“I wish I knew this earlier” – I heard this line from dozens of my clients. Why not learn from other people’s mistakes? In this post, I will list 10 most useful habits that go a long way to prevent problems and save you money.
1. Open a business account and start strict separation of business and personal money.
This is really simple, yet almost nobody does it. If it’s for business – pay from business account or charge on a business credit card. If it’s personal – use personal. If it’s mixed, such as gas for your car and cell phone bill – stick with personal money. Never pay for business expenses from personal account and, above all, never pay for anything personal out of a business account.
2. Avoid cash.
Yes, cash is convenient, but it is also conveniently forgotten during the tax time. There is no receipt, no recollection, no proof. The contractor can claim the next morning that you did not pay him, and you have no proof. (Been there, done that.) And if the IRS knocks on your door, they will want to see your proof, as well. If you must pay in cash, then at least get a signed receipt, even if it is hand-written and not looking official. Carry a set of 3×5 index cards in your truck for this very purpose.
3. Start a bookkeeping system for all expenses.
Throwing whatever receipts you find on the floor of your truck into a paper grocery bag is NOT a bookkeeping system. I know recording things is a pain, but not having any records for tax preparation or, worse, for an IRS audit is a far bigger pain. The old excuse was that you do not carry your computer with you. But now you do! Get some expense tracking app for your phone today. Here are some suggestions to start your search, and there are countless other options. One tip: stay away from those free one-clever-guy-from-Argentina-wrote-this apps. You need something that will be around and supported for years to come.
4. Use an app for creating mileage log.
The IRS loves auditing mileage logs. Why? Because nobody keeps them. There is no good excuse for that sloppiness nowadays, because of the smart phones. Some of the expense tracking applications create a mileage log, too. In addition, there are many apps dedicated to just mileage tracking, both for Android phones and for iPhones.
5. Scan all receipts after marking project and people involved.
You did know that the IRS will want to see your receipts, right? And you did notice that receipts tend to disappear with time? And that those you did manage to keep become useless due to fading? Then scan them! Once again, technology makes this task simple and affordable, with some portable scanners going for under $100! Here is one of the online reviews of scanners, and you can google up many more.
Please notice a very important tip in my sub-header: before scanning your receipt, hand-write which project/property it was for. If this is a restaurant receipt, write on it names of the people you invited and the business purpose of your meal. You will thank me later, if you ever have to defend yourself against an IRS audit.
6. Keep dated photographs of all projects and events.
I’m sure you can figure out how this habit can help you in your real estate business: jogging your memory when negotiating the deal; keeping tabs on contractors; supporting insurance claims, and so much more. One extra benefit not to take for granted: dated photographs are excellent documentation for the IRS when you need to prove that the property was available for rent at a certain date, that an extensive damage happened to it, that you really did actively search for new properties, that you did spend numerous hours personally involved in the rehab.
Do not forget a critical part of this photo-documentation: save the electronic date on each picture.
7. Get SSNs from all contractors – before they start.
If you want to get the cheapest labor, chances are these folks do not have valid tax IDs anyway. You’ve heard that your “savings” can backfire on you: you may be responsible if they get injured on the job, and the IRS may hit you with taxes on their labor plus penalties. Not to mention the shoddy work and petty theft often plaguing day labor projects.
The more experienced investors prefer to save the trouble and hire clean labor. If you pay any of the contractors $600 or more during the year, you will need to file IRS Form 1099-MISC the following spring, and that form needs the guy’s SSN and address. It is too late to ask for this data when the job is finished. You need to ask before the job started. Skip this step – and be ready for some unpleasant conversations with the IRS, resulting in writing them big and painful checks. In case you did not know, you can easily verify the contractor’s SSN online.
8. Verify HUD-1 statements.
Why? Because they are full of costly mistakes. Even the largest title companies make regular major errors. The smaller the company and the newer the closing officer – the more it can cost you. Worse, the damage is hidden until you show your closing statement to an experienced accountant. To be more exact, to an accountant who actually cares. Yes, we exist.
Here are a few sample mistakes that we found on our clients’ HUD-1s:
- client charged for an insurance policy that he already paid for outside the closing
- client not given credit for the earnest money he paid, paying it twice
- client not getting property tax credit for the seller’s part of the year
- client double-charged by his hard money lender on both ends of the deal
- client charged for the delinquent property taxes that are the seller’s responsibility
Got the idea?
9. Verify interest.
Yes, mortgage companies make mistakes, too. However, their mistakes are not as staggering as some of the errors we have seen from private lenders and hard money lenders. Carefully examine what you were charged on the front end, what you were charged at payoff, and what you paid in between. Crunch some numbers. Compare your figures to the contract you signed. If the difference is substantial, ask questions.
I can’t tell you how many clients reported that the lender said oops once confronted with the client’s own calculation. But if you do not check – they will keep your money, and no thank you card will be sent. Not very good at these numbers? We will be happy to help.
10. Set aside 1/3 of profit from each deal for taxes.
Yes, I know it hurts. If it makes you feel any better, I must set aside 1/3 of what you pay me – for my own taxes. But the alternative hurts more. The alternative is to spend or reinvest the money once the deal is done, and “figure it out later.” Yeah, right. I will figure it out for you when I do your tax return, and you will gasp for air. Then you start looking for a payment plan, while the new deals create new taxes.
Guys, this is a very serious trap – please do not take it lightly. I do know an excellent bankruptcy attorney, and unfortunately I have given his business cards to quite a few of my clients. I have some of his cards left. Do you need one? You will need it, if you do not start setting aside 1/3 of your profits for Uncle Sam.