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Tax Strategies For Real Estate Investors - 2010 Version

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Real Estate Investor PowerPoint

Tax Strategies for Real Estate Investors

Tom Sawyer, CPASawyer & Latimer, P.A.www.sawyerlatimer.com954-491-723311Are you satisfied with the taxes you pay? Are you confident youre taking advantage of every available break?Is your tax advisor giving you proactive advice for saving on your taxes?Ive got bad news and Ive got good news. The bad news is, youre right. You do pay too much tax. Youre probably not taking advantage of every tax break you can. And most advisors do a poor job of actually saving their clients money.The good news is, you dont have to feel that way. You just need a better plan. Today, were going to talk about some of the biggest mistakes that real estate investors make. Then well talk about how to solve them.

The Secret to Beating the IRS There is nothing wrong with a strategy to avoid the payment of taxes. The Internal Revenue Code doesnt prevent that. William H. Rehnquist

Tax planning is financial defenseTax planning guarantees results

22Whats the secret to beating the IRS? Its really no secret at all. Its planning.I dont care how good you and your tax preparer are with a stack of receipts on April 15. If you didnt know you could write off your kids braces as a business expense, theres nothing we can do.Tax coaching is about giving you a plan for minimizing your taxes. What should you do? When should you do it? How should you do it? And tax coaching offers two more powerful advantages.First, its the key to your financial defenses. As an investor, you have two ways to put cash in your pocket. Financial offense is making more. Financial defense is spending less. For most of us in this room, taxes are our biggest expense. So it makes sense to focus our financial defense where we spend the most. Sure, you can save 15% on car insurance by switching to GEICO. But how much will that really save in the long run.And second, tax coaching guarantees results. You can spend all sorts of time, effort, and money advertising your properties. But that cant guarantee results. Or you can set up a medical expense reimbursement plan, deduct your daughters braces, and guarantee savings.Taxable Income+ Add Taxable Income-minus Adjustments- minus Deductionsx (times Tax Bracket)- minus Tax CreditsEarned incomeInterest/dividendsCapital gainsPension/IRA/AnnuityRent/royaltyAlimonyGambling winningsOther income

33Lets start by taking a quick look at how the tax system works. This will lay a foundation for understanding the specific strategies well be talking about soon.The process starts with income. And this includes most of what youd think the IRS is interested in: Earned income from wages, salaries, bonuses, commissions, and businesses. Interest and dividends from bank accounts, stocks, bonds, and mutual funds. Capital gains from property sales. Pensions, IRAs, and annuity income. Rental income and losses Alimony and gambling winning. Even illegal income is taxable. The IRS doesnt care how you make it; they just want their share! (The good news is, if youre operating an illegal business, you can deduct the same expenses as if you were running a legitimate business. If youre a bookie, you can deduct the cost of a cell phone you use to take bets.Adjustments to Income minus Adjustments to Income minus Deductions times Tax Bracket minus Tax CreditsIRA contributionsMoving expenses SE taxSE health insuranceKeogh/SEPAlimonyStudent loan interest

Add Taxable Income44Once youve added up total income, its time to start subtracting adjustments to income. These are a group of special deductions, listed on the first page of Form 1040, that you can take whether you itemize deductions or not. Total income minus adjustments to income equals adjusted gross income or AGI. Adjustments to income are also called above the line deductions, because you take them above AGI.Adjustments include IRA contributions, moving expenses, half of your self-employment tax, self-employed health insurance, Keogh and SEP contributions, alimony you pay, and student loan interest. Deductions/Exemptions Add Taxable Income minus Adjustments to Income minus Deductions/Exemptions times Tax Bracket minus Tax CreditsMedical/dentalState/local taxesForeign taxesInterestCasualty/theft lossesCharitable giftsMiscellaneous itemized deductions

55Once youve determined adjusted gross income, you can take a standard deduction or itemized deductions, whichever is greater. The standard deduction for 2010 is $5,700 for single taxpayers, $8,400 for heads of households, $11,400 for joint filers, and $5,700 each for married couples filing separately. Tax deductions reduce your taxable income. If youre in the 15% bracket, an extra dollar of deductions cuts your tax by 15 cents. If youre in the 35% bracket, that same extra dollar of deductions cuts your tax by 35 cents.You can also deduct a personal exemption of $3,650 for yourself, your spouse, and any dependents. Tax Brackets Add Taxable Income minus Adjustments to Income minus Deductions times Tax Bracket minus Tax CreditsRateSingleHoHJoint10%00015%8,37511,95016,75025%34,00045,55068,00028%82,400117,650137,30033%171,850190,550209,25035%373,650373,650373,6506Once youve subtracted deductions and personal exemptions, youll have taxable income. At that point, the table of tax brackets tells you how much to pay. You may also owe self-employment tax, which replaces Social Security and Medicare for sole proprietors, partnerships, and LLCs. Youll also owe state and local income and earnings taxes.Tax Credits Add Taxable Income minus Adjustments to Income minus Deductions times Tax Bracket minus Tax CreditsFamily creditsEducation creditsFirst-Time homebuyerForeign taxGeneral business Low-income housingRenovation77Finally, youll subtract any tax credits. These are dollar-for-dollar tax reductions, regardless of your tax bracket. So if youre in the 15% bracket, a dollars worth of tax credit cuts your tax by a full dollar. If youre in the 35% bracket, an extra dollars worth of tax credit cuts your tax by the same dollar. Theres no secret to tax credits, other than knowing whats out there.

Two Kinds of Dollars Add Taxable Income minus Adjustments to Income minus Deductions times Tax Bracket minus Tax CreditsPre-Tax DollarsAfter-Tax Dollars88Ultimately, there are two kinds of dollars in this world: pre-tax dollars, and after-tax dollars. Pre-tax dollars are great. And after-tax dollars arent bad. But theyre not as good as pre-tax dollars.Keys to Cutting TaxEarn as much nontaxable income as possibleMake the most of adjustments/deductions/creditsShift income to later years if lower-brackets are anticipatedYou lose every time you spend after-tax dollars that could have been pre-tax dollars.99So heres the bottom line:You lose . . . every time you spend after-tax dollars . . . That could have been pre-tax dollars.Let me repeat that.You lose . . . every time you spend after-tax dollars . . . That could have been pre-tax dollars.Were going to spend the rest of this presentation talking about how to turn after-tax dollars into pre-tax dollars.Were going to use three primary strategies.First, earn as much nontaxable income as possible.Second, make the most of adjustments to income, deductions, and credits. Theres really no magic to it, other than knowing whats available.Finally, shift income to later tax years and lower-bracket taxpayers. This includes making the most of tax-deferred retirement plans and shifting income to lower-bracket children, grandchildren and other family members. Avoid Audit ParanoiaPercentage of returns Audited

1010The second big mistake is nearly as important as the first, and thats fearing, rather than respecting the IRS.What does the kind of tax planning were talking about do to your odds of being audited? The truth is, most experts say it pays to be aggressive. Thats because overall audit odds are so low, that most legitimate deductions arent likely to wave red flags.Audit rates are actually at historic lows. For 2008, the overall audit rate was less than one in every 100 returns (.8%). Over half of those audits targeted the Earned Income Tax Credit for low-income working families. The IRS primarily targets small businesses, especially sole proprietorships, and cash industries like pizza parlors and coin-operated laundromats with opportunities to hide income and skim profits. In fact, they publish a series of audit guides that you can download from their web site that tell you exactly what theyre looking for when they audit you!The IRS doesnt break out audit statistics for those of you filing Schedule E. However, the combined audit rate for those filing Schedule E or Form 2106, where you report employee business expenses, is just 1.26%.Take a look at the bottom of the chart. Youll see that the IRS audits less than one-half of one percent of S-corporations and partnerships. If youre really worried about being audited, you might consider reorganizing your business to help fly under the radar.

Make the Most of DepreciationDivide basis between land and improvements. Assign as much as possible to depreciable improvements. The IRS suggests you use local property tax assessments. You can use any allocation (such as bank appraisal or your insurers estimate of replacement costs) so long as you show reasonable basis. LandNot depreciableImprovements27.5 39 yearsProperty1111If you own your properties individually, jointly with your spouse, or through a single-member LLC, youll report income and expenses on Schedule E. If you own them through a partnership, multi-member LLC, or corporation, youll report them on Form 8825 and attach it to your partnership or corporation return. In either case, youll start with rental income, t

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