EXPLAINED: how much can a real estate CPA save me?

[Michael Plaks]

This is a follow-up to my last year post where I discussed CPA charges: https://www.biggerpockets.com/...

The #1 question we receive from investors who inquire with my firm about our tax services is "How much can you save me?" The thinking goes like this: if I'm paying them $3k, I should get back $10k or more. If I'm paying them $10k, I should get back at least $30k. Otherwise, my ROI (return on investment) does not make business sense.

It's a reasonable approach. When it comes to investments. However, it totally does not work when applied to professional services like tax services. There is NO measurable ROI on tax services. Let me explain.

1. Savings... but compared to what?

Have you ever seen a price tag on a piece of jewelry anywhere or on anything at Marshall's that does not indicate some 50% "savings"? Against what? Aha, against MSRP. Anybody charges or pays MSRP? Nobody I know. These are imaginary savings against imaginary prices. In other words, you ARE paying normal prices, with no real savings. And we will save (pun intended) discussing the most cherished American holiday, Black Friday, for another day.

So, if we're talking about savings delivered by a CPA, what numbers do we look at? We need to have one number that is "without this awesome CPA" and then the second number which is "after I hired her." 

Let's say you DIY-ed your tax return or got it prepared at one of those gas station places where you can get a haircut and a manicure while they're doing your taxes, sometimes by the very same person. Then a CPA looks it over and points out that there was no depreciation taken. The CPA adds depreciation, and your taxes go down by $2k. Did you save money? Sure, but compared to what? Compared to an incompetent work done previously. News flash: a job done correctly always beats a job screwed up previously. 

Can I claim that I saved my clients money by pointing out that they are allowed to deduct driving, marketing and education expenses? Of that they can contribute to retirement accounts? If I am a salesman, then definitely yes. Otherwise, I merely educated my clients in some fundamentals of taxation.

So, if you don't know the basics, then any accountant will deliver "magic" results to you. In this case, you're paying mostly for education.

2. But I can see how large my refund is!

Uhm, no. It tells you nothing about your tax burden.

Let's review the concept of an IRS refund. Refund is your own money that you previously overpaid - like a rebate. You cannot get a rebate if you did not pre-pay anything. In order to get a rebate, you must pay first, and pay more then you should have. Then, after the hassle of applying for this rebate, you get a portion of your own money back. You're overcharged first and reimbursed later. How is that a freebie, again?

Another example. You buy $15 worth of groceries, which is roughly a carton of eggs in 2023 prices. You give the cashier a $20 bill (if you can find a store that still employs actual cashiers). You get back $5. Here, this is your "refund" - are you happy? But wait, there's more! I can generate you a much bigger refund! Easy! Give the cashier $100 instead of $20. Any idea how much you will get back? I'm an accountant, trust my numbers: you will get a whooping $85 in change! (unless the cashier was educated under Common Core math.) A $85 refund instead of a $5 refund! Awesome, what a day to be alive!

So, don't be fooled by the size of your IRS refund. It does not indicate how much you saved on taxes. It merely indicates how much you previously overpaid the IRS, most likely via your paycheck withholdings. They first took too much out of your paychecks, and now they "gift" it back to you. How sweet of them.

3. But I can easily compare my IRS refund this year to my last year's refund!

You sure can. And it is a completely meaningless comparison, just like the refund itself.

First, your salary has likely changed. The amount of taxes taken out of your paychecks has possibly changed. Even if you somehow had absolutely identical paychecks, tax calculations change from year to year - sometimes slightly and sometimes significantly. 

More importantly, your salary is not the only thing that is factored into tax calculations. There're investments, personal deductions, adjustments, credits - all of which change from year to year. You never have a clean "assuming nothing changed" comparison between two years. 

And this is before we consider your real estate! Your rents, mortgage interest, property taxes, insurance premiums, utilities, maintenance, repairs - all of that changes every year. Plus, your driving, marketing, education and all other overhead expenses. And your taxes will go up and down accordingly, simply because your income and expenses vary.

It's like trying to compare your last week's grocery bill to this week's. The only way it will be an apples-to-apples (or bacon-to-bacon, whatever you shop) comparison is if you have an absolutely identical grocery shopping list week after week. In this case, I feel sorry for you, and not because of taxes.

4. I don't need to compare! My CPA did it for me and printed a neat graph for me. Now I know.

No, you don't know. Whenever you're presented with a number that refers to "before this strategy", ask yourself (and your presenter) - why would I ever be without this strategy? Is it some advanced strategy that a run-of-the-mill accountant would not know about? Example: cost segregation. Or is it just a basic concept that only a totally incompetent clown (of whom there's no shortage) would miss? Example: straight depreciation. 

Because comparing a competent job to a screw-up is an easy sell. If you believe in software-generated graphs showing you "before and after" - then I have a warehouse full of weight loss supplements and anti-aging creams and house-flipping-millionaire courses to sell to you. Each one comes with a full-color photos of "before" and "after."  You're most welcome.

5. So if I cannot measure my savings - then what am I paying for?

May I ask you - what are you paying for when you get your teeth cleaned (assuming you still have them)? What are you paying for when you have your car oil changed? What are you paying for when your get your hair done, carpet washed, clothes dry cleaned and so on? All of these tasks could, at least in theory, be DIY-ed. None of them result in direct measurable savings. Yet you're paying other people to do them.

What are you paying for then? Mostly for intangibles. Preventing future problems. Peace of mind from knowing it's done correctly. Avoiding the hassle of learning to do it yourself. Feeling taken care of. Freeing up your time. 

This is exactly how you should look at hiring a tax professional. You absolutely can do it yourself - if you invest enough time and effort in learning what we learned over years. When a quality tax professional prepares your tax return, a lower tax bill could be one of the results, but it's not guaranteed. This is what we do deliver:

- tax return that is compliant with the IRS requirements

- tax return that includes all your income and all your legitimate expenses

- tax return that presents your business in the most beneficial way

- tax return that minimizes your IRS audit exposure (FYI: nobody can make a tax return completely "audit-proof")

And, if your taxes are lower as a result, it's the icing on the cake. Not the cake.

6. Wait, are you saying that CPAs cannot save me any money?

Absolutely NOT saying this!

First, if you, like most investors, do not have a solid understanding of real estate taxation, we will educate you and make sure you're not leaving money on the table by overlooking existing deductions and credits. At least half of the tax returns that we are asked to review contain major mistakes and missed opportunities of basic variety: missing or incorrect depreciation, suspended losses not carried from year to year, K1 losses not applied to personal taxes, no deduction for business driving, and so on. These mistakes can be very costly. 

Second, in some situations we can, in fact, dramatically reduce your current taxes either by after-the-fact tax strategies (for example, cost segregation and QOZ fund rollovers) or by applying advanced analysis to your specific situation (for example, Real Estate Professional status, STR material participation "loophole", past depreciation corrections, etc.). Now THESE are the strategies that call for a real estate expert and are not familiar to many "regular" CPAs.

Third, most of the major tax savings that we can deliver to you are in proactive tax planning. In other words, tax strategies that produce you future as opposed to immediate savings. When you start talking about 1031 exchanges, real estate investments within self-directed retirement accounts and other high-end tax planning strategies - that's where the meat is! (For vegetarian investors, substitute tofu.)  Absolutely requires a real estate expert accountant.

7. Aha, so there ARE tax saving strategies, after all?

Definitely. The question is - is there one FOR YOU?

The important thing to understand is that we cannot promise you that there is a strategy that helps you, and helps you now. For example, if you and you spouse both had a full-time W2 job the entire year, you won't qualify for the highly desirable REP status, and no accountant can break you out of this predicament. Yes, I can print you a pretty graph showing you the potential benefits of REPS, but you won't be able to grab them. Sorry.

Also, many strategies are one-hit miracles. Cost segregation is a great example. If you can benefit from it (and not everybody can!) - you will get a huge tax relief in one year. In all future years, not only you will no longer have the benefit of cost segregation for this same property, but you will have less depreciation and more taxes! That is, unless you buy another property and apply cost segregation to this new property.

If we saved you $10k (or $100k) in taxes last year, this year we may be unable to repeat the magic. It does not mean we stopped catching mice. It means your situation has changed, and there're no new opportunities to harvest.

Conclusion.

Do hire competent tax accountants specializing in real estate.

Do NOT evaluate such hire on an ROI basis; direct immediate savings are not guaranteed.