Military Landlord Series #14: Should I DIY my taxes or engage a tax professional?

It goes without saying, but I’ll say it anyway, I am highly biased on this topic. But I’ll try my best to provide some good information to help military landlord’s make this decision without telling them my answer. 

How difficult is DIYing landlord taxes?

Really I think the question should be how difficult is it to get it right. But the answer is the same and it is perhaps the most common tax and personal finance answer: it depends. Let’s look at three paths for DIY landlord taxes. 

1. Just follow the retail tax software. It is easy. It tells you want to do. Never had a problem with the IRS.

It is relatively easy to follow retail tax software. It does not tell you everything you need to know or do. And just because you have never had a problem with the IRS doesn’t mean you did it right.

I’ll give you an example. There is a popular retail software that I looked at last year and just looked at again. I looked at how people enter a rental property for depreciation.

a. In this software after you have entered your expenses you get to the point where you click on depreciation or review expenses. When you first enter the asset the directions are to enter the date the asset was first used as the date in service. Many people think that the date should be the date it was first rented, when the first lease started. That date could match the date in service, but that is not the definition of the in service date. 

b. The next screen indicates that you should enter the original cost or basis. It doesn’t state the definition. It isn’t even asking for what it should really ask, so of course wrong data will be entered. Many will assume that the original cost is the buy price. In theory the depreciation basis could equal the buy price. But I have never seen that for residential rental property, except when it was entered in error on a depreciation schedule.

c. On the same screen the 3rd sentence of the fine print says: Do not depreciate land. This can be and often has been missed. Plus, “But I don’t have land, I have a house”. Most RE properties have land. Even most condos have a land value. Nowhere in the software does it tell you how to determine land value. “No problem, I’ll use the search function”. I searched for “land value” and I searched for “determine land value”. Nothing came up that was helpful. “I’ll google it”. You’ll find lots of advice on determining land value. Some might even be right. Unfortunately, there is plenty of wrong advice (side note: there is absolutely NO thumb rule for land value acceptable to the IRS. Court case after court case confirms this). And also a lot of the “right” advice leaves some info out.

Often, with a quick glance I can see that the depreciation basis was incorrectly determined with no information other than the depreciation basis itself. It works at least 99% of the time.The basis is a nice even number like $172,000. Depreciation errors are one of the most common errors with residential rental property taxes. Unfortunately, not just from DIYers, but also with tax preparation from tax pros. The most common: not depreciating, depreciating land, and wrong building or improvement basis. 

2. Okay, fine. I’ll use the free tax review or tax pro assist.

Or maybe for a small fee. This will reduce your risk for errors. But I don’t like this one unless combined with the third method. As you might expect, I will tell you why. I have worked as a tax pro assist person. There is certainly good to be said about it, for both the employee and the customer. But the first problem is that you don’t know who you are going to get. You might say it is like a box of chocolates. You might get one of the top 1% of tax professionals in the country. You might get a tax pro with true expertise in rental property tax preparation. However, often you don’t. The amount of times I had to correct something that was previously advised by another tax professional was very disappointing to me. And I had trouble too. I couldn’t see the client’s source tax documents or spreadsheets. Ever try walking someone through a closing disclosure or 1099 B when they have never looked at one before and when you can’t see what they are looking at? It can be difficult. I did get better at it over time. Too bad for the first few I helped. Can I guarantee what they told me was on the document was indeed what was there? No. 

3. Okay, fine. Tell me the right way.

I will, because I like telling people the right way. I want you to complete accurate tax returns. Here is the secret to doing DIY tax prep accurately: do it like a tax professional. Correction. Do it like a good tax professional or at least as close to one as is reasonably possible.

Here are the things you need to do:

a. Remember the tax software is a tool to help you get the correct results. You produce the correct results, not the tax software.

b. You need to read and research IRS publications and instructions at a minimum.

To be more tax pro like you should also refer to the internal revenue code, treasury regulations, and other tax authority. In many cases you can do reasonably well with just the IRS pubs and instructions. But this is important to note. Let’s say you draw what the IRS determines is an incorrect conclusion based on an IRS pub or instruction. And even if you can show you followed the pub or instruction precisely, if there is another tax authority that says differently according to the IRS and possibly the courts, then too bad, too sad. This is your fault and problem, not an IRS problem even though they wrote the pubs and instructions. The other important thing to note is: do you want to do reasonably well on your tax return or do you want it to be accurate?  

c. Which pubs and instructions?

Great question, I’m glad you thought of it. The answer is whichever ones apply to your tax situation. First start with IRS Publication 17 and the 1040 instructions. If you or your spouse is in the military also use Publication 3. As you go through those two or three references, situations applicable to you will come up. When that happens, often the references will refer you to additional references. That can continue in multiple layers. The real fun begins when you get sent to things like the tax code, federal regulations, and revenue procedures. 

For those with residential rental property these publications and instructions are usually applicable: Schedule E instructions, Pub 523, Pub 527, Pub 530 (possibly), Pub 535, Pub 551, and Pub 946.

This is not a complete list. You don’t have to have them all memorized. You don’t have to read every word in each one. You need to read enough to make sure you cover what you need to know. Make sure you are using the reference for the correct year. 

d. Stay up to date.

Tax laws change. Sometimes they even change retroactively. You probably aren’t going to do all the continued education I do each year and you don’t have to. The first tip to stay up to date is that the IRS wants you to stay up to date. So IRS publications and instructions each year have a “What’s New” section. Simply review that section for the publications and instructions that apply to your tax situation. Many states do something similar. 

Also, the IRS has newsletters that include information about changes. Subscribe to the newsletter that is important to you. The IRS has a “newsroom”, and you can subscribe to newsletters there. Many states offer newsletters as well. 

Sure you can read articles about taxes. Sure you can listen to or watch news. But what you read, see, or here from those sources should be verified. 

e. Do pay attention to tax tips and information provided by your tax software.

Just make sure you validate the tips and information and how they apply to your tax situation. I’m not anti-tax software, that would be silly.

f. Be diligent.

This simply means take the time and effort to get it right. Don’t accept “good enough” or “probably right”. Be sure. That is the short version. Tax professionals actually have much more detailed guidance to follow.

g. Check your work.

Look at the actual results, the tax forms. Compare them to the previous year and make sure any differences make sense. If you are sure you made a profit from the rental property, but the schedule E doesn’t show a profit, make certain that you know why and that it is correct. If you are expecting to owe money, but the tax return shows a $10,000 refund you better know why before filing the return. Keep in mind that the most common errors are universal. Transposing errors, typos, bad math, and outright missing a source document like a W-2.

h. Know that states with income taxes do not always conform to federal tax law.

Meaning you need to do the same things to get state tax preparation right that you need to do for federal and some of the rules are indeed different. For example, if you are familiar with bonus depreciation (you should be once you start DIYing your landlord tax prep), many states do not permit the bonus depreciation that is allowed under the federal income tax system.

i. Know that you don’t know what you don’t know

And strive to know it. This is hard for both taxpayers and tax professionals. Unfortunately it is often learned the hard way. Sometimes you read a publication or a section of the tax code and you think you have your answer, but no. There is another publication or section of the tax code that can apply. How do you know when to look for that other section? You know that you don’t know what you don’t know. Knowing when to apply that concept comes easier for some than others. Some of it comes from experience. I don’t know how to teach it.

Should I DIY my landlord tax preparation?

If the answer to all these questions is yes, then yes:

  1. Am I comfortable doing DIY landlord tax preparation the right way, as described above? 
  1.  Am I willing to take the time needed to do DIY landlord tax preparation the right way?
  1. Am I really going to be diligent while doing DIY landlord tax preparation the right way?
  1. If I said yes to the first three questions, am I being honest with myself? 

If you gave four yeses, then great! Go knock out some tax returns!

(I had to look up the plural of yes. If you haven’t figured it out yet, grammar is not my area of expertise).

If not:

And you know you want to find a tax professional, wouldn’t you know it, I happen to have advice for that in another article right here

And if you are undecided:

 I think you just haven’t read enough of what I’ve written and I humbly suggest you read the previous 13 Military Landlord Series Articles listed below:

  1. The “Military Extension or Exclusion”. https://jzfinancialmanagement.com/2022/07/01/the-military-landlord-series-1-5-myths-on-the-military-extension-of-the-capital-gains-exclusion-for-the-sale-of-your-primary-home/
  2. Choosing a Tax Professional https://jzfinancialmanagement.com/2022/07/06/the-military-landlord-series-2-choosing-a-tax-professional/
  3. Depreciation Errors https://jzfinancialmanagement.com/2022/07/11/the-military-landlord-series-3-depreciation-errors/
  4. Signs you may not survive an audit. https://jzfinancialmanagement.com/2022/07/29/military-landlord-series-4-signs-you-may-not-survive-an-audit/
  5. Should we move back into our rental property https://jzfinancialmanagement.com/2022/07/29/military-landlord-series-5-should-we-move-back-into-our-rental-property/
  6. Landlords and the Qualified Business Income Deduction https://jzfinancialmanagement.com/2022/08/13/military-landlord-series-6-landlords-and-the-qualified-business-income-deduction-qbi/
  7. Converting a residence to rental property https://jzfinancialmanagement.com/2022/10/10/military-landlord-series-7-converting-a-residence-to-rental-property/
  8. Common landlord tax errors. https://jzfinancialmanagement.com/2022/10/10/military-landlord-series-8-five-common-landlord-tax-errors/
  9. What is Depreciation Recapture https://jzfinancialmanagement.com/2022/12/17/military-landlord-series-9-what-is-depreciation-recapture/
  10. Debt and landlord taxes https://jzfinancialmanagement.com/2023/01/06/military-landlord-series-10-debt-and-landlord-taxes/
  11. When do I have to prepare and file a 1099-NEC form https://jzfinancialmanagement.com/2023/01/12/military-landlord-series-11-when-do-i-have-to-prepare-and-file-a-1099-nec-form/
  12. How rental property saves you on taxes. Let’s count the ways. https://jzfinancialmanagement.com/2023/09/02/military-landlord-series-12-how-rental-property-saves-you-on-taxes-lets-count-the-ways/
  13. What happens with passive losses https://jzfinancialmanagement.com/2023/09/24/military-landlord-series-13-what-happens-with-passive-losses/

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