As a financial advisor who provides holistic, comprehensive financial planning, I’m often reviewing tax returns and completing tax forecasts. Below are a few costly mistakes and oversights I’ve witnessed throughout the years.
1) Rental property is not being depreciated.It is not a requirement to depreciate rental property. However, a complication comes into play when one decides to sell their property. Whether or not the property was depreciated, the IRS states that there will be depreciation recapture regardless. Depreciation is important to take because it lowers your rental profit on your Schedule E. The lower your reported profit (or higher reported loss) on schedule E, the less taxes you pay. It’s not far-fetched that this technique can save you thousands of dollars on taxes annually, which could really build up over the years.
Here are some tips on rental income, deductions,and record-keeping from the IRS: https://www.irs.gov/businesses/small-businesses-self-employed/tips-on-rental-real-estate-income-deductions-and-recordkeeping
2) Failure to file form 8606 for nondeductible IRA contributions. There are two types of contributions to a traditional IRA: a deductible contribution which lowers your tax liability and a non-deductible contribution which does not lower your tax liability. A nondeductible IRA contribution is made with after-tax dollarsand in most cases, defeats the purpose of an IRA contribution1. It is your responsibility to track what portion of your IRAis funded with deductible contributions and what portion is funded with non-deductible contributions. This tracking is completed on form 8606. If form 8606 is not filed, chances are you will be paying taxes on your contribution when you withdraw those respective funds from your IRA. Hence, you could end up paying taxes twice: once before your funds were deposited into your IRA and again when you withdraw them.
1The potential benefits of a nondeductible IRA contribution are complex and will not be discussed in this article.
3) Record keeping as a 1099 contractor. I find most clients are aware of this, but do not implement good habits. You need to track your business expenses if you are a 1099 contractor. The higher your business expenses, the less your profit, andthe lower you pay in taxes. It can be surprising what types of items can be written off. Because it is not always black and white what can be written off for your business, it’s worth speaking with your accountant to get a better understanding of what qualifies as a business expenses in your specific field. There are several mobile apps or websites that can assist you in tracking your expenses. Although they cost money, many times they pay for themselves several times over.
4) Self Employed with no retirement plan. For people with self-employed income who can afford to contribute to a retirement account, it almost always makes sense to open a SIMPLE IRA or a SOLO 401(K). Typically, people are not aware of these options. These retirement plans work similar to how a 401(K) at a larger company works;they will lower your Adjusted Gross Income (AGI). Speak to your financial advisor to open a retirement plan for yourself if you have self-employment income.