Disclosure: For the purposes of this article, I use the term “Realtor” to describe everyone I work with who is involved in the real estate field. In most but not all cases used as examples my clients are licensed Realtors as well as participants in other real estate activities. Use of the term here in this post is simply a matter of convenience in the discussion of the relevant tax and financial management issues.
This past tax season I saw more tax problems with Realtors than in any other previous year. While our tax administration system was widely described as a “disaster” across the entire federal tax system1 in 2020 and 2021, I observed a greater concentration of problems with my real estate clients than the population overall. I promised my practice advisor that after the end of the tax season I would investigate the issue and offer whatever help I could learn from this exercise to the local Realtor offices. Since the end of the 2020 tax season, this topic has been on my mind. I’ve scheduled mastermind conversations to look at the issue more closely as it evolves.
I typically handle more clients in the real estate field than any other. This stems partly from my former role as a board member on the National Association of the Remodeling Industry when the majority of my clients primarily served as contractors but often rebuild properties for their own account. Today a higher portion of clients describe themselves as “flippers” meaning that they take title to properties while doing remodeling work. Many act in a combined capacity; for example, as sales agent, redeveloper, investor, or “flipper” together in combination. I’ve been a real estate investor myself for 40 years, as was my father before me. I sometimes say that I grew up in the real estate trades and that real estate was primarily responsible for elevating my family from the middle working class to upper working middle class during the years that I was completing my formal education and purchased the first properties for investment, improvement, and resale. For these reasons, I never seemed far from the tax and financial issues of Realtors.
These are some of the widely observed tax issues, along with my comments on the probable cause as well as the steps I am taking to resolve the issues:
Not withholding taxes quarterly. Over 80% of Realtors operate as independent contractors who report and pay their own taxes. Federal law requires independent contractors to make quarterly payments of estimated taxes. Many Realtors are not doing that. As a result, a large tax bill often became an unmanageable debt. and requires further action to negotiate and settle the debt. This single issue, more than any other, was the reason that so many Realtors have tax debt today. While about 1 in 14 Americans has tax debt, I suspect the ratio many be higher this year among Realtors. In response to this concern, I am offering more support to help bring clients into compliance or increasing my fees to account for the extra work stress and risks associated with ongoing independent contractor noncompliance.
Unreasonable tax expectations. While the bulk of income earners in the middle-income population of the United States might generally consider some total tax of about 20 to 25% of their gross income as a unsurprising amount to pay in taxes, many Realtors do not share this position. One Realtor client with over $300,000 gross income had a net tax bill, after assertive tax planning, of $25,000. He was in disbelief. He expected to pay no tax as he had on several earlier years. I pointed out that his overall effective tax rate over a three year period was 6%. He still felt this to be an unreasonable result and still owes the money to federal and state government, despite having the cash resources to make the payments. In response, I am taking more time to engage in coaching discussions separately from accounting and advisory work – about setting reasonable financial expectations for my clients’ real estate businesses.
Not keeping adequate records. Some Realtors believe that they can create records for tax reporting purposes ‘after the fact’. Tax law clearly requires contemporaneous records, especially for business travel and driving expenses. Technology can make recordkeeping easier now than ever in the past, but only if we properly harness its power.
Inadequate professional financial help. Too many Realtors engage with their accountant one season out of the year. Some are accustomed to paying for tax preparation and plan to handle the rest themselves. Some Realtors are terrible bookkeepers. That is not surprising. The executive skills associated with sales and business management success are often not coordinated with the skillset of a bookkeeper. These Realtors can benefit from additional help with these bookkeeping tasks. Some Realtors are surprised to learn that my tax service is evenly spaced throughout the year and that tax preparation cost is the smallest portion of the work. Many are not accustomed to spending greater amount of effort of financial and tax planning and acting.
Unprepared for sudden sharp success. All of my Realtor clients in the Philadelphia/South Jersey area seem to have bucked the trend reported by the National Association of Realtors. Their 2021 Summary Report says “The median gross income of REALTORS® was $43,330 in 2020, a decrease from $49,700 in 2019. REALTORS® with 16 years or more experience had a median gross income of $75,000—down from $86,500 in 2019”. In every Realtor client I served, the 2020 earnings were higher than in 2019. The range of 2020 incomes in the Realtor clients I worked with ranged from twice the national average to over six times that amount. All reported being “very busy” when I checked in throughout the year. Additionally, many had additional income from the sale of real estate or other sources. Often that added hundreds of thousands of dollars income in 2020. These Realtors were unaccustomed and unprepared for the shift in financial consequences of jumping into this higher income level. Some were unaware, for example, of how many favorable tax provisions available to middle income taxpayers phase out and become unhelpful as income climbs.
1 Both the NJCPA and the AICPA have recently issued sharply worded statements criticizing the level of service of the IRS.