CPA or tax advisor

A CPA explains how your flip or rental will be taxed, and whether to buy in your own name or through a company. In Arizona, that includes interest from tax lien certificates.

When you need one

• Before you buy: the plan changes the taxes.
• At tax time, for your records and deductions.
• Before you list a rental you want to trade in a 1031 exchange: a qualified intermediary must be in place before the sale closes, and your sale money goes to them, never to you.

How to find one

• Ask for a CPA who works with real estate investors.
• For a 1031 exchange, your CPA or title company can name qualified intermediaries. Check that they’re bonded and insured and keep your money in a separate account.
• In Nevada, the state regulates qualified intermediaries (NRS 645G).
• In California, the state regulates exchange facilitators (Financial Code 51000 and following).

Questions to ask

• How would a flip and a rental be taxed for me, including tax on depreciation when I sell?
• Should I buy in my own name or an LLC?
• What records should I keep?

A CPA or enrolled agent helps you keep rental and flipping taxes legal and organized. The hardest rental rules are the “passive activity” rules. Rental losses usually can’t offset wage income, except for a special allowance of up to $25,000 for owners who actively take part. That allowance shrinks once your modified adjusted gross income passes $100,000 and is gone at $150,000. It’s also smaller, or zero, if you’re married filing separately. Flips are taxed differently (see “Fix-and-flip investor” under “Should you hire one?”). When you sell a rental, the depreciation you took is partly taxed back.

The bigger exception is “real estate professional” status. You must work more than 750 hours a year in real estate businesses, and that must be more than half of all your working hours. You must also “materially participate” in the rentals themselves: real, regular and continuous work, measured by tests listed in IRS Publication 925. The IRS counts each rental separately unless you file an election to treat them as one. The Tax Court regularly rejects claims backed only by estimates or by calendars rebuilt from memory during an audit. If the tax you underpaid is large, the court can add a 20% penalty unless you show reasonable cause. Owners who win usually have good records.

How they’re paid

• Fee structure: the IRS says to avoid preparers who base their fee on a percentage of your refund.

Check before you hire

• Confirm the preparer has a PTIN and signs the return. Check credentials in the IRS directory of preparers.
• Credentials: enrolled agents, CPAs and attorneys have unlimited representation rights before the IRS. A PTIN lets a paid preparer prepare returns, but it doesn’t by itself let that person represent you. If you might face an audit, prefer a CPA, enrolled agent or tax attorney, and ask who will help if your return is questioned.
• Ask about fees up front, and walk away from percentage-of-refund pricing.
• Ask how they will document the $25,000 allowance or real estate professional status, and what logs they need from you.
• Give them complete facts, including your hours and other jobs. Relying on a professional only helps if you gave them all relevant information.
• Ask about experience with rentals, flips and passive-loss rules.

Real stories

Detailed spreadsheets won real estate professional status (2018)

The IRS disallowed the couple’s rental loss. The wife was the only person running the day-to-day work. That included cleaning, repairs, tenant contact, rent collection and hiring contractors. She backed it up with detailed spreadsheets, time-keeping entries and receipts. The Tax Court found she met the real estate professional test and allowed the loss.

Lesson: Good records kept as you go are the strongest proof for a real estate professional claim.

Logs kept at the time saved $200,000-plus yearly losses (2017)

The IRS disallowed real estate losses of about $220,000 to $242,000 a year for 2010 to 2012. It argued the husband’s dental work came first. He produced logs showing more than 1,000 real estate hours a year. He testified credibly that the logs were kept at the time, and witnesses backed him up. The Tax Court found he was a real estate professional.

Lesson: Logs written at the time, not rebuilt later, made the difference in court.

Calendars rebuilt from memory fell apart (2018)

The couple claimed real estate professional status without keeping any log. During the audit they rebuilt calendars from memory. Bank records showed them in London and Dallas on days the calendars said they were working on the properties. The court rejected the claim and applied a 20% penalty.

Lesson: Don’t claim real estate professional status unless you can back up the hours. A log kept as you go is the strongest proof. A calendar or appointment book can work, but numbers rebuilt from memory during an audit usually fail.

“On-call” time didn’t count; most of loss disallowed (2010)

The owner worked about 1,900 hours at his plant job. He estimated 645 hours on his rentals, with no detailed log. He argued his “on-call” time should count. The Tax Court disagreed, so he could deduct only $9,172 of a $40,490 loss. He also got a negligence penalty because he hadn’t given his CPA his hours.

Lesson: A CPA can’t protect you if you don’t give them the facts, and estimates aren’t records.

Preparer faked rental losses for clients (2024)

A paid preparer in Oneida County, New York filed client returns from 2014 to 2018. The returns claimed false rental losses that cut the clients’ taxes. She was sentenced to three years of probation and ordered to pay $101,636 in restitution to the IRS.

Lesson: A preparer who invents rental losses puts you at risk. Choose credentialed professionals and review what they file.