2021 Year-End Tax Strategies

As the year comes to a close it’s a good idea to review your tax position and determine if you can make any last-minute moves to reduce income tax.

In this article, we’ve broken out year-end strategies for you to consider during the final weeks of December. Note that these strategies should generally be implemented with the guidance of a CPA and this article is not an exhaustive explanatation on how to implement the various strategies.

Real Estate Year-End Tax Strategies

Review the material participation rules for real estate professional status (REPS) and short-term rentals (STRs)

The passive loss rules apply to all “rental activities” unless you qualify as a REP, and any trade or business in which you do not materially participate.

These rules limit your ability to claim losses from your rental real estate against your ordinary income. For example, your W-2 income is considered “non-passive” which means a rental property producing a “passive” loss will not be able to offset your W-2 income.

To use rental losses against your “non-passive” income, you must qualify for an exception to the passive activity loss rules, one of which is qualifying as a REP.

Qualifying as a REP is beyond the scope of this article, though we wrote an extensive 12,000 word free e-book on the topic if you’d like to learn more.

Once you qualify as a REP, you must show that you “materially participate” in the rental activities. We wrote an article back in August on what that means.

Assuming you qualify as a REP and materially participate in your rentals, the losses will be considered “non-passive” and will offset your ordinary income.

STRs can qualify for a special loophole allowing you to skip the REPS tests and focus squarely on material participation to make the losses “non-passive.”

Make sure you and your CPA understand the nuances of REPS and material participation before the end of the year.

Finish your time log for tax filing

In addition to understanding how to materially participate, you must be able to prove that you actually did materially participate. That’s where your time log comes in.

Don’t delay in recording your time in a time log. At a bare minimum, you should use Google Sheets to record every minute you spend on real estate activities.

Your time log needs to show, per entry, the date, amount of time, location of the work, and notes about the work.

Your notes should be detailed too. Entering “responding to emails” on 100s of rows will hurt you in an audit. Specifically what emails were you replying to and what was the context?

A solid time log will help you 3-6 years from now when/if you get audited. This is not an area to skimp out on.

Complete last-minute repairs

Take stock of your rentals by having your property manager walk through them. What do they call out as needing repair?

Decide if you want to make repairs this year or next. If you have high cash flow this year, or you are trying to maximize your rental losses, pay for and complete the repairs before year-end.

This will increase your expenses which will either decrease your net income or increase your net loss.

Invest in a syndication

If you are looking for a way to create large losses quickly, investing in a syndication can be a great option for you. Investing in a syndicate often yields large losses because the syndicate will engage in a cost segregation study that will create a large tax loss thanks to bonus depreciation.

At the end of the year, you’ll have clarity on your tax position. You should know roughly how much income/gain you have from other sources to offset. This allows you to determine how much you should invest in a syndicate.

A very real scenario is wiring $100k to a syndicate and getting an $80k tax loss passed back to you. Even if the syndicate closes on 12/31, the bonus depreciation will still apply to this tax year.

But be careful. The real question is whether or not you can utilize the loss allocated to you. Is that $80k loss passive or non-passive and how does that impact your tax position?

I also feel that I should add a disclaimer that investing in syndicates is risky as you are giving your money to a team of people and you’re hoping they deliver on their promises. Do your own due diligence and don’t skimp.

Business Year-End Tax Strategies

Solo 401k

A solo 401(k) is for self-employed business owners without employees. It allows you to shelter a significant amount of business income.

As an employer, you get to make the employee maximum contribution as well as the employer profit sharing contribution.

The employee contribution is maxed out at $20,500 for 2021. The employer profit sharing contribution can be as high as 25% of business profits.

The total you can contribute to a solo 401k in 2021 is $58,000.

Pre-pay next year’s expenses

If you are struggling to identify ways to knock down this year’s income, and you don’t expect next year’s income to be as high, then consider pre-paying next year’s expenses.

Any expense can be pre-paid. We often see software subscriptions, travel (book flights in advance), and advertising costs pre-paid.

The benefit is that you increase your expenses this year which reduces your net taxable income and subsequently reduces your tax.

The con is that you won’t incur those expenses next year, since you pre-paid them, unless you pre-pay them again for the following year.

This is a valuable strategy that has its place but can put you on a hamster wheel or pre-paying expenses that is tough to step off of.

Defer income until January

Similar to accelerating expenses as described above, you can also defer income until January. To defer income, wait to send invoices or collections reminders until January 1 or communicate with clients that you want to receive payment in January.

Moving this income into the next year can save you thousands of dollars in taxes while minimally impacting cash flows.

Retroactive S election

If you have been running your business through an LLC this year, take a look at electing S status.

In effect, the S election will make your LLC an S-Corporation which will allow you to avoid FICA taxes (aka self-employement taxes) of 15.3% on your net profits. It’s a significant benefit available to business owners who are subject to self-employment taxes.

To illustrate, assume you net $100,000 in your LLC. You’ll pay FICA taxes of $15,300 before you even factor in your marginal federal and state tax rates.

If instead you net $100,000 in an S-Corporation, you may be able to pay yourself a $60,000 W-2 wage which is still subject to FICA taxes of 15.3%. But the remaining $40,000 in profits avoids FICA taxes and is distributed to you as a cash dividend. The S-Corporation, in this example, saves you $6,120 in taxes.

There are a few caveats:

• For this strategy to work, your LLC must have already been established. If you set up a new LLC today and immediately elect S status, all future income will be sheltered but income you’ve previously earned will not. If your LLC is already established, you can retroactively elect S status up to the establishment date (most of our clients retro-elect to January 1 of the current year).
• You must pay yourself a “reasonable salary” which means that you can’t just elect S-Corporation and pay yourself a W-2 wage of $1. The IRS wants it’s FICA tax from you and will challenge unreasonable wages.
• Expect higher audits of S-Corporations in the future. Due to people not paying themselves a reasonable wage, the IRS will be ramping up audit efforts on S-Corporations starting in 2022.
• Check state tax laws. Some states exact high taxes on S-Corporations and will negate any FICA tax benefit you’ll receive.
• You have to pay for payroll software to facilitate your payroll runs (unless you want to do this manually, which isn’t fun).

Buy a business vehicle

If you need a vehicle (a big IF) for your business, then consider acquiring one at the end of the year. If the vehicle is a “heavy SUV” over 6,000lbs GVWR, the purchase will qualify for Sec. 179 and 100% bonus depreciation up to the purchase price of the vehicle (assuming it’s 100% used for business).

Buying a vehicle at the end of the year can be a great way to lock in tax benefits by reducing net business income.

Other Year-End Tax Strategies

Give to charity

At any point of the year, you can make a donation to a qualified charitable organization and receive a deduction for the donation.

Thanks to the 2020 CARES Act, you can deduct a $300 cash donation ($600 if married filing joint) even if you don’t itemize your deductions.

Sell bad stock (or crypto) investments at a loss

Year-end tax loss harvesting is a must. Analyze your portfolio and determine what positions you hold that are currently showing a loss. If you do not wish to continue to hold those positions, consider selling the positions.

Selling at a loss will provide you with flexibility to sell other positions at a gain. This offsetting effect allows you to restructure your portfolio without incurring tax.

Review withholding and estimated tax payments and prepare a projection

Minimize April surprises by getting a tax projection compelted today. At this point, you know what your income and expenses look like. You also know how much you’ve withheld and any estimated taxes you’ve paid.

Reviewing all of this information and preparing a projected tax return will help you avoid being suprised when your final tax return is prepared. It will also help you get ahead of large tax amounts due – it’s much better to know about an impending bill in December when you have plenty of time to figure out how to pay for it.

Keep an eye on the Biden Tax Plan

The current word is that the Plan will not pass in 2021. Still, there are two weeks left in the year and plenty of time for Congress to whip up a vote. Pay attention to the Senate over the next week or so to see if there’s any movement on the Biden Tax Plan.