The National Association of Realtors states that 87% of Realtors are independent contractors. While starting as a real estate agent may feel like an uphill battle, especially without a vast network or track record, overcoming these challenges can eventually pave the way to earning a substantial income. However, not being well-informed about how taxes work for the self-employed and eligible business expenses can greatly diminish what you're left with, as the IRS always expects its share of the income.
In this article we dive into the tax strategies and deductions tailored for real estate agents, rather than covering the standard tax deductions available to everyone. First, it's crucial to grasp the two types of taxes that a self-employed real estate agent is responsible for. Then, we can dive into strategies for minimizing your potential tax liabilities.
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Federal Income Tax
Federal income tax is calculated based on your total income. If you file jointly with a spouse, it's determined by your combined income. This tax system is progressive, meaning that the more you earn, the higher the percentage the government will take.
The initial dollars you earn at the start of the year are taxed at a lower rate. As your income increases and moves into higher tax brackets, subsequent earnings are taxed at progressively higher rates. For example, the highest federal income tax rate is currently 37%. However, due to the progressive nature of the brackets, even if your income reaches the level of the 37% bracket, you won't pay 37% tax on all of your income. The income earned in the lower brackets is still taxed at those bracket rates.
Self-Employment Tax
The self-employment tax consists of two components—the Social Security tax and the Medicare tax. When you work for an employer, payroll taxes for these programs are split between you and your employer. However, when self-employed, you pay the full tax yourself via the self-employment tax.
So as a Realtor, you need to pay this self-employment tax to support federal entitlement programs, just as W-2 employees and employers do through regular payroll taxes. Fortunately, some strategies may help reduce your tax responsibility.
Determine your self-employment tax liability by reading our self-employment guide and using our easy online calculator.
Reducing Your Tax Liability by Reducing Your Taxable Income
One alluring aspect of being a real estate agent is the freedom and flexibility it offers. You are in charge of structuring your days and ultimately how much money you earn. However, with this liberty also comes responsibility. Without an employer footing the bill, you must cover the various costs required to run your real estate business yourself. But there is an upside - you can deduct eligible business expenses from your earnings before calculating taxes. So you only pay income tax on your actual profit left over after covering those expenses. In exchange for handling your own expenses, you enjoy deductions that help minimize taxes on your hard-earned income.
10 common tax deductible business expenses for Realtors:
Commissions or wages paid: As a real estate agent, you often pay commissions to others for bringing in sales leads or hire assistants to handle non-sales activities. You can track these payments by collecting receipts or invoices and maintaining a spreadsheet.
Home office expenses: If you work from home instead of renting separate office space and use a portion of your home exclusively for your real estate business, that portion can be deducted as a business expense. For example, if 10% of the home is an office, 10% of expenses like rent/mortgage and utilities can be deducted. So while you still pay your whole mortgage and utilities bills, part of it counts as a business cost rather than personal.
Office Expenses: Think about all the office supplies you buy in a year, such as paper, ink, staplers, printers, and postage. There are numerous excellent and free expense-tracking apps available for download to help you keep track of your office and business expenses. By the end of the year, you might be surprised to see how much you've actually spent on those seemingly small $15 and $20 trips to the office store.
Rent: Rent outside of your home paid for office space, storage, or any other business-related use is fully deductible.
Auto mileage: driving between properties for showings, meetings, and inspections can be tracked on many mileage-tracking apps. In 2024 the standard mileage rate is $.67 per mile which really adds up for those who travel thousands of miles a year for work.
Advertising: Advertising is one of the major expenses for many Realtors, encompassing online ads, brochures, signs, and more. Tracking this is not only smart for taxes, but will provide insights into what is working and what advertising expense should be eliminated.
Professional services: If you make a habit of covering the costs for photos, appraisals, home inspections, staging, etc. you should keep a good record of all of these expenses. All of these expenses will reduce your taxable net income when filing taxes.
50% of business meal: Have you ever paid for a meal at a restaurant while meeting with a prospect or client? Remember to track these expenses because you can deduct 50% of the meal cost as a business expense. However, the tax cuts during the Trump era have restricted entertainment expenses, so activities like golf outings or sporting events are no longer deductible.
Education, CE, and licensing: Consider all the courses you took to obtain your license and the ongoing continuing education needed to keep it. It's important to track the costs of both the courses and the actual license.
Professional dues: Just being able to call yourself a Realtor costs money and many agents decide to join networking groups and other professional associations. All of these membership dues can be utilized to offset your taxable income.
Health Insurance Deduction
As a self-employed Realtor, you may be eligible to deduct premiums you pay for health, dental, and qualifying long-term care insurance for yourself, your spouse, and dependents. This deduction lowers your adjusted gross income and thus lowers the amount of taxes you are liable for. Having the ability to deduct health insurance premiums can make a substantial difference as health insurance is unfortunately expensive for many people.
Eligibility is determined month-by-month based on whether you or your spouse were eligible for an employer-subsidized health plan. For instance, if you became a real estate agent in July and didn't have health care coverage provided by an employer or your spouse's employer for the latter half of the year, you can deduct premiums for six months.
However, the deduction cannot exceed the income you earned as a self-employed individual. So if you operated at a loss, generating no earned income, then you cannot claim the deduction. The key is that the deduction is limited by both eligibility and earned income tests.
Qualifying as a Real Estate Professional
Over time, many successful Realtors may acquire one or more rental properties. As a full-time real estate agent, you're uniquely positioned to meet the time commitment and income requirements needed to reclassify passive losses as active losses.
Although many properties generate positive cash flow, the "paper loss" resulting from depreciation can transform the profit into a loss on a tax return. This loss is typically categorized as passive and cannot offset active or ordinary income, and can only be carried forward to future years for non-real estate professionals. However, real estate professionals (REPs) can categorize these losses as active, allowing the losses to offset ordinary income earned from commissions and other sources.
Individuals who don't commit at least 750 hours and earn over half their income from real estate activities wouldn't qualify as a REP. This creates a distinct advantage and tax-saving opportunity for Realtors who decide to invest in real estate.
Reducing Your Self-Employment Tax Through an S-Corp
The final topic we're going to cover is more of a strategy than a deduction. As mentioned the self-employment tax can take a big bite out of your net income. By reclassifying yourself as an S-Corporation you could potentially save yourself thousands in self-employment taxes.
Under this structure, the realtor can pay themselves a reasonable salary, which is subject to employment taxes, including Social Security and Medicare. By setting a salary at a reasonable level based on industry standards and the realtor's role, they fulfill their employment tax obligations while minimizing exposure to self-employment taxes on the entire income.
Distributions, on the other hand, are not subject to employment taxes. This allows the realtor to take a portion of their earnings as distributions, providing a tax advantage compared to the sole proprietorship or independent contractor status. However, it's crucial to maintain a balance and ensure that the salary is reasonable to avoid scrutiny from tax authorities. You can read more about this strategy and use our S-Corp savings calculator by clicking here.
Wrapping Up: Real Estate Agent Tax Deductions
In conclusion, understanding business expense deductions and implementing effective tax strategies can significantly impact the amount you're left with after accounting for taxes. By maximizing deductible expenses that were mentioned in this article you can reduce your taxable income and increase your bottom line. Moreover, strategic tax planning, such as converting to an S Corporation, can further optimize tax efficiency while maintaining flexibility and autonomy. At UnitedTax.AI, we specialize in navigating the complexities of real estate tax obligations. Contact us today to learn how we can support your financial goals and alleviate the burden of tax compliance.
