Tax Planning for Real Estate Agents
Are you crushing it in your real estate business? If you hit an all-time-best GCI in 2021, these tax planning action items are for you as we enter 2022.
1. Backdoor Roth IRA Strategy
What is a backdoor Roth IRA?
The backdoor Roth IRA strategy is designed for individuals in the upper levels of the federal income tax bracket schedule.
As of 2021, if a married-filing-jointly taxpayer has more than $214,000 of income for the year, they are disqualified from contributing to a Roth IRA account.
This is important because contributions to a Roth IRA grow tax-free and allow for significant tax advantages in the long run.
Due to the income limitation, many Top Producers miss out on making contributions to a Roth IRA. This is where the backdoor Roth IRA strategy comes in.
By following a specific sequence of steps, including funding a non-deductible IRA and processing a Roth conversion, you can successfully fund your Roth IRA every year completely aboveboard. This even with an income above the usual Roth IRA income limitations.
The process for properly executing this strategy can quickly become complex and is not a right fit for everyone.
You will want to plan with your financial advisor and CPA to verify if this strategy is suitable for your situation, but it should certainly be at the top of the list for tax planning opportunities to consider.
Tax deadlines for Roth IRA
You have two tax deadlines to be aware of when implementing the backdoor Roth IRA strategy.
First, the contribution deadline for any given tax year is until you file your taxes, typically April 15.
Second, the conversion deadline is December 31 of each year—meaning you must complete the Roth conversion element of the backdoor Roth IRA strategy within the calendar year.
2. Charitable Giving
Reminder: Don’t give up on reporting your contributions!
In 2018, the Tax Cuts and Jobs Act doubled the standard deduction amount available for taxpayers to claim each year. In 2021, a married-filing-jointly couple would be eligible for a standard deduction of $25,900.
As a result, recent data has shown that about 90% of taxpayers now claim the standard deduction, as opposed to the itemized deduction, as many did in the past. (You are entitled to the greater of the two.)
Since charitable giving falls into the itemized deductions category for tax reporting purposes, most Americans unfortunately no longer receive any tax benefit for their charitable giving.
Without the tax incentive, many stopped reporting charitable contributions altogether.
Fast-forward to 2020: The CARES Act brought back a small benefit for the charitably inclined who still take the standard deduction.
This is the ability for a married-filing-jointly couple to take the standard deduction and still claim an additional $600 deduction (for the year 2021) for qualified charitable gifts.
Tax deadlines for charitable giving
Charitable giving must occur within the tax year it is being claimed, so you will need to have made your contributions before year-end if you planned on taking the extra $600 deduction for the 2021 tax year.
At this time, this deduction will not be available in 2022 unless Congress extends it.
3. Estimated Tax Payments
All-time GCI = All-time taxes
Typically, an all-time-best GCI year means an all-time-high tax year.
Meaning, if you are crushing it this year, this is a good time to make sure your financial planner and CPA are up to date on your income level.
The primary goal of making estimated tax payments is to avoid generating a tax penalty for underpaying throughout the year.
How to avoid a tax penalty for underpayment
Below is the two-pronged safe harbor for avoiding a tax penalty for underpayment:
- At least 90% of the tax for the current year OR
- 100% of the tax shown on the return for the prior year, whichever is smaller
Once you have confirmed you will not accumulate a penalty (which, in the case of an all-time-best GCI year, would be verified by paying in at least 100% of last year’s tax liability), you want to start planning for the additional tax bill.
For cash flow purposes, you might feel more comfortable paying in beyond your safe harbor amount to avoid a large chunk of tax liability due all at once on April 15 of the following year.
Make Paying Taxes Easier
Lastly, here are a couple of tips to make paying your estimated taxes easier, so instead of spending time on your taxes, you can focus your time where you want to focus it—your business!
Top Producer Tip #1: Make an electronic payment! The IRS is extremely backlogged on the paper side of things right now.
Top Producer Tip #2: Change the last dollar of each payment to reflect the corresponding quarter. If the IRS gets its wires crossed and you need to resolve a discrepancy, you can easily identify what payment they are missing.
Ex.: $10,001, $10,002, $10,003, $10,004
Tax deadlines:
Upcoming estimated payment due dates are as follows:
- 1st payment: April 18, 2022
- 2nd payment: June 15, 2022
- 3rd payment: September 15, 2022
- 4th payment: January 15, 2023
4. Consider Switching to an S Corp in 2022
Rising stars: When to make the jump
One of my peers, Matthew Jarvis, CFP®, sums up tax planning well by stating:
“My job is to make sure that you pay the IRS every dollar that you owe, but that you don’t leave them a tip.”
If you are a rising star in the real estate business, one of the big tax decisions to evaluate is if and when you will make the jump from an LLC or sole proprietor to an S corp.
This is a crucial decision that you will want to bring in your financial team for. This team of trusted advisors will usually consist of your attorney, CPA, and financial planner. Each plays a specific role in helping you make the right call.
While this decision has several angles, the financial side of things revolves around evaluating the following two factors:
Extra costs and hassle vs. massive potential tax savings
Extra costs would include:
- Hiring a CPA, if you have not already
- Enlisting their services to help you with payroll
- Filing a separate tax return for your business each year
Massive potential tax savings would include:
- S corporations act as a “pass-through” entity and avoid double taxation
- S corporations allow your business to pay out a dividend to you, the business owner
- By earning less salary and instead earning a dividend, FICA taxes can be saved
FICA taxes equate to an additional 15.3% tax above and beyond the federal income taxes that individuals pay.
Multiply your all-time-best GCI by 15.3% and you quickly realize the massive potential tax savings here.
Tax deadlines:
As this writing is taking place late in 2021, it is likely too late in the year for you to make any significant impact by switching to an S corp.
That said, the action item here is to begin planning now. Start the discussion with your financial team to get your business entity selected and in place for the next tax year.
5. Establish Your Solo 401(k) Now
Turbocharge your retirement savings
While a SEP-IRA is a great place to start, the Solo 401(k) has some big advantages, particularly for high-income Top Producers.
Remember that whole backdoor Roth IRA strategy we already went over? The same tax treatment is available via a Solo 401(k), if designed properly.
Solo 401(k)s can specify in the plan document if they allow for Roth contributions into the plan.
And here is the best part: Solo 401(k) plans have drastically higher contribution limits than an IRA account.
Here’s the breakdown:
Solo 401(k) Contribution Limits for Tax Year 2022
- Employee contribution: $20,500
- Employer contribution: $40,500
- Total contribution limit: $61,000*
*For those age 50 and older, you are entitled to a catchup contribution of $6,500 beyond the standard contribution limit of $61,000.
Every dollar that you contribute to a Roth Solo 401(k) will benefit from tax-free growth within the account.
By contrast, a traditional Solo 401(k) contribution will have taxable withdrawals in the future. In exchange for being taxable down the road, you can take a deduction to your earned income for every dollar you contribute.
While both scenarios have their benefits, your unique situation will determine how to best allocate your retirement contributions.
Regardless of the style of the Solo 401(k) plan that you select, the driving force behind your financial success will be the fact that you are saving to begin with!
Tax deadlines:
You do not need to contribute until you file your taxes, but the plan must be established (i.e., plan document drafted and in place) before year-end.
Tax Planning Recap
You must be proactive with your tax planning because if you wait until you file your taxes to adjust your strategy, it may be too late!
The five tax planning action items you need to evaluate this year are:
- Backdoor Roth IRA strategy
- Charitable contributions
- Estimated tax payments
- A potential switch to an S corp in 2022
- Solo 401(k)
While all five tax planning action items merit your consideration, not every action item will be a good fit for every Top Producer.
Further, the tax planning strategies we outlined today can be complex to implement, and we recommend collaborating with your CPA and financial planner to verify that each strategy is properly executed.
Schedule a complimentary insight meeting to discuss your situation and how we may be able to help.
