Making a payment to someone? Plan ahead

Hi June,

I have a quick question. I own a rental property here in San Francisco and I had a tenant who I paid off to leave the building. I paid her $20,000. I would like to write it off but the tenant refused to fill out the W-9 form. I have her new address but not her social security number. What are my options?

Rusilla


Hello Rusilla,

An overview before I answer: Whatever an indie pays someone in the course of business is a deductible business expense. And, that someone must claim the income regardless of amount received. If any individual is paid $600 or more the indie must file a Form 1099 stating the amount paid to the individual . The Form 1099 is sent to the government and to the individual.

What you are supposed to do before you pay anyone is have him or her complete a Form W-9. This provides you with the person's legal name, address and social security number. All this info is needed when you file a Form 1099.

Rusilla, you didn't do this.

Step #1: The IRS says that if someone refuses to give you the necessary info you should withhold 28% from the payment and send the withheld money it to the feds. In other words you are responsible for withholding and paying the tax of the individual you paid. Of course, since you already paid the vacating tenant that can't be done.

Here's steps 2, 3, 4, and 5.

#2: Send a letter to the tenant with a request for info. Let her know that failure to provide you with the info will cost her a $50 penalty. [Big incentive. Right?] Include a W-9 with your letter.
Keep a copy for your records. IRS suggests that you get some kind of postal receipt acknowledging delivery.

#3: If you get no response, repeat Step #2.

#4: File the Form 1099 with no social security # for the tenant.

#5: You'll get a notice from the IRS about why there's no SS#. You explain and include copies of your letters to the tenant.

You may still use the $20,000 payment as a cost of business. There is no need to forfeit such a cost but you must follow the above procedure.

For all my readers: Learn from Rusilla's error. Get the info upfront.

Best,
June

ALERT! Real Estate Seminars

Hi June..

Stumbled into your site. Great info, but could not locate a question similar to the one I have. I had spent a fortune last year (2006) on real-estate training. I heard from those gurus the line that this is "tax-deductible check with your accountant."

I hear different approaches to deducting those expenses.

As a background, I work a w-2 job in the computer industry. I am developing myself into a real-estate consultant and investor to be done on a part time basis. My wife is also joining me and is preparing to get her real-estate agent license.

I have started an LLC this year. It is Nevada-based. I will be adding my wife to the LLC soon. I have one rental property in Alabama bought in 2007 and am a resident of California.

Back to the deduction of all those expenses -- the approaches that have been suggested are:

A. Use all those education (including travel etc) expenses and add it as a basis for acquiring the rental property and therefore use it as part of the depreciation calculation.

B. The other suggestion is to "loan" the said amount to the LLC I have, since I will be serving the LLC with all that expertise acquired through the education.

C. The other one I found was to take $5K in the 1st year as business start-up expenses and keep the rest for subsequent years.

What are your thoughts and suggestions?

Thanks - Ravi


Hello Ravi,

I am so glad that you stumbled onto my site. I hope it keeps you from some serious stumbles in the future!

Were those "different approaches to deducting ...expenses" that you list presented to you by the butcher, the baker, and the candlestick maker? Certainly not by your tax professional -- right?

You cannot get sound advice unless you

A. Seek out competent professionals.

B. Present your background fully.

C. Ask well thought-out questions.

I would not advise on which real estate to buy because I don't have the expertise. And I don't expect accurate tax advice from realtors or guys selling real estate seminars. My readers should not spend money on such seminars unless they check out the credentials and expertise of the presenters before taking the courses. Note I said, BEFORE.

Based on the info as you present it, it appears that all the advice you got is wrong.

You say you are an LLC but you didn't say which kind of tax entity. Check out my posts about LLCs linked here? If you are a sole proprietorship LLC you cannot loan money to yourself.

You say that you are developing yourself into a real-estate consultant and investor. There are different tax treatments depending on your business relationship to real estate, such as, are you a ...
... Real estate investor
... Rental property owner
... Rental property owner as a real estate professional
... Rental property owner providing services.

Read this post Real Estate Sales & Self-employment Tax to understand the differences.

You said you are "developing" a business, not that you are a business. And so, contrary to what the seminar presenters told you, you cannot deduct as a business expense any education costs that prepare you for a new profession. However, there are various educational tax credits available for all taxpayers.

Nor are the expenses considered start-up costs. I suggest you read More about START-UP COSTS: The expense of checking out a new business .

To any of you considering a business in real estate -- or any other indie venture -- I suggest you start by learning the basics about indie taxes in my book, Self-employed Tax Solutions. It's your first step toward developing an indie business mindset.

Real Estate Sales & Self-employment Tax

Mr. Anonymous, after reading Poor College Student [see comments] asked:

Wow--could the same apply in real estate transactions? I bought 3 properties a few years ago with extra money I had saved, held them relatively short-term and sold them at a profit. Had no clients---just myself making money for myself. This was my only income I had that year.

Accountant classified me as Self Employed, I paid IRS. IRS audited me last year and I assessed substantial additional taxes and penalties as Self Employed on those properties' sales. Was I really not SE, is the IRS wrong, and/or did my accountant unintentionally help me believe I was, therefore possibly misclassifying me in the first place?

Mr. Anonymous maintained his privacy but lost the opportunity to get a good answer from me because I can't get in touch with him to get clarification on his situation. So instead of directly answering his question I'll give you all some info on being self-employed and owning real estate. And, I also hope this will give you some guidance on how to ask a question.

Mr. A said there were "real estate transactions" on "3 properties" held for a "relatively short-term."

Real estate transactions: Hmmm ... could be buy, sell, trade, or exchange.
Three properties: Barren islands off the coast? Residential rentals? Golf courses?
Relatively short-term: Never relative. It's specific. One year or less is short term. More than a year is long term.

With real estate you have three, well sort of three, possible tax treatments:

1. Income from the sale of real estate held as investment property is taxed using capital gain and loss rules.

2. Rent received from rental property results in rental income, which is ordinary income.

If you are a real estate professional then any loss from renting property may have a more advantageous tax treatment.

If you are a real estate dealer, depending on your intent for holding the property -- rental income or investment profit -- it may also be subject to self-employment tax.


3. Rental property with services you provide is self-employed income.

You buy land in Santa Fe. Do nothing with it. Sell it two years later. That was an investment. Just like buying and selling stocks. It is not self-employed income.

Rent that you receive from tenants less rental expenses leaves you with rental income that is taxed as ordinary income. It is not self-employed income unless you provide services such as cleaning, linens, meals, etc. for your tenants. Here's an example:

• Mike Mobile had a sizable piece of land near the lake. He let visitors park their campers there for a fee. He provided no services. The fees he received were rental income not self-employed income subject to S-E tax. Within a few years the spot had become so popular that he added some amenities and raised the rent. He provided things like a laundry facility, fax and phone line hook-ups in the main office, fresh water, etc. Now he’s receiving income as a self-employed.

Creative Auto Expenses

June --

I want to know, if I hire an independent contractor to put my magnetic signs on her car can she deduct the full mileage she drives with the sign on the car? She is an independent contractor and I am paying her to use the space on her car to promote my business. I know I can't deduct the full mileage for promoting myself, but can an independent contractor?

Florida Realtor


You may deduct your costs for the sign and whatever you pay for the service of the independent contractor. But, there is no business deduction for the person who owns the car and has the sign, or even permanent printing, on the car. There is a deduction for the costs of business miles only -- for instance, taking the car to the sign painter to have the work done.

Think about it: If you could deduct all your auto expenses just by placing a sign on your car, well, in this ever-increasing world of self-employeds we'd see a lot of moving billboards on the road.

And, as always, read the book that can simplify your tax and financial life, AND save you money!SELF-EMPLOYED TAX SOLUTIONS .

-- June