How to Set Up a Real Estate Agent Business (Reduce Your Taxes!)
- Hey guys, Toby Mathis here. And today, we're going to talk about structuring a real estate agent business. It can be very specific. Now, if you want to throw in the broker in there too, but really, I'm talking about realtors, the people that are going out and doing all that hard work don't necessarily have a whole bunch of employees working for 'em, but it's really sweat of your brow. So let's jump right on in.
Number one, we got to do a big step back and start talking about the difference between really good behaviors and really bad behaviors when it comes to business and how we operate. Really good behaviors gets you into that top 1% range. By the way, top 1%, according to a study that came out last week, was about $600,000 a year. So if you're making money, whatever you're making, about $600,000 a year gets you into the top 1%. Over a quarter million dollars a year, 250,000, gets you into the top 5%. So it's a lot easier to get into those numbers than you realize.
'Cause a lot of times you think about rich people making millions and millions of dollars. It's very few and far between. It's a large number, but it's a small percentage. That's the easiest way to think about it. I'm going to say that we have the top 5%, and then we have the bottom 80%.
The bottom 80% are people that realistically, they're never going to create a legacy. They're never going to be able to retire comfortably. They're always going to have to work and they're going to require some sort of assistance, either relatives are helping 'em or there's government assistance.
They'll be relying on something like Social Security or something along those lines, right? Or they're going to have to downsize considerably. They're not able to maintain their lifestyle all the way through. And I know that sounds harsh, but that's about right, about 80%.
The biggest difference I see in mindset between that top 5% and the bottom 80%. And by the way, the difference there, those people are gravitating into one or the other. You're usually going either up or you're transitioning back down to the 80%, depending on what your habits are, right? So a lot of it is about what type of habits you develop, what you create. Let me give you guys some mindset stuff. Number one, if you are in that bottom 80%, I'm going to use three words to describe you, right? It's you probably earn money, then you pay taxes, and then you spend it. You probably earn money, you pay your taxes, and then you spend it.
That's typically. Now what a lot of real estate agents do, 'cause they're generally speaking, about 78% of our sole proprietors, which is crazy in my opinion. You know, I always say like there's two types of businesses that you could be, it's either a entity or an entity. You pick one. Well, I want to just be me. No, I'll show you what it looks like.
Here's what it looks like. You ready? You have money come in, and it goes into this weird realm called you. And you say, "Hey, wait a second.
If that's just going to me, what's the problem with that?" Well, what about your business? Your business is in here, your investment is in here, your taxes, and making sure you're paying everything all goes into this little bubble. And it's like a big old gray area, right? Just don't like it. That's what most of the agents I see look like, and they're paying up the nose in taxes. It's going to be real difficult for you to climb into that 1% or 5% doing that. What's going to happen is you're just not going to go anywhere, you're running in circles. You're working really, really hard, but so much of it, typically on average, more than 30%, is going out the back door because it's being hit so hard in taxes, progressive taxes.
If you don't do something smart, they're going to take a huge chunk of your income in the form of tax. It's going to be more than a third of it. Every day, you wake up and you work. Let's say, you work 12 hours. Okay, four of those hours are directly for the government, eight of 'em, you get to keep.
And you're like, "Gosh, I make all this money. Why does it seem like I don't have any?" Because of that, right there. And a big part of it is 'cause you're used to earning money. "Hey, I earn it."
And then you're getting taxed on everything because you don't know how to structure things appropriately to minimize the tax and to avoid the tax. And then you get to spend what's left and this tax is taking such a big chunk out that there's just not a lot left. You're making a million bucks and you're spending a million bucks, and you're still at zero, or you're slowly growing and you're slowly moving up, and you're like, "Gosh, I'm absolutely lighting it on fire. Why does it seem like somebody else who's making less is getting farther ahead than I am?" And it's because the difference is if I'm making a million dollars here and I'm kicking off 350,000 of it in taxes, my net might be 650 versus somebody who may be 20% less than you.
They're only bringing in 800, but they're paying almost no tax because they're structuring themselves in a way that they're in a tax-advantaged way. In real estate, for example, if you're investing in real estate and you're running your business as an appropriate entity, and you're running and you're using things like 401(k)s and defined-benefit plans and putting money aside, it's very easy to cut your tax down to a very minimal amount. And so that's the biggest difference is yes, you're outearning them by 10, 20%, but you're not outkeeping them because they're doing it in a smart way. And I'll show you what a smart way kind of looks like.
So the top 20% and really, the top 5%, and really, that top 2%, the top 1%, they really start nailing this stuff. As they're making money, so they're earning, they realize pretty quickly that you got to spend it in a tax-advantaged way. So they spend next. And the way you spend it is you put a buffer in-between you and that money. And that buffer is almost always going to be some sort of S corporation, LLC taxed as an S corporation, something like that. But you have a business, and so the money is going into that business, and then we have the ability to direct it places.
So for example, let's say, you're making $100 thousand, I could immediately it a bunch of money into a 401(k) and write it off. I can put $19,500 in this year immediately from that and deduct it. It goes straight on in there. I might have some employment taxes, some old-age, death, and survivors, and Medicare, the Social Security taxes. I may have a little bit of that, but I can pretty much jam in there quite a bit of that hundred thousand.
Let's just say that I put $30,000 then I'm going to pay myself, 19,500 goes in there, and then I can put another. If it's 30,000, I could put another 7,500 from the company. So I could put 25% of whatever it pays me. So let's just say that I paid myself out of this business $30,000, and 19,500 goes in as an employee contribution, and another 7,500 goes in. What did I just do? I just wrote off, what is that? $27,000 of the 30,000.
I just got a big fat deduction that's going to save me a lot of money as a result of doing something very, very simple. This is just a 401(k). And I mentioned very specifically paying yourself a salary and I'll explain why. If I do that, magically, when this comes out to me, let's say that I paid some salary, let's say that I paid some expenses, let's say that because I'm running this business, there's something called an accountable plan, and all of a sudden I have additional things that I could write off. Let's just say, for sake of argument, that all my expenses, everything adds up to, I don't know, gets me down to $50,000. So I have the 30 plus I have another 20.
Part of it's going to be that $7,500, part of it's going to be other things. But let's just say that I get myself down, 'cause there's certain things that I can write off. If I have a business that I cannot write off as an individual, for example, I can have an administrative office for the home. There's something called 280A. I'm going to be reimbursing personal use of mileage.
I can reimburse 100% of anything that I have like my equipment, my cell phone, even my data, and all those things become deductible, whereas I can't write them all the way off and I'm limited severely. I can't do 280A, I can't do an administrative office, if I am a sole proprietor. So you're setting up a business. This is generally going to be an S corp or an LLC taxed as an S corp. There's no such thing as an LLC for tax purposes, it's going to be S corp.
So you're setting it up as an LLC in your state, it's a limited liability company, and you're choosing S election, or you're just getting a regular old S, and you're going to run your realtor business through that. Even if your state says, "We will not pay an entity," there's still a way to do it. Actually, you're still able to get it in there.
Just trust me on that, tax lawyer, 25 years. There's actually a revenue procedure and a few other things that address it so long as you're that, you have an employment agreement, and you're letting your brokerage company know. You can get it in there. And when it comes out, the money that comes out to you, guess what? When this happens, and this is an S corp, I'm just going to put that down, S corp, easy peasy, I just eliminated 15.3% of employment taxes.
Believe it or not, distributions out of an S corp of net profit are not subject to old-age, disability, and survivors. They are not subject to Medicare or the hospital insurance. So if you are over here, you are paying on every dollar, 15.3%. You cannot take a salary. You are getting hit with this puppy. Actually, you get a partial deduction.
So the math ends up being 14.1%. But let's just say, we were comparing side by side these two business structures. This one is going to generate you an extra $10,000, give or take, a couple dollars a year in extra cash flow, just because they did that, and that's what the wealthiest people are doing. If you don't get enough put away, you can have a spouse getting this too. So like we could literally get almost all of that hundred thousand.
If we want to, we could get a huge chunk of that into a retirement plan. And all it means is that, hey, it's just going to grow, compound over the years. And when I start taking it out, when I'm 72 and I'm required to start taking it out, I'm going to pay tax then at my then tax rate.
Right now, it's coming out of my highest bracket. So if I'm at a hundred thousand, I might be in the 20 something percent tax bracket, if I have state taxes, and you know, maybe I'm close to 30%. So what is it doing? Every dollar that I save is like saving 30 cents. So if I can get even 20, $30,000 into retirement plan, it's saving me another 10 grand plus I'm saving this other 10 grand. Can you see just on a hundred grand, on a $100 thousand, we're going to be able to save about $20,000 just through this basic little structure? And that's what you do on an annual basis. And so then you have that money, it's going to keep compounding.
If that is all you did and all you did is put $10,000 away for let's say, 30 years, like whatever your career is, 30, 40 years, like you started in your 20s, you'll retire when you're 65. So you have a 40-year career. That money there could be as high as four, five million bucks in a retirement plan, and I'm not kidding you. At 10%, which is about what the S&P's been averaging, 11 to 13% over the last 10 years, let's just say, all you did is you put it in basic old index funds, and you just let it ride. In a tax deferred account like that, you're going to be looking at a minimum there of probably take-home pay in the $3 million mark, probably over four, 4 1/2 million.
That would be grossing inside the retirement plan. If that's all you did, that's the difference between you being legacy, leaving stuff, being in that top 1%, and not. Just that little guide. You do that, you put that system in place, and you let it operate.
It's actually very, very, very simple. And that's all you really have to do. But because we have this mechanism at our disposal, we have other options as well. We could be looking at other types of investments like real estate.
You start investing in real estate, and you're going to say, "But Toby, I can't deduct the real estate." Well, hold on for a second. If you are a real estate professional, then this guy all of a sudden starts to generate you active ordinary loss, if you accelerate depreciation on it. I get something called depreciation based on the value of the property that I invest in.
If you're not familiar with this, by all means, check out my YouTube channel, there's tons on there about depreciation. But what we're able to do is on any investment property, we should be able to take between 20 and 30% of it, and if we do the appropriate tax election, it's called a cost segregation, I can write off about 20 to 30% of that property, the improvement value in year one, in year one. And that's being really conservative, it's actually sometimes quite a bit higher. But generally speaking, I buy a two, $300,000 property, I could be looking at anywhere from probably about, I would say, a 40 to 60,000 deduction in year one. Now because you are a real estate professional and so long as you are actually participating in that property, which you're going to do if you're a realtor, you're going to probably manage your own property.
If you do that, then automatically, you're going to be taking massive write-offs by investing in that real estate. This is what that top 1% does. They don't just look at a return of an investment. They're saying, "What other ancillary benefits can I get?" It's kind of like a compounder. As I'm looking at these things going, "What else can I get?" So if I'm going to invest in real estate, it's not just the return on the real estate, but can I lower my tax bill while I'm doing it? And the answer is yes, especially for you guys, if you're a realtor. It never makes sense to me that realtors do not buy a real estate.
I'm like, it's what you're selling, you should be investing in it too, right? But there's some huge tax benefits for doing so. If you want to look at the tax code that covers it, it's 467 or 469(c)(7). So you can go in there and you can look, it lays out the rules for being a real estate professional. You guys are going to qualify 'cause you're brokering, you're selling business, you're selling real estate, and as long as you're materially participating on your real estate, which would be really tough for you guys not to do, you get to take it as an ordinary loss. And by the way, a spouse could actually qualify on the material participation.
But yeah, not going to dive into that. I just want to talk about how we are actually setting up that business just by doing a tiny, like two or three basic small steps, I'm going to start netting out massive difference than this. And you want to know what's really wild? Is when I compare these two, if I do versus, not only am I making an extra 10 to $20,000 a year more by being the S corp, but the audit rate goes from 1.6 at a hundred thousand
versus 0.2, the audit rate means you actually decrease your audit rate by a multiple of eight. It's usually between 800 and 1000% difference of how often a sole proprietor is audited.
And get this, sole proprietors, when they're audited, they lose their audits between 94 and 95% of the time. If you are a sole proprietor and you get audited, you are going to lose that audit between 94 and 95% of the time, and that's according to the IRS data book, you can go pull it up and look at it and go, "holy shmoly." Why is that? Because this is a gray. You've mixed your personal affairs with the business. Once you go over here and you start operating as an independent entity, the money goes into the entity, the entity is doing things like paying payroll, it's paying expenses, then it's distributing the money to you, and you're taking that money and you're putting it in investments. Magically, the audits A go to almost zero, like we know what gets audited in an S corp.
You probably didn't take a salary out of it, period. Like you're just running it years and years and years, and paying no employment taxes whatsoever. You're supposed to pay a small salary. Doesn't have to be a ton, a reasonable salary. Like what is a reasonable salary? I don't know, the IRS can't define it.
We have a difficulty doing it. Courts usually say about a third of net profit. So you make a hundred grand, put $35,000 towards salary, dump most of that directly into a 401(k). You've just got a huge deduction. You're not paying much tax. The rest of it comes out and it's not subject to self-employment taxes, Social Security, FICA, whatever you want to call it.
It's not subject to that 15.3% plus because you're an employee, all of a sudden you qualify for all these other ancillary benefits from an accountable plan. And you're saying, "Why the heck wouldn't more people do it?" 'Cause this is what's weird. 70% of the businesses are actually sole proprietors, even though they get audited more, lose, and get such worse treatment from a tax standpoint. I don't know why, probably bad advice, or just not digging into it. Probably, the accountants just do the lazy thing or the accountants don't know, or they're talking to attorneys who don't know any better, or they fall for the old, hey, it's much more difficult.
It is slightly more difficult. I'll tell you this. That an S corp return, if I look at the actual S corp return versus where you're filing your sole proprietorship, it's going to go on Schedule C of your 1040.
They're virtually identical. I put them up in classes all the time, and I say, "Which one looks more difficult?" By about two to one, people say that the sole proprietorship looks more difficult. So it actually has more lines to complete. And so people are generally saying either they're the same or the Schedule C looks harder, and that's pretty much is accurate too for accountants. Here's what I'd say for an accountant. Anybody who does accounting in prep is going to say, number one, all businesses, regardless of whether you're a sole proprietor or an S corp have to keep good books and records, period.
It's the same requirement. Doesn't matter whether you're an S corp or a sole proprietor, it's the identical rule. You got to keep good books. So assuming you have good books, they're about the same, not much of a difference, but they're so much more complex.
You got to file something with the state every year, they send you a little thing, you pay the state. If you have a registered agent, they'd probably do it for you, you give 'em a check, 100 bucks, 200 bucks, 50 bucks, whatever it is, depending on the state that you're in. It's not significant compared to the benefit. Worst-case scenario, like let's say, you're in California, they're going to hit you for, what is it? 800 bucks for the franchise fee. And you're like, "Gosh, that sucks."
Still, you're saving 10, $20,000 a year, I think that it's okay. That's still a 20-time return on that little investment. And the good news is when you do this and you set this up appropriately, you also have liability protection. If you're an agent and you show a house, and you didn't know that there was a defect, termites, fill in the blank, whatever it is, buyer gets it, a year in, they're mad because something they think wasn't disclosed. Who do they sue? I just saw this.
I'm watching a termite case right now against one of the realtor clients. and they're like, "God, bless it." Sometimes you get sued on stuff, it's just part of doing business.
Especially if you're really, really good, the more business you'd create, the more opportunity for someone to try to take it. This isolates it, limits it, keeps it in a box, so that it doesn't come out and get your other assets. There's a ton of ancillary benefits.
I could go into things like, hey, entities, don't die. You operate as a sole proprietorship, you get sick, nobody's going to be able to run your business. You set it up as an S corp, you get sick and you have somebody else as an officer that can step in and act on your behalf. You pass away, still an entity.
You pass away here, business is done. You just killed your business too, 'cause it is you. There's no difference. It's all tied in into one. So what do the best agents do? The top one, 2%, top 5%, 100% of the time, 100% of the time, they're either already structured that way or they're headed in that direction because the pain is getting so intense for what they're doing. Like they may already be doing things on the outside and they just haven't put that final piece in place, but it's almost impossible.
I would say that there might be that few outliers like they've somehow managed to run the gauntlet and maybe they just didn't care that they were overpaying taxes. Every year, they make a million, every year, they're kicking off $400,000 to the tax man, but they live modestly, so they don't care. There's those people out there.
But for the most part, again, think of any industry, like I always think of like Bill Gates, and some of these guys, Elon Musk, all that stuff, they're not operating as sole proprietors, period. The most accomplished people in our society, the best of the best in just about everything, without exception, they're operating in some sort of entity structure. And that's what I'm going to say to you guys. If you want to join that top one to 5% and you're a real estate agent, you got to start acting like it. Sooner than later, it pays off and allows you to get there faster. So remember, bottom 80% is most everybody, right? They're the ones that, "Gosh, it could be tough to retire."
If you find yourself in that situation where you're like really starting to wonder, like every year, I'm paying these big checks, I'm making good money, but it doesn't seem like I'm getting ahead, sometimes all it is is how you structure it, and you can unlock some of that money and get you to get out of that 80%, you'd start transitioning. Even if you're in the top, what is it? 85% or top 90%, you start getting up into, I guess that would be the 20% or 10% like, hey, I'm in the top 20% now, I'm in the top 10% now, you start moving up there because you're able to retain things and invest them. And it's starting to compound. That's where you want to be. We would love to have everybody in that top 1%, obviously.
Statistically speaking, it's impossible, but our clients could certainly make up a huge chunk of it, and it's just operating smarter, sometimes, not harder, but it's realizing that very simple things that I can do, very simple things I can do that would tweak it would make a huge difference, and allow me to take more and keep more. So if you are a realtor, I'm going to leave you with this final note, make sure that you are not operating in your individual name. If you are in a state where they say, "we cannot pay an entity," does not mean that you don't put the entity in place. And there is a rule that says that you could still get it moved in, there's two ways to do it, into the escort, and then you can still unlock this.
If anybody's telling you, "you can't," they're absolutely 100% incorrect. You absolutely can, and there's rules on the books that allow you to do it. There's two steps that you take. It's actually really easy.
And boom, you're going to be way better off by doing it that way. All right, if you liked this information, please hit the like button and subscribe. If you know anybody else that would benefit from this information, forward it to 'em. And if you have any comments or questions, please put them in the comments below because we're always drawing out of those to determine what other things we're going to create for your benefit. Thanks for joining me.