Contractors and Taxes (two topics for the price of one)

[Vladimir K.]

Hi All, I'm getting close to pull the trigger on a cash deal not to far from me and, due to many years of reading horror stories, want to be prepared as best as I can. So, I have the following questions:

1. 1099 - I plan on having my attorney draft an agreement that would work for my benefit, including firing a contractor if needed. I also understand that I'll need a 1099 for each sub-contractor or on 1099 for GC if I hire a GC.

If a contractor does not give me a 1099 tax info, am I still able to write off the expense off my taxes?

2. What happens if a contractor does a poor job or walks off the job site. I presume the agreement would need to cover this, but what steps have you taken to make sure that does not happen?

3. What is the maximum amount you pay upfront (for labor) before the job starts? I presume it's not unreasonable to pay 100% for materials, but not sure about the reasonable labor fees. I'm sure it's a good idea to discuss this during the estimates.

4. What is a good estimate for tax liabilities? I.e. if I make a profit of 30K (as an example), should I budged 10K for income taxes? I'm in a 25% marginal income tax bracket currently.

Thanks.

[J Scott]

1. What you want is a W9 form. This is the form the contractor fills out with all his company/tax information, allowing you to send 1099s at the end of the year. You can download the form online (do a search for "W9"). If a contractor doesn't fill out this form, you still need to provide a 1099, which can be more difficult because you may not have a mailing address or tax ID. That said, I believe you can still take a write-off, but you open yourself up to additional scrutiny from the IRS, especially if you can't successfully file a 1099. Good rule of thumb -- no-one on your jobsite gets paid until they give you a W9.

2. You can't really stop a contractor from doing a poor job or walking off, but what you can do is to ensure that your contract calls out specifically when and how much the contractor gets paid at various point in the project. For example, one line item may say, "Contractor is to receive $3000 upon completion of interior paint." You won't pay that until that portion of the work is completed to your satisfaction, so there is no risk that you will lose money on that task. Always ensure that the contractor has done more (or equal) work than he has gotten paid for; that way, if he walks off the job, you haven't lost any money (just some time).

3. For a new rehabber using contractors they don't have a relationship with, I would recommend paying nothing upfront. Even if that means making payments every evening for work completed that day, I wouldn't make a payment prior to work being done. Once you have a relationship with your contractors and are comfortable with the process, there's no reason you can't pay a contractor some money upfront (I sometimes pay 50% or more upfront if the circumstances warrant it), but until you gain a good bit of experience, I don't recommend upfront labor payments.

4. I don't want to give tax advice, but would recommend assessing your tax situation after each lump sum of income/profit you generate. There are plenty of online worksheets you can use to estimate your tax liability at various points in the year, and then just make payments that reflect your current liability. To be safe, if you're not good at money management, pay a little extra to account for the fact that you may jump into a higher bracket later in the year.

And read these:

http://www.biggerpockets.com/renewsblog/2010/02/17/whats-in-a-contract-contractors-rehabbing-real-estate/

http://www.biggerpockets.com/renewsblog/2010/04/07/the-paper-trail-every-rehabber-should-follow/

http://www.biggerpockets.com/renewsblog/2010/05/26/are-you-sure-your-independent-contractors-really-are/