Real estate professionals take a lot of training and pass a really tough exam to earn a license to conduct business. Buyers and sellers of real estate are depending on their knowledgeable agent or broker to locate properties, bring the parties together, and navigate transactions to the settlement table.
Unfortunately, all that training and exam-taking doesn’t cover the special IRS tax rules that real estate professionals need to know and understand. Real estate professionals who don’t know the rules could end up getting an unwelcome tax notice about underpaying or incorrect filing.
Real estate professionals can avoid tax headaches by knowing about and understanding these three areas:
- Business Type for Tax Purposes
Real estate professionals operate their business as a sole proprietorship, unless the she or he forms a partnership or incorporates. The IRS considers licensed real estate professional as statutory nonemployees and treated as self-employed. This is because substantially all payments for their services are directly related to sales or other output, rather than to the number of hours worked. Real estate services are often performed under a written service contract providing that they will not be treated as employees.
- Tax Responsibilities
Real estate professionals are individually responsible for filing and paying all taxes, including federal, state, and local income, as applicable. Business income and expenses are reported on Schedule C, “Profit or Loss from Business,” and filed with the individual income tax return. Net business profits are also subject to the employer and employee portions of the Medicare and Social Security taxes (i.e., FICA), totaling 15.3% of net profit. FICA is paid to the IRS with the individual business owner’s income tax return.
- Deduction for Business Expenses
Expenses incurred to run a business as a sole proprietorship are deductible. The IRS does not publish an exhaustive list of eligible business deductions. The rules state that the business can deduct expenses that are “reasonable and customary” for that business. Common deductible expenses for real estate professionals include marketing, education, business licenses, and payroll taxes. Keep track of business expenses throughout the year; they really add up and reduce your taxable income.
Special IRS tax rules that real estate professionals need to know and understand aren’t included in the licensing test materials. Don’t know the rules? Consult www.irs.gov or with a qualified tax professional. You’ll be very glad that you did.