Are you crushing it in your real estate business this year? If you hit an all-time high in your GCI in 2021, these five money-savvy tax planning tips are for you.
Tax planning tip number one, we’re looking at the backdoor Roth IRA strategy. The biggest barrier to entry to the Roth IRA for top-producing real estate professionals is the income limitation. In 2021, if your total income is in excess of $208,000 for the year, you’re automatically disqualified by the IRS to make a contribution to a Roth IRA account, which in turn grows tax-free going forward.
The way that we can get around this limitation for top producers is the ability to implement the backdoor Roth IRA strategy. While this strategy takes a handful of a sequence of events in order to make that work, this is a strategy that enables top producers with high GCI the ability to still access the tax-free growth that’s available from a Roth IRA, even if you’re over the income limitations.
The process for implementing the backdoor Roth IRA strategy can become complex fairly quickly, so you’re going to want to make sure you partner with your CPA and your financial planner to make sure that you dot your i’s and cross your t’s on this, but it’s certainly one of the top tax strategies you need to be evaluating in 2021.
Our second tax planning move is charitable giving. What happened was, in 2018, the standard deduction got doubled. As of 2021, you have up to $25,100 of standard deduction for couples that are married filing jointly. That’s double what the standard deduction used to be prior to 2018, and as a result, more often than not, folks are taking the standard deduction, as opposed to itemizing like they were before. As of a recent study, up to 90% of tax filers in the United States were claiming the standard deduction.
Where charitable giving comes into all of this is that charitable giving falls under the itemized-deduction category. When that big change happened in 2018, you saw folks that were previously getting a tax deduction for their charitable giving lose that benefit completely, and as a result, a lot of folks just stopped reporting it on their taxes because it didn’t make any impact on the final number.
But what came back last year was the ability to take the standard deduction and still take, albeit a small one, a charitable deduction as well. In 2021, don’t give up on reporting your charitable contributions, even if you’re still going to take the itemized deduction. There’s still $600 of deduction that’s available to you even if you claim that standard deduction of 25,100.
Number three is to make your estimated tax payments. If this was an all-time-high year in your GCI, that means it’s probably going to be an all-time high in your tax bill as well. Making those estimated payments becomes very, very important to make sure that we don’t get a tax penalty at the end of the year.
There’s a two-pronged test for the safe harbor to avoid a penalty on your taxes, and you get to pick the lesser dollar amount of the two. You can either pay 90% of last year’s tax liability or 100% of this year’s tax liability, the lesser of the two.
Step one is just to make sure you’re hitting one of those safe harbor amounts, especially if this is an all-time GCI year for you. You’re going to want to make sure you don’t have a penalty. Then even if you are above those safe harbor amounts and you’re not going to have a penalty, that doesn’t mean you might not have a surprise come tax day.
The next thing we want to take a look at is just for cash flow purposes, you want to be planning for that tax bill, if this is an all-time high year for your GCI and potentially paying more in those quarterly payments, if you want to spread that liability out of it. But however you want to approach that, whether it’s making a little bit higher estimated payments or just saving up that chunk to pay at the end of the year, just be sure you’re ready for that come April 15th.
Tax planning move number four is consider switching to an S corp. This really applies to the rising stars that we see in the real estate industry right now. If you’ve been a top producer for a long time, you’ve likely evaluated the S corp scenario quite a while ago.
But for you that are really just coming into full stride with your real estate business, the S corp is certainly something to evaluate. You’re going to want to pull in your financial planner, your CPA. Then if you decide to move forward with it, partner with an attorney to get the documents drawn up. But there really is some pretty big value in evaluating if an S Corp is the right business entity for you to select for your real estate business.
When evaluating if an S corp makes sense for your real estate business, the two things that we want to weigh here are, do the extra hassle and cost outweigh the massive tax savings that’s available? Those are the two things we’re looking at.
The extra hassle and cost really come down to if you’re going to have an S corp, we really recommend partnering with a CPA for your personal filing, your corporate filing, then helping you with your payroll throughout the year as well. That, as compared to or weighed against the benefit of having the tax benefit of having an S corp, is the ability to splice out your income between a salary that you’re paying yourself as an employee of the business and the dividend that the business can pay you as the owner of the business.
Really, this comes down to FICA taxes. FICA taxes are at 15.3% above and beyond the federal income tax that all taxpayers pay on their income, specific to small business owners, and you don’t have to pay that tax on the dividend income. Certainly something you need to pull in your CPA to figure out how to portion out and splice out that split between those two tax treatments, but that’s where the real value is for tax planning and moving your business to an S corp.
Our final tax planning tip is opening up your solo 401(k) plan. If this is a banner year for your real estate business, an all-time high in your GCI, one of the things that we’d really encourage you to consider is opening up a solo 401(k).
We already talked about how the Roth IRA can be a great tool for real estate agents, specifically the backdoor Roth IRA strategy, if you’re over that income threshold. But the solo 401(k), we would argue, outpaces even that backdoor Roth IRA strategy purely because of the income limits associated.
That solo 401(k) is going to let you pack in a lot more savings than you can in just a regular IRA and either get you the tax deduction that you’re looking for, or inversely, even more dollars into the Roth portion of that solo 401(k) if that’s the goal that you have for your retirement savings.
In the year 2021, solo 401(k) contribution limits are all the way up to $58,000—19,500 of that is considered employee contribution, and then the remaining $38,500 of that total amount is employer contribution. That’s one of the huge, huge advantages of a solo 401(k) above and beyond the Roth IRA or even a SEP-IRA is the ability to pack away more of your savings on a tax-deferred or tax-free basis.
All right. We made it through all five of our tax planning moves for 2021, and just to reiterate, you really have to be proactive in this planning. Many of the strategies we outlined, you can’t wait until April 15th to get this stuff done. You’ve got to do it in advance.
We’d really encourage you to partner with your financial planner, partner with your CPA, start looking at this stuff now before the end of the year, get it in place, and we think you’ll be really pleased with the outcome after kicking the tires on a handful of these tax planning strategies in 2021.
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