If you’re a veteran agent, you know how much of your hard-earned money goes to the government in the form of income tax. If you’re new to the profession, you’ll soon learn that the most significant cost of helping families achieve the American Dream is not a business expense – it’s the tax you pay on income earned making those dreams come true. Calling income tax a significant cost may be an understatement. The average realtor pays nearly forty cents on each profit-dollar to the federal and state government!
Giving forty percent of one’s income to the government is a heart-sinking fact. But, there’s good news in the flip-side of this tax-equation - and it’s the reason we created the Real Estate Agent Tax-Cut Library. Every dollar you deduct as a business expense saves forty cents in tax, it puts the 40% back into your pocket! That’s $40 savings per $100 deducted, $400 per $1,000, $4,000 for every $10,000 deducted! Obviously, learning to minimize your tax liability is a super-high-yielding investment!
Cutting your most significant expense, however, requires an understanding of how realtor taxation works. In this article, we’ll help you to develop this understanding by providing an overview of Schedule C, business income, and deductible business expenses.
Schedule C: Form Schedule C Profit or Loss from Business, is the tax form filed by the vast majority of Real Estate Agents. Schedule C is not a separate return. It is a form that attaches to and becomes part of the agent’s Individual Income Tax Return, Form 1040. The profit from Schedule C is used to determine Self-Employment Tax on Schedule SE and also carries to on Schedule 1, Additional Income and Adjustments to Income.
Business owners, such as Real Estate Agents, use Schedule C to report their income and deductible expenses to determine their business profit or loss. Schedule C is a two-page form that has seven sections and five parts:
- Business Information, Business Activity Code (the code for Real Estate Agents is 531210 Offices of Real Estate Agents and Brokers), and 1099-MISC Gotcha Questions,
- Part I - Gross Income,
- Part II - Expenses,
- Home Office and Profit,
- Part III – Cost of Goods Sold,
- Part IV - Vehicle Information, and
- Part V - Other Expenses.
A Real Estate Agent will generally complete all sections except for Part III, Cost of Goods Sold.
Cash Basis: The vast, vast majority of Real Estate Agents are cash basis taxpayers. They report their gross income (receipts) when it is received or constructively received (it is credited to their account and they have unrestricted access to it but may not physically possess the money). Expenses are reported in the year paid or when debt is incurred to pay them (such as a bank loan or a credit card charge).
Income on Schedule C: The vast majority of real estate agents receive notification of income on the Form(s) 1099-MISC their broker(s) provides in January of each year. Agents earning $600 or more during the calendar year should receive Form 1099-MISC. The amount earned is reported in Box 7, Self-Employment Income.
It should be noted that all income earned (even if under $600) from your services as a real estate agent is taxable, regardless of whether or not a 1099-MISC is received. Taxable income includes all commissions, finders’ fees, property management fees, payments for speaking or teaching, and any other income earned in your profession.
There are also several types of taxable income not reported on Schedule C. Examples include; interest on your business checking account (reported as interest income), Rental income (reported on Schedule E), or credit card points and rewards (if on an exclusive-use business card, reduce cost/expense of items purchased that generated the reward).
Expenses on Schedule C: Our Real Estate Agent Tax-Cut Library covers all potential expenses a real estate agent can deduct on Schedule C. These deductions, like all allowable business deductions, must share two fundamental characteristics: They must be both Ordinary and Necessary for the real estate agent. These are two critical tests that can make the same purchase deductible for one realtor but not for another. Being both ordinary and necessary depends on each agent’s use of the item and intent in making its purchase. Each criterion is critical - so, let’s take a look at both.
Ordinary: Ordinary expenses are common and acceptable in your industry. They are typical for those in the field of real estate who provide a similar service to a similar market.
Necessary: Necessary expenses are appropriate and helpful in your business and industry. A necessary purchase benefits your business, it’s an investment – or at least that’s the intent at the time of purchase. You must also prove that the underlying reason for the purchase is business and not personal in nature.
Ordinary & Necessary Bottom Line: A cost being ordinary and necessary is vital to take it as a deduction, but don’t let their definitions scare you. A cost being ordinary does not mean you cannot be the first to adopt a new advertising strategy, for instance. Moreover, a necessary purchase depends more on your intent and use of the item than proving it generated a profit.
Making sure your deductions pass the laugh test is also critical. For example, writing off a Ferrari for one’s real estate business might make an auditor burst out in laughter (a snickering auditor is a bad sign, by the way). But the auditor is much more likely to be persuaded that the deduction is ordinary and necessary for an agent showing multi-million-dollar mansions in Naples, Florida than an agent selling middle-class homes in rural Kansas.
The key is to demonstrate that your purchases are made to help operate your business and earn income.
Summary and Invite: We hope this article has provided a helpful overview of Schedule C, reportable income, and deductible expenses. If you’d like to learn more about cutting your most significant 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.