Real Estate Is Taxing

Anyone with a 1065 Partnership or 1120-S S-Corporation should have bookkeeping in my opinion, but if you don't...this episode is for you. This is your head-start on getting everything together for your tax professional to file your 2024 business tax return.

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Introduction

[00:00:00] Welcome to Real Estate is Taxing, where we talk about all things real estate tax, and break down complex concepts into understandable, entertaining tax topics. My name is Natalie Kolodij, I'm your host, and I am so excited that you've decided to join me.

[00:00:23] Hello. Hello everyone. We have just made it past the first fall extension deadline. Any 10 65 partnerships or 1120-S S corporations were due on September 16th this year. So we've just passed that hurdle. And part of what I realized this year is that there are a lot of people who don't know they've created an entity.

[00:00:49] They're not aware that they have a partnership. I've talked about this before. Or there are people who create the entity, they create a partnership or they create an S corporation, but they don't really know. Or their tax professional didn't give them a good rundown on what the differences are, what is required for filing, and what will be different because you now have this entity.

[00:01:12] So if you are someone who has a partnership or an S corporation, and you do not have formal bookkeeping, you don't have full QuickBooks, you don't have a bookkeeper, then this episode is for you. So I will note if you are using Tessa for your rental properties and you have a partnership, this is not formal bookkeeping.

[00:01:33] It's not a true bookkeeping system or a true double-entry platform. So while Tessa is great for keeping track of a profit and loss, and just keeping track of your income and your expenses for a property, once you move into a separate tax return, once you move into a 10 65 partnership filing, there's more information we need to keep track of, and it doesn't do this very well.

[00:01:57] For today's show, I'm going to talk through some of the differences, like why we need more information for these returns and what information you should start gathering now to help prepare for the upcoming filing for the 2024 tax year.

[00:02:18] So I'm trying to give you a little bit of a head start. It's quarter four, so you have time to either find and hire a good bookkeeper to help you get books before the end of the year or start gathering all of the information I'm going to talk about so that you have a jump on all of the information your accountant is going to need. If you go to a tax professional and they're not asking for all of this information, while they might technically be doing your tax return, they're doing it in the most surface level numbers on forms way possible.

[00:03:00] What kind of talk about that a little bit more. But I recently had a new client who went to a large well-known tax and attorney firm. And last year for their entity return, where they didn't have full books, they just had the client complete an organizer.

[00:03:09] So they just used whatever information he told them—whatever amounts for bank account balances, etc. They did not ask for any of the actual documents to check any of this. And if that's the case, there's close to a 0% chance your return is accurate.

[00:03:27] So let's dive into it. Let's start off with what happens when you create a partnership or an S-corporation.

[00:03:35] The first thing that I want people to consider when they are creating a partnership or creating an S corporation is that this creates a whole new, additional tax return. So there's a whole separate filing. Even though something might not have changed with your business last year, you might've had two rentals and they were on your personal return, and this year you have two rentals and now they're in a partnership, there's a whole additional filing.

[00:04:05] Entities require more information. There's more we have to track, and there's more you have to do. So the first consideration I want you to be aware of if this is going to be your first year with a partnership or an S-corp is that it's going to cost more money if you go somewhere to have your taxes done.

[00:04:21] Now how much more it's going to cost, I can't say for sure because different firms, different locations, and different levels of expertise or specialization are going to impact that pricing. But like with anything, there's going to be higher-end and lower-end and everything in between. The same way you can get a steak at an Applebee's for $8.99, or you can go to a Ruth’s Chris and pay $89, it's across the board.

[00:04:50] The price point I most often see for entity preparation at better tax firms is going to be a minimum of $1,500 to $2,000 per return for just the filing.

[00:05:02] So keep that in mind when you're looking to create an entity or switch over to being a partnership or an S-corp. Kind of pencil in that ballpark number into your mind as an additional cost. And that number tends to surprise people when they have multiple entities. I think because the big picture price point can add up really quickly, and it's not expected.

[00:05:57] If you look at one of the commonly well-known self-prepare software online, you can do your own entity return. It costs $800 for you to do it yourself with their software or $1,750 for you to have one of their quote tax professionals do it for you. If it's going to cost you $800 just to do it yourself, if you're going to a firm and an expert is doing it for less than that, to me, that would be a little bit of a warning.

[00:06:00] I would just be a little cautious there.

[00:06:02] So now you're aware of the additional costs that can come into play for just the filing. What else might you run into? Well, the next consideration is that bookkeeping and tax preparation are typically separate engagements.

[00:06:50] So if you are expecting to give someone a pile of receipts and bank statements and all of that, and have them organize it into categories and make sure everything ties together, and then use that ending information of total costs for all of your different expense categories to then prepare a tax return, that is bookkeeping.

[00:06:50] So if they're starting with raw information that's not organized at all for the whole entire year, that's going to be an additional cost. That would be a whole separate cost. So be aware of that. If you do not have formal bookkeeping, you don't have QuickBooks and a bookkeeper, at the very least you will want to make sure you have the following information together ahead of time for your tax professional, unless you are also intending to pay for bookkeeping.

[00:07:00] If you don't want to do that, you're going to want to listen on because these are the bare minimum of what you should start organizing now.

[00:07:28] The first consideration, which you should always have if you have a business or rentals, is a profit and loss. So no matter what kind of business you should have a profit and loss, if you have rentals, this should be sorted by each property. It will need to note total rents or total income for that property and then a breakdown of all of the expenses by expense category.

[00:07:51] For these categories, you can look at a Schedule E on the 1040 or an 88, 25 on a partnership return, and that will give you a good example for breakdowns.

[00:07:54] In addition to just having a profit and loss, another common question that comes up is repairs versus renovations. When does it get capitalized? You don't have to figure that out. That's what you're paying a tax professional to do. So you can put the total number into your repairs account. You can have that in there, and then when you give it to your tax professional, just make sure they have the details of what that number is composed of.

[00:08:23] The next item is really the big difference that creates a lot of this extra tracking and information needed for a partnership or an S-corp, and that is a balance sheet.

[00:09:00] Your balance sheet is exactly what it sounds like. It has to be in balance, and it's a snapshot of everything at the end of the year. A balance sheet lists your assets, your liabilities, and your equity. And as long as these are all correct, your assets should equal the same amount as your liabilities and your equity.

[00:09:31] This is what makes it very hard to prepare one of these returns, a separate entity tax return, without actual bookkeeping. Because when we are trying to piece this together without formal bookkeeping, I can almost guarantee that that is not going to balance on the first try. Now there are requirements for when an entity has to have a balance sheet. It is my preference and it is my belief that you should always have one because it is that check system.

[00:09:50] It is what proves that this return is in balance. And that it's correct. So it is a good practice to always have your balance sheet, even if you don't technically need it yet. The other reason is because you might cross that threshold to suddenly need at one year where you are required to have it. 

[00:09:50] And with the information on the balance sheet, it's really something that is much easier to track on an ongoing basis. Then to try to [00:10:00] recreate the entire history of in one year. When it is now required to be done. 

[00:10:05] So now that we've covered the big picture items related to these returns, it's going to cost you more. You're going to need to have accurate records and you're going to need the information to create a balance sheet. Let's go into what that information is. What will you need? And what should you start thinking about now and getting information and creating a checklist now. To know you have everything to provide your tax professional with in a few months to do your 2024 tax return. So again, a balance sheet is made up. Of assets, liabilities and equity. Let's start with assets. For your assets. What we are going to need is a snapshot of all the asset amounts as of December 31st. if [00:11:00] you have several different bank accounts for your partnership or your S-Corp, You will need to provide your accountant with the year end bank statements for each of those accounts. 

[00:11:12] They need to know the total amount as of 1231 that you have in any bank account. Now a caveat to this is many bank statements. Do not end on the 31st. So if your December bank statement goes through December 23rd, And then your January bank statement technically has the information from December 24th. On through January 23rd. You will need to give your tax professional December and January. Because they are going to need the information for all of December. 

[00:11:47] That's on the December statement. But then also those few days of transactions that could occur the last week of December, but end up on the January statement. So they need to be able to create [00:12:00] a tied out total. Of the amount that would have been in every bank account of that business as of December 31st. They are also going to need a balance for anything owed to you. 

[00:12:13] So if your company. Loaned someone else, money or sold something on financing, like an installment sale to a new owner that wasn't inventory or goods. Anything of that nature, where there's a loan that your company should be receiving payment of that should be listed as an asset. There might also be some escrow amounts for items that you've basically prepaid in to your rentals. 

[00:12:40] You prepaid to have an amount kind of in an account that your mortgage company is holding, that they will then use to pay your insurance and taxes. You'll need that amount. So your accountant is going to need your year end loan statements for any of your properties. To be able to tie out those amounts. [00:13:00] And then one of the common assets that you'll see on a balance sheet is going to be the real estate. 

[00:13:06] So if you have rentals and they are in a partnership, They hopefully are not in an S corporation. That's a whole nother show. If you have rental properties, the year end balance sheet will list the asset value. So that's going to be their starting basis and increased by any other renovations or things like that. And then it's also decreased by the amount of depreciation that has been taken up to that point. So all of those things tied together should create your year end asset amount for a balance sheet. 

[00:13:42] Moving to the lower half of the balance sheet of Schedule L, you will have your loan balances. It is important to note that the amount on your 1098 is not the year-end balance for your loan. So even if you gave your tax professional a 1098 for your mortgage interest, that will likely not have the correct loan balance.

[00:14:04] Make sure they have a loan statement for each of your mortgages that go to each of your rentals, listing the amount as of December 31st. You will also need your end amounts for any other loans that the company is liable for. So if you loaned your company money and it's documented on a formal note, recording interest and expecting repayment, you have a shareholder loan or something like that—it would be listed as a liability. If you have credit card balances, those are also liabilities.

[00:14:52] Your tax professional will need to know the balance on any and all credit card accounts for that company as of December 31st. They will need that year-end credit card statement. If it straddles two months, where the December statement ends on, say, December 23rd, they will need the December and January credit card statements.

[00:15:27] Also under your liabilities will be security deposits you're holding from your tenants. When you collect a security deposit and hold it until the tenant moves out, it is listed as a liability because you technically owe it back to them. So, the year-end amount of security deposits you have as of December 31st needs to be listed as a liability and provided to your tax professional.

Equity Section

[00:15:41] The final piece of the balance sheet is the equity section. This is arguably the trickiest section because it involves various components that can be confusing. Most of the assets and liabilities are amounts we can accurately confirm. For equity, it ties together different aspects, including net income or net loss for the year, contributions during the year (money put into the business), and reductions by any money taken out of the business.

[00:16:45] Make sure you have a running tally of any money yourself or other partners or shareholders put into the company or took out. This often involves constructive contributions, such as paying for business expenses with personal funds. If you pay for a business expense personally, that needs to be recorded as a contribution to the business.

[00:17:43] If you pay for something related to the business personally, either from your bank account or credit card, or if someone else does this for you, it needs to be recorded as a contribution. Conversely, if you withdraw funds from the business or if the business pays for personal expenses (like personal taxes), that needs to be listed as a distribution.

[00:19:57] If you have withdrawn money from the business or if the business has covered personal expenses, make sure this is recorded accurately. This helps avoid mistakes in the balance sheet.

[00:22:09] If you are flipping houses or developing properties, the handling of your balance sheet will differ. The purchase price, renovations, and holding costs of each property are added to an asset account on the balance sheet. Each property should be listed separately as an asset.

[00:23:06] Once a flip or new build is sold, the inventory amount gets zeroed out on the balance sheet and transferred to "Cost of Goods Sold." Your tax professional will need purchase documents and detailed costs for each property bought and sold during the year.

Final Recommendations

[00:25:10] If you have a partnership or an S corporation, it is highly recommended to have formal bookkeeping. However, if it's not possible right now, gather the following:

[00:29:30] Start preparing now and consider finding a good bookkeeper. This early preparation will help you be ready for tax season and ensure that you can provide all necessary information to your tax professional.