Year-End Tax Planning Tips from our CEO

Year-end tax planning tips

Thinking ahead can protect you from waiting until there may be too little time to do things in a thought-out way. Here are some year-end tax planning tips that should be considered before you start planning your end-of-year celebrations. These can help you begin the next tax year in the best position to plan for future wealth. This way, you’ll really have something to celebrate in your company!

Here’s how to get to work:

Trevor McCandless's Year-End Tax Planning Tips

Phase 1: Update your records and stabilize your finances

Reconcile your bank and credit card accounts

Reconciling and including all transactions from the property’s or entity’s bank and credit card accounts is absolutely mandatory.

If you aren’t the one managing your accounting or QuickBooks files, you may have no idea how to check this. That’s common for some property owners, but all owners should at least have access to their QuickBooks files even if your internal team is not doing the day-to-day data entry.

The action item here is for you as the owner or your Finance Lead to log in and run a Balance Sheet report. Eyeball the balances for each of your bank accounts and credit card accounts.

If there are differences, start asking your accountant a lot of questions. You may have a real big problem if you see negative balances in these accounts. Fortunately, we can fix these short-term accounting problems by correcting the entries for missing transactions, double-counted transactions, or misclassified transactions.

Make sure your Escrow accounts are up to date

This process is very similar to your checking and credit card reconciliation. Compare these Escrow accounts to your lease contracts, your closing statements, or for whatever you’re using the Escrow accounts.
If you’re delegating this reconciliation step to someone internally who HATES reading legal contracts, you’re likely going to find errors.

Loan payment reconciliations

You would be surprised how often we see THIS screwed up. The action item for your team is to make sure that you have your amortization schedules in hand and that you compare them to the financial statements.
First, you’re making sure the debt balances as reported on your balance sheet match the debt balance as reported on your year-end mortgage statements and amortization tables.

Secondly, you want to confirm that the interest deductions on your income statement match the interest payments on the year-end mortgage statements, as well as the amortization schedule.

Where we see misreporting is:
  1. When we see accountants or owners trying to deduct the entire mortgage payment, which is is the most common among “DIYers.”
  2. When we see the entire loan payment treated as a distribution, it would be fully non-deductible.
  3. When there was some mid-year change to the accuracy of the amortization schedule. Inaccuracies can occur if you missed a payment or terms were re-negotiated on interest rates, or there could also be some debt forgiveness, etc.

In this light, Phase 1, the stabilization phase, can be very smooth depending on if you’re currently managing the accounting yourself or if you have a great CPA that’s overseeing it on an ongoing basis for you.

Phase 2: Analyze where you can save with deductions and depreciation

Phase 2 is entirely dependant on the accuracy of Phase 1. For most of our clients, we are handling the adjusting of journal entries and the reconciliations during the stabilization phase that we mentioned, but we do have clients that have high-quality internal accountants with which we can coordinate the review of these items.

Step 1: Keep track of qualified tax deductions & depreciation

First, I want to touch on Qualified Tax Deductions & Depreciation either via Bonus Depreciation or Section 179 Depreciation. With the tax reform, these forms of depreciation have taken on a new light, so it’s important to highlight here.

Qualified tax deductions

We’re often asked, “What can I deduct?” or “What is a qualified business deduction?” The IRS defines qualified deductible expenses as Ordinary and Necessary expenses that are incurred in the carrying on of your business. The definition can obviously then raise more questions. CPAs commonly think of Ordinary expenses as those that are helping to further the growth and sustainability of your venture. For example, paying for real estate taxes on your commercial property is going to help you sustain your ownership of that property. Paying your vendors and employees is necessary to running your business. What likely does not qualify is the vacation you may take to Italy for Christmas with no business purpose.

Depreciation and the Section 179 deduction

Cost segregation studies

We mostly speak about Cost Segregation studies for newly built properties or properties that have just been acquired. The goal of a cost segregation study is to identify and separate the assets that have been acquired in a transaction that may be able to depreciate over a much shorter time frame than the entire building.

For example, if we acquire a property for $1 million, we may be able to identify $50k of carpeting that may be depreciated and deducted over five years versus 39 years. What this achieves is the ability to speed up deductions and further reduce your taxable income in the current year.

It should be noted – sometimes owners should not want to speed up deductions if they have other properties that are also generating losses in the early years and not much taxable income. Generally, we want to be able to time deductions in years where we have the most taxable income when we are in higher tax brackets than in years when we are in lower tax brackets.

Bonus depreciation

That being said, if we have significant positive Net Income, let’s look at how we can speed it up with the 2017 tax reform, and through 2022 we have a new 100% bonus depreciation on eligible assets on acquisitions, new construction, or renovation (whereas it used to be 50%).
Note that the 100% bonus depreciation election gradually declines from 80% to 20% in the 2023 – 2026 tax years on eligible assets, such as tangible property, like carpeting, wallpaper, interior glass, built-in cabinets, a breakroom sink – these are eligible for bonus depreciation.

Land improvements depreciation

There’s also 15-year land improvements depreciation (this differs from building improvements) and this includes landscaping, signage, parking lots, sidewalks, and generally items that you see outside of the building. While it’s not eligible for bonus depreciation, it is eligible for Section 179 depreciation. A VERY important note: that Sect 179 property can only be depreciated up to the amount of positive Net Income.
Thus, if you have a loss in the property, we don’t like taking Sect 179 depreciation because it is limited and you’re not going to get the immediate benefit of it.
For example, if I have $20k of net income, but $50k of Section 179 property, I can’t create a loss with Section 179 deductions to offset other income, but you can with bonus depreciation.

Other notes on these forms of depreciation:

Total Section 179 eligible property is limited to $1,020,000 for active properties. Phase-out begins at $2.5 mm and is done at $3.5mm of eligible assets. There’s no limitation for bonus depreciation.

 

 

Step 2: Calculate your Estimated Tax liabilities

Understand Net Income and Cash Flow

Firstly, let’s clarify the differences between Net Income (which your taxes are based off of) and Cash Flow because quite frequently entrepreneurs confuse the two when thinking about how much taxes they may owe.

In commercial real estate versus, say, professional services companies like accounting or law, the differences between Net Income and Net Cash Flow are FAR greater. For commercial real estate owners, depreciation is a much bigger deduction and thus has a much BIGGER EFFECT (because of all of the Capital Intensive Assets that we need to acquire) on the difference between Net Income and Cash Flow. 

For example, while you may have $100k of cash on hand, we may only have $20k of Net Income on which you’re taxed due to depreciation (which is a paper deduction). Depreciation isn’t actually cash coming out of your pocket. In a similar manner – LOANS & DEBT also create similar differences between Net Income and Cash Flow. For example, when a loan is being paid off in any given year, you may have $100k in Net Income but $20k of cash on hand, but in this case, you’re being taxed on the $100k. In this case, paying off debt isn’t deductible.

Therefore, Cash on Hand and Cash Flow is very different than Net Income and what you’re being taxed on.

The full tax return

So, let’s chat about how to proactively estimate your tax liability in any given year. The more complex (but most accurate) method is to proactively prepare a full tax return with all of the information that you have for the coming year. Most of the time your CPA is going to do this, so just let your CPA firm do it for you behind the scenes. It’s not going to slow you down.

For example, if it’s June of 2021 and we want to accurately know what our 2021 tax liability looks like, we’ll roll over all of the prior year’s information (2020) that we know of, edit any changes to prior year investments, sources of income and expenses that we have in 2021 and add in new acquisitions or disposals of assets and sources of income from 2021. In this example, we’re doing this in June with some assumptions of what’s going to happen for the final six or seven months, but if we have a business that has large swings of income, we could edit this every quarter for the actual performance that occurs. Keep in mind that this isn’t a DIY method for the most part, but this next one can be if you’re so inclined.

The projection

In the more simplified method, we’re not preparing a whole tax return and doing a projection which is best used if there have been very little to no changes in the amounts and sources of the Net Income of your company and properties from the prior year. 

In this scenario, you can simply look at your previous year’s tax return and divide your Taxable Income by your Total Tax calculation and you’ll come to your Effective or Average tax rate across all of the marginal tax brackets.

If you are looking at the 2019 tax forms, you can find the Taxable Income amount on line 11(B) on page 1 of the Form 1040 and then the Total Tax amount can be found on page 2 of the Form 1040 on line 16, then this can be more of a DIY method or if you want to get a quick calculation for how much to budget.

Put these dates on your calendar

Estimated quarterly tax payments are due on April 15, June 15, September 15, and January 18. Good to put these in your calendars or sign up for our tax deadline reminders.

Let's help you make this end-of-year the best one yet

This blog article is not intended to be the rendering of legal, accounting, tax advice or other professional services. Articles are based on current or proposed tax rules at the time they are written and older posts are not updated for tax rule changes. We expressly disclaim all liability in regard to actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided on this website is not all-inclusive and such information should not be relied upon as being all-inclusive.

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