Potholes #6 & #7 - Business Expenses & Taxes

The last two categories of expenses can suck a big chunk of your rehabbing profits. But they can be difficult to plan for and control, because they're not tied to any specific project. Rather, they're both governed by your annual profits and expenses.

When you're rehabbing, all your profits are considered by the I.R.S. to be ordinary income, just the same as a paycheck that you receive from a regular job.  There are two big differences when you get a paycheck though:

1. Somebody else (the company accountant) is responsible for figuring out their income, expenses, profits, and filing all the appropriate paperwork.
2. The company has already taken taxes out of your check for you - the only thing you have to do is file your personal income tax return each year.

But now, you have money coming in and going out through your rehabbing "business". Like it or not, that means you're now a company and have to do the bookkeeping and deal with the I.R.S.

To start with, your profits from rehabbing are considered ordinary income. How much tax you end up paying depends on your business organization structure and your allowable expenses.

There are three basic business structures for tax purposes. You need to have a long, quality discussion with a qualified tax accountant about the pros and cons of each. You can also Google a lot of info for free, but remember that some things are worth what you pay for them.

The three business structures are:

• Sole Proprietor - this means that you're just a regular Joe (or Jane) and everything is taxed at your regular income tax rate, just like the paycheck from your day job.
• "C" Corporation - this is the form used by big companies, who get all the cool tax breaks and end up paying less in taxes.  This probably isn't you, unless you're renovating dozens of properties and employing lots of people.
• "S" Corporation - this is a combination structure that has less accounting and some better treatment of expenses, but still ends up taxing things at your normal tax rate.  That's why you need an accountant to help you figure things out.

In any event, you need to keep track of every dollar that you spend. Is that Starbucks latte you bought this morning a valid business expense? Depends on several things. But, you can't use it as an expense if you don't have a record of it. Even if it's not a deduction, you need to keep track of your cash flow.

A good accountant can give you a list of dozens, or even hundreds, of items that might be usable as tax deductions - based on your own situation. Use that list and keep track of everything that you spend.

Remember, if you're in the 30% tax bracket, every dollar of deductible expenses that you keep track of is thirty cents you don't pay to Uncle Sam.

Speaking of Uncle Sam, here are a couple of inescapable land mines that will blow you up, if you're caught unaware.

1. Self-Employment Taxes - In a normal paycheck, you'll find deductions for unemployment insurance and social security. That's only half of what gets paid, though. Your employer pays the other half. When you're self-employed, you get to pay both halves. To be fair, though, the government used to want people to be self-reliant, and they gave you a break - the self-employment ends up being somewhat less than twice the deduction on your paycheck.
2. Quarterly Estimated Taxes - An individual files their tax return once a year, paying or getting back the difference between what they owe and what was deducted throughout the year.  But, the company actually has to file a form and pay taxes they withheld from your paycheck four times each year. If they don't, the I.R.S. will hit them with huge fines, seize their bank accounts, and even shut down the business. When you're self-employed, you are the business.

Welcome to the big leagues, Slugger.

So there you have it - a whole boatload of reasons to be worried if you're still bound and determined to jump into renovating distressed properties for fun and profit.  Education and due diligence are required if you intend to end up with anything other than an expense education.

I think we'll jump into dealing with contractors next. I could go on about contractors for weeks and months - they're one of those groups I love to hate.

Right now, I'm dealing with a failed water well at my own residence. I'm a week into trying to get a licensed plumber out here to deal with it, and getting tired of hauling in potable water.

Damned plumbers.

But that's a topic for another day.