The most valuable asset you have as a real estate agent is time. You want to invest your time, not waste it. Invested time is utilized performing one of two activities: 1) Making current clients happy (profitably), and 2) Getting new clients. All other business minutes are either spent on necessary tasks that mitigate a crisis or wasted on activities that have no direct relationship with making sales. (For more information on effective time management check out our article Grow Your Business, Invest Your Minutes).
Minimizing your taxes is a different type of investment; it helps to cut your most significant expense! Every thousand dollars properly deducted can save up to $400 of tax! Two critical factors in maximizing your after-tax profit are: 1) Learning what’s deductible, and 2) How to substantiate the deductions claimed on your tax return.
It’s Your Responsibility: It’s the taxpayer’s responsibility to prove they’re legally entitled to all deductions claimed on their tax return. To do so, they must prove that each deduction was ordinary and necessary for their business. They must also substantiate that each deduction in terms of time, place, and amount claimed.
To maximize their after-tax profit, a real estate agent should develop a basic understanding of which transactions are and are not deductible. Helping real estate agents develop this understanding is why we created the Real Estate Tax Cut Library. Volume three of the library shares an efficient and effective way agents can track their expenses and substantiate their deductions. This article will highlight this methodology. But first, let’s take a look at the consequences of being unable to substantiate deductions.
Lost Deductions: There are two primary reasons real estate agents lose deductions and pay more tax than they should. The first is relatively simple – they’re busy, they’re on the road a lot, and they have a family and a life. As a result, its super-easy to forget about deductible transactions incurred throughout the day. No need to substantiate deductions they didn’t claim - they don’t even know what they are!
The second cause of lost deductions is much more consequential - the IRS denies them during an audit. The IRS knows that the self-employed are the low-hanging fruit of the tax world. Why? They do not make tracking expenses a priority, tend to re-construct deductions when tax time arrives, and are not able to substantiate the deductions claimed.
An audit is stressful for anyone, but for those who lack proper records, they can prove emotionally and financially devastating. Emotionally, it’s like being the target of a criminal investigation, except it’s not the auditor’s job to prove you’re guilty. It’s your responsibility to prove that you’re innocent - that you’re entitled to every deduction. Financially, denied deductions result in additional tax, interest, and penalties. Worse yet, you run the risk of having more years audited.
Easy Recordkeeping Steps: Following these easy recordkeeping steps will ensure that you can confidently and quickly substantiate your deductions.
- Use a Separate Checking Account for Business Transaction: Segregating business and personal transactions by using a business checking account is a fundamental business principle with quite a few benefits. First, it makes recordkeeping easy because all of your business transactions are one place. Second, bank statements provide a paper trail showing where your money went. Third, canceled checks reveal the date funds were spent and who received them. Fourth, statements provide proof that bills are paid. Fifth, although checks do not replace receipts in terms of proving a deduction, they can go a long way to substantiating a deduction when receipts are misplaced or destroyed. Sixth, the segregation habit may help develop a more professional business attitude. Seventh, it avoids the possibility of the IRS (or some other third party) prying into your personal affairs when reviewing your business records.
Using a separate checking account exclusively for the business may also protect non-business assets in a lawsuit (depending on your business structure - ask an attorney).
- Use a Separate Credit Card for Business: Segregating business credit card transactions is crucial for many of the same reasons. Also, interest paid on a business-only credit card is deductible. Interest on a personal/business blended credit account is a risky mess to deduct.
- Avoid Mixing Personal and Business Transactions: When rushing through check out with a cart full of groceries and a few business supplies, it’s tempting to purchase the items together and figure it out later. Please don’t do it! You’ll spend more time trying to figure it out than purchasing the business items up separately. Chances are, you’ll never figure it out and lose the deduction.
- Do Not Use Cash: Using cash to pay bills is a recipe for lost deductions. Using cash requires the purchaser to remember the transactions and to keep the receipts until recording them in their expense recording system. Chances are, they won’t and will lose the deduction. Cash also throws a wrench in the cogs of our Manila Receipt System (discussed later).
- Track Online Purchases: If you purchase products or services over the internet, use your business debit or credit card to do so. Also, try to use online vendors that keep your purchase history so you can access receipts if you need to. Make these purchases on a device that can physically print. When you make an online purchase, do two things with the receipt. First, create a single expense folder (for example, “Business Online Receipts 2019”) on your computer and save the receipt to that folder as a pdf file using the payee’s name. Next, print a copy of the receipt and place it in your Monthly Manilla Receipt Folder, which we’ll discuss next.
- Use the Monthly Manilla Receipt System: Hey, you’re busy, you’re on the road a lot, you have a family and a life. You’d like a simple way to record and keep evidence of your expenses while NOT losing any. This is why I developed the Manilla Receipt System, a fancy word for a simple process. Each month you grab two 10*13 manila envelopes. Place one in the car you use for business. If you use more than one vehicle for business, use an envelope for each car. Keep the car-envelope(s) in a place you cannot miss it. In a door compartment, on the passenger seat, slide it between the passenger seat and the center console. The key is to keep it in a prominent location until you develop your receipt-keeping habit.
Keep the remaining envelope in your home or outside office where you pay business bills and make online purchases.
Now that you have your envelopes put every business receipt into your car or office manila envelope as soon as you make the purchase or pay the bill.If you’re leaving the office supply store, do not place the receipt in the bag. Keep it in hand until you get to your car, then put it in your car envelope!
- Categorize Monthly Expenses: This step may vary depending on the type of record/bookkeeping system you use. If you already have an efficient method to track business expenses, use your check register, bank, and credit card statements to record and categorize transactions at least once per month. More than once per month may prove a time-waster. Less than once per month and the task may become too daunting – making it more likely you will put it off and not do it.
If you do not have an efficient way to track your expenses, you will need to use a spreadsheet, bookkeeping software, of columnar sheets to record and categorize them.
- Secure Monthly Receipts: For the first month or two, you may want to match the receipts to your bank and credit card statements to make sure none are missing. Once you’re confident in your receipt-keeping ability, you can skip this step.
At the end of each month, transfer all receipts to a single 10*13 manila envelope and write the month or year on it in large print.Then, seal the envelope so no receipts can escape. Next, place each monthly envelope in a place where they can be easily located.At the end of the year, bind them together with a big rubber band and store them with essential documents.Make sure you keep your bundled receipts for AT LEAST three years after filing your tax return.
Why the Manila Receipt System: Using a single bank account and credit card for business will allow you to categorize monthly expenses easily. The manila receipt system will ensure you do not lose any receipts for those expenses and can quickly substantiate all business deductions on your tax return.
Summary and Invite: By following the steps listed above, your business transactions will be easy to track, so you can quickly and confidently maximize deductions, and easily substantiate them when needed. You will also have more time to invest 1) Making clients happy, and 2) Getting new clients!
If you’d like to learn more about cutting your largest expense, TAXES, check out our Real Estate Agent Tax Cut Library. The Real Estate Agent Tax Cut Library includes over eight hours of video broken into twenty-nine searchable volumes and covers every possible deduction a Real Estate Agent can take on their tax return. Our Broker Version will help your entire agency cut their taxes! We also invite you to browse our courses.