Real estate agents and brokers face a significant financial planning challenge before the sale of their first real estate parcel. Realtors often work with agencies or brokerage firms, and as such their names are publicly tied with a company. However, they’re generally considered independent contractors and receive Form 1099-NEC reporting their gross commissions for the tax year. It’s up to them to consider the tax responsibilities and implications of their income and track expenses related to their real estate activities.
Agents and brokers must consider their real estate activities as a business entity, separate from their personal financial activities. This leads to confusion about entity structure and tax deductions. We’ve addressed some frequently asked questions we hear from prospective or new real estate agents about these topics.
Q: What business entity structure should I use when establishing myself as a real estate agent?
A: Since real estate agents are independent contractors, they are treated as both the employee and employer for tax purposes. The most common ways to organize your realtor activity are as a sole proprietor, limited liability company (LLC) or S-corporation. Some states mandate that a professional limited liability company (PLLC) is formed in lieu of the LLC. Choosing to operate your real estate activity as a sole proprietor, LLC or S corporation is primarily a legal decision that should be discussed with an attorney.
Sole proprietorships and single-member LLCs (one owner) report activity on Schedule C of Form 1040. Net Schedule C income is subject to federal income tax at the standard rates (up to 37% for 2020). In addition, Schedule C income is subject to self-employment tax of 15.3%.
Q: Is there any way to reduce or avoid the self-employment tax?
A: An LLC can make an election to be taxed as a S corporation by filing Form 2553 with the IRS. This is a useful tax planning tool to help mitigate a portion of the 15.3% self-employment tax. An S corporation reports the 1099-NEC income and related expenses on a separately filed tax return. It’s considered a flow-through entity; the net income generated by the S-corporation is reported on Form K-1 to the owner. (In other words, it is ultimately taxed at the individual level.)
The IRS requires an S-corporation to pay the owner a “reasonable compensation” as taxable wages. Wages are subject to payroll taxes which equate to 15.3%. The net income of the S-corporation after deducting the wages is, however, not subject to the 15.3% self-employment tax. There is an incremental cost to becoming an S-corporation including additional income tax and payroll tax filing requirements. Realtors should take all facts into consideration prior to making a decision.
Deductions for Real Estate Agents & Brokers
Plenty of commonly used deductions available to help offset the income reported on the 1099-NEC. These deductions can be utilized regardless of your entity structure.
Q: I drive all the time for work. Can I deduct expenses related to the use of my personal vehicle?
A: In many cases, yes. In fact, the deduction for business use of a vehicle is likely the most common tax deduction taken by real estate agents and related professionals. Self-employed individuals are eligible for a deduction of 56 cents per business mile driven (for 2021) or the actual expenses used to maintain the vehicle (fuel, repairs, etc.) prorated for business vs. personal use.
Administratively, tracking mileage is much easier than actual expenses; smartphone apps are available to streamline the process. Each day, the IRS mandates removal of the normal commute from your daily mileage, which is the mileage to and from your office or normal place of work. Depreciation deductions, which take a portion of the vehicle’s costs basis as a deduction over the depreciable life, are available with certain limits imposed for vehicles owned in the name of the sole proprietor, LLC or S corporation.
Q: How do I make deductions for use of my home office?
A: A deduction is available if you use an office in your residence as your primary place for business. (This residence can be rented or owned.) Like the vehicle deductions, both a simplified method and an actual expense method are available. The simplified method simply takes a standard deduction ($5 for 2021) times the square footage of the office space. The actual expense method has to be prorated for amount of the home’s total square footage occupied by the office. Remember, the office has to be exclusively used for business, and the taxpayer cannot have dedicated office space available elsewhere.
Q: I’m still meeting clients (safely!) for lunch or dinner. Can I deduct these meals?
A: Yes! You can deduct meals eaten with clients or other professionals. In fact, this deduction received a significant boost for 2021 and 2022. For 2020, any meals paid by the taxpayer during which business was conducted is 50% deductible for tax purposes. The Consolidated Appropriations Act increased this deduction to 100% for 2021 and 2022 as long as business was conducted during the meal and the meal was acquired from a restaurant.
Q: I pay for my own health insurance. Do I get a tax break on that?
A: Self-employed health insurance premiums are generally 100% deductible for tax purposes. A sole proprietor or LLC member must have a net self-employment income to benefit from the deduction. An S corporation must include health insurance premiums paid on behalf of the owner in taxable wages to benefit from the deduction. Premiums paid for coverage for both you and your family qualify for the deduction. If you’re covered under another employer’s or a spouse’s cafeteria plan, however, you’re not eligible for this deduction.
Q: What else can I deduct as an independent contractor?
A: Retirement planning can also generate tax deductions, with a number of retirement vehicles available for self-employed taxpayers. These plans are tailored to your individual cash flow and goals, so it’s best to meet with your financial advisor and CPA to outline the options available. Other common deductions for real estate agents include expenses for continuing education, licenses, gifts (subject to limitation), advertising, and more.
When considering business entity choices and tax strategies, it’s best to consult with a real estate CPA. They’ll have the latest on structures and deductions for real estate agents and other industry professionals.
All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.