct “points” or prepaid interest on investment property in the same way you can for a personal residence. That has to be amortized over time, like other capital expenses.

Subscriptions. Any subscriptions to magazines, newsletters and the like, directly related to real estate investing, are deductible – provided you are actually in the real estate business (or you can ascribe it to start-up costs).

Books. Any books you buy related to your business are deductible.

Start-up costs. Just getting underway? You may be able to deduct up to $5,000 in new business start-up costs.

Self-Employment Taxes. If you flip a lot, chances are good you’ll fall under the IRS’s special rules for dealers. That means you’ll owe up to 15.3 percent right off the top, on much or all your profits, thanks to self-employment taxes. The remainder of your profit gets taxed at ordinary income rates, not capital gains rates. For a short-term flipper, it shouldn’t be a huge deal if you don’t have capital losses, because ordinary income and short-term capital gain rates have the same marginal tax rate. Just make sure you deduct what you pay in self-employment taxes (OASDI and hospital insurance) before you figure your taxes on what’s left.

Medicare Surtax. It’s the 3.8 percent tax that the Affordable Care Act levies on capital gains for certain high-income taxpayers. If you’re a dealer, though, you aren’t subject to this tax on any properties that aren’t eligible for capital gains treatment.

Property management fees. These are generally deductible. However, some expenses you pay through your property management company may not be deductible. For example, if your manager handles an improvement and sends you a bill, you don’t get to deduct the improvement costs simply because they’re on a management invoice. Those you’ll have to add to your tax basis and amortize over time – generally 27.5 years for residential property.

Private Mortgage Insurance Premiums. Deductible. Write “PMI” on line 9 of your Schedule E.

Repairs and maintenance. But not improvements or renovations! Those you must amortize over 27.5 years for residential property! EXCEPT…

Small Taxpayer’s Safe Harbor. This is a new one. The IRS recently issued a set of regulations designed to make things simpler for small landlords (and came up with 222 pages of fine print to do just that!) The rule now is that if the building’s worth less than $1 million (not counting land value), you can deduct anything you spend on improvements, repairs or maintenance up to $10,000, or 2 percent of the value of the building – whichever is greater. You can also deduct pretty much anything that costs $500 or less, under the de minimis expense rule – provided you have a written policy in place (Applicable Financial Statement) allowing it. If you don’t have a written accounting policy in place, you can deduct almost anything that costs up to $200. This helps prevent the absurdity of having to depreciate a 9-volt battery over 27.5 years.

Disability Access. Section 190 now lets you deduct up to $15,000 in improvements to accessibility for the handicapped or elderly in the first year. The improvements don’t have to be legally mandated to be deducted. Amounts spent over the $15,000 threshold can be added to basis. (Pro tip: If you’re spending much more than $15,000, split them between two tax years to maximize your deduction.)

Section 179 Expenses. These can be a very big deal in some circumstances, but are beyond the scope of this kind of article. See Section179.org for more details.

Note: Even though a deduction may ordinarily be allowed, the law may limit it in your particular case because of such things as hobby loss rules and passive activity rules. This article is for general informational purposes only, and is not intended to constitute tax advice. Our intent is to provide you with enough to jog your thinking and to present some concepts like the new safe harbor rules to the attention of your tax advisor. RealEstate.com does not give tax advice. For information related to your specific circumstances, you should retain the services of a tax professional licensed in your jurisdiction. 

original post by Jason Van Steenwyk on March 25, 2014, Realestate.com

The post Tax Deductions for Flippers! appeared first on BucksFU.