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VOLUME IVAvoid Property-Owning Expense Headaches This Tax SeasonBy Nikki DavidsonThere are two types of property owners when tax season comes around each year. There's a group of calm, cool and collected people who have a well-organized bookkeeping system. Then there are those in a mad scramble to finish a year's worth of paperwork in a few hours.
But the pandemic has changed what a smooth tax filing season looks like for even the most prepared property owners. Last year was a difficult filing season. National Taxpayer Advocate Erin M. Collins presented an annual report to Congress that called 2021 "the most challenging year taxpayers and tax professionals have ever experienced." According to the report, the IRS struggled with inadequate staffing and a heightened workload, and they still haven't finished processing last year's returns.
While some hurdles will be unavoidable in 2022, tax preparation professionals say property owners are in the best position to get the most out of the upcoming filing season by understanding what they need to have on hand for a successful return.
To assist, several financial experts give the inside scoop on what exactly property owners should have ready, including lesser-known paperwork and records that could save them thousands of dollars in tax breaks, deductions and penalties.
Receipts From Repairs or ExpensesWhether it's a fresh coat of paint after a tenant moves out or a repaired roof, property owners should keep records for all work done.
"When you're in business, you have to be good at documenting, and the landlords that we work with are not always good at documenting," said Brandon Hall, a Certified Public Accountant (CPA) and managing partner of nationwide real estate accounting firm The Real Estate CPA. "They'll send us random profit loss statements that just have random numbers and transactions and expenses. As a CPA, I can't trust that. I say, 'I need to have actual legitimate transactions and expenses.'"
Hall added that CPAs often have to apply for an extension if clients don't already have their paperwork in order.
The era of keeping shoeboxes full of printed receipts is long gone, thanks to technology. Hall advises his clients to convert their paper receipts to digital versions as soon as possible. He recommends using a mobile app like Expensify, which will scan receipts and upload that information directly into the popular bookkeeping software QuickBooks Online.
If property owners are audited, they'll be glad they kept precise records. In the case of an audit, the IRS will ask for expense receipts, organized by date, with notes about what they were for and how they relate to the business. Those who don't have that evidence could end up paying additional taxes and penalties. It’s also worth noting that property owners are more likely to be audited if they’re making a significant amount of money.
Closing Disclosures and Tax AssessmentsIf property owners buy or sell in 2021, they'll want to have all of those records on hand for an accountant.
According to Ryan Bakke, the CPA behind the Instagram account @LearnLikeaCPA, many clients forget to give accountants a copy of the Closing Disclosure, the form that both parties receive when the transaction is complete.
"That's going to show your sale price, any sorts of credits, any sort of prepaid interest or taxes, or any other seller credits," said Bakke. "It's one of the most important documents to have in the year that you either buy or sell a property."
He added that a county tax assessment is also helpful if a property owner has made a new purchase in the last year. Property owners can find this document online through their local county assessor's website.Form 1098 Mortgage Interest StatementProperty owners who have a loan on the property will get a statement for mortgage interests and taxes, as well as hazard insurance. Typically, the information appears on the Form 1098 Mortgage Interest Statement. It's essential to have that document on hand for tax season because it'll usually show how much interest was paid, along with property insurance costs.
"Definitely don't forget, especially if your insurance is escrowed through your mortgage company and you've got a mortgage on the property, you want to make sure that you get those deductions," said Bette Hochberger CPA, CGMA and founder of a boutique accounting firm in Florida. "Those property insurances are astronomical, so don't miss that deduction. It's a big one."
According to the National Association of Insurance Commissioners, Texas and Florida residents face higher insurance costs due to hurricane exposure and other severe weather risks. The agency reported that from 2016 to 2020, Florida experienced eight disaster declarations while Texas has experienced nine. The silver lining is the money paid for higher-than-average insurance protections that can translate to a hefty tax write-off.
Common examples of independent contractors or service providers that would qualify include cleaning or regular maintenance workers, plumbers, lawn care specialists, attorneys, electricians, locksmiths and bookkeepers.
Nonprofit organizations, such as condominium associations, also need their condo boards to file W9 forms for hired help that they've paid more than $600 to in the last year. Although the board may be a nonprofit corporation, the individuals they hire are for-profit and must claim taxable income. Pre-hire, it’s highly suggested to have all vendors fill out a W9 form to avoid scrambling to collect these documents after the work is done.
"Sometimes vendors don't want to fill out a form W9 because they don't want to report the income that they're receiving from you, which is tax fraud," said Hall. "So we tell clients to put a form W9 clause in your contract and add a clause that says 'I'm not going to pay you until you give me your form W9.'"
Property owners who fail to file W9s, as well as vendors who fail to include income from their 1099s, could face significant fines. According to the IRS, late fees for payee statements could range from $50 to $560 each.
Payment Reports From Short-term Rental Platforms Like AirbnbIf a property owner is one of the four million hosts on Airbnb, take a second look at the documents provided by the short-term rental platforms come tax season.
Airbnb collects and remits taxes in approximately 30K jurisdictions around the world. According to Hochberger, there might be information in the income reports provided by the platforms that could serve property owners well.
"You might not be reporting everything that you could," said Hochberger. "They might have fees that they're withholding that you can deduct, and you need to see that full report to be able to figure out what's going on."
Tax season for Airbnb hosts will get more complicated next year. The platform currently only issues tax documents to hosts who made more than 200 bookings and earned at least $20K per year. As part of a new American Rescue Plan Act, Airbnb will issue income tax forms to all hosts who make more than $600 a year. Hosts who fail to supply their income tax information won't be able to rent on the platform.
Rental Income StatementsProperty owners also need to keep track of any payment received for the use or occupation of a property. Aside from the obvious monthly rent or vacation rental fees, other sources of income can be easy to overlook.
If landlords receive advance rent, they need to claim it in the rental year it's received. That rule also applies to landlords who request a new tenant pay the first and last months' rent. If the final month of the lease agreement isn't until the next year, property owners still have to report that they received the money on their income taxes the year it was received.
Security deposits do not usually count as income unless the money has already been used to fix a tenant's mistake. In that case, landlords need to claim that money as recorded income for the year. If a tenant pays money to end a lease early, that amount also needs to be reported as taxable income.
Records of Meals, Travel and Office ExpensesProperty owners may pay daily business expenses that could be deductible. To get the most out of tax season, experts say it's important to keep detailed records. Phone bills, advertisements for new tenants, and even gas mileage when collecting rent or showing properties could add up to significant deductions.
According to Hall, the tax laws are constantly changing and some hefty deductions aren't as apparent to people who aren't accounting professionals.
"I think a lot of people are unaware that business meals are now 100% deductible," said Hall. "And that's true for 2021 and 2022. So any business meal that you incur in those two years is 100% deductible. Normally, it's 50%, but this is just a temporary provision."
The temporary tax break on meals is part of the Consolidated Appropriations Act, created to help restaurant businesses during the COVID-19 pandemic. If property owners offer free food at open houses or frequently has business meals with realtors and other potential partners, the tax break may be in their favor.
Prior Tax ReturnsLandlords who stick with the same CPA year after year will generally need to collect less paperwork come tax season. If a new accountant is hired, property owners will need to make sure previous returns and tax work is well-documented so that the transition doesn't end up costing them in the long run.
The responsibility falls on the property owner to understand past returns so things don't fall through the cracks. It's not unusual for important details to get lost in translation if a CPA is forced to start from scratch.
"I've seen a lot of mistakes," Hall said. " A lot of CPAs make mistakes, and everybody makes mistakes. (Landlords) need to know the general details so that you can hold everybody else accountable because it's your money on the line."
Other Tax Tips Property Owners Should Keep In MindAll three accountants above said one of the most important things that property owners should remember every tax season is to make sure they’re filing accounts for property depreciation.
"I've seen many, many people, especially if they're doing their own taxes, who neglect to depreciate the property," said Hochberger. "Really, that is going to be one of your bigger deductions. If you don't know how to depreciate the property, find a tax professional because that alone will [cover the] cost of having someone do your taxes."
Hall added that depreciation is a big motivator for new property owners, but they often don't file for it correctly.
"When people buy rental properties, they're typically told that they have great tax benefits," said Hall. "Sometimes they don't find out until later how those tax benefits actually work."
No matter what situation a property owner might find themselves in, the accountants said a successful tax filing season hinges on organization and preparation year-round. It's a habit that doesn't always come second nature to new property owners.
"Don't have your shoes tied together in knots before you start the race," recommended Bakke. "A lot of people jump into buying real estate out of their personal account, and are commingling funds between their personal and rental properties. You want to make sure that you've got everything in line before moving forward."