7 Bookkeeping Mistakes a Real Estate Agent (and All Taxpayers) Should Avoid

Many people asked me how I did it – writing blog posts every single week for the last 3.5 years, accumulating over 150 blog posts today. Trust me, it hasn’t been easy.

I look everywhere for materials that can be relevant to my followers, so I can provide valuable information for them.

One of my favourite source of material is the recent court cases – YIU-CHO NGAI and HER MAJESTY THE QUEEN.

Earlier this week, I stumbled across this court case relating to a real estate broker in Toronto. He’s disputing in court about certain deductions he took in 2005 and 2006 that Canada Revenue Agency disallowed.

The court case ended January 26, 2018. ?

It’s over a decade ago and he finally got a ruling from the judge last month!

1. Cash gifts won’t cut it

The taxpayer, Mr Ngai, claimed deductions with respect to cash gifts he made to his clients and referral source against his realtor income.If you are thinking of giving cash gifts to anyone, think again!

He could only provide names of the people who received the gifts but other than that he couldn’t provide any evidence to prove his claim.

He didn’t invite recipients of these cash gifts to corroborate in court.

He couldn’t even provide cash withdrawal support from his bank. In theory, he would have got the cash gift from somewhere, likely his bank account, to gift them to the referral source.

Lessons learned? Do not give cash gifts. If you are giving a gift, make sure you have it properly documented. From the bank withdrawal, to the name of the person who received it, contact number and the address.

If you want to make sure you get the deduction, get an invoice or receipt, tie it to a specific deal that you are working on.

If you are unsure you can get a receipt, you may even want to avoid cash gifts altogether.

2. Documentation matters

Yep. You’re right. We are in 2018. We are talking about a case related to the taxation years of 2005 and 2006.I graduated from University of Waterloo with my Master of Accountancy in 2006 and wrote my Chartered Accountant Uniform Final Exam that year!

That’s a LONG TIME AGO!

How are you supposed to remember everything that happened that far back? You can’t!

That’s why documentation matters.

In the court case, Mr. Ngai, the taxpayer had stated that a Louis Vuitton designer purse was given to a client’s wife as a gift for purchasing an industrial building with him. He also made an inconsistent comment that the purse was given to thank the client to let him use their BMW for business purposes.

The judge disallowed the deduction, on the basis that Mr. Ngai provided conflicting reasonings for the deduction.

Lessons learned? Write down what the gifts are for specifically when you are spending the money! Don’t wait until 10 years later. Write it down directly on the receipts. You may even want to take one step further. Write down how this is related to earning your commission income/rental income! This will help you in court 10 years down the road!

3. Follow KISS principle

For those of you who don’t know this principle, it means Keep It Simple and Stupid.A taxpayer is entitled to claim any deductions that he incurs to earn the specific source of income, subject to a bunch of exceptions.

The easier it is for you to tie a specific expense to income, the easier it is for the judge/CRA to allow the deduction.

For example, if you buy a Louis Vuitton designer purse for a client who just closed a property that’s worth $1million, it is worthwhile for you to write down on the receipt that this is for Mr. XYZ’s wife and Mr. XYZ just closed a deal on ABC street.

When you get audited by CRA, you already establish how the expense is related to the income earned.

I am not saying that by writing down the name and the deal, you are able to deduct a Louis Vuitton designer purse. But making it simple and stupid surely make your position a lot stronger.

4. Corroboration matters

In this court case, the taxpayer didn’t invite any witness to substantiate his claim.The judge even offered to hold off the case to allow the taxpayer to invite some of the people who he claimed to provide cash gifts to stand in court.

Mr. Ngai turned down the opportunity citing cultural differences.

Going back to the cash gift example above, Mr. Ngai couldn’t provide any paper documentation as to how he got the cash to issue payment to the referral source.

Should Mr. Ngai asked some of these recipients to appear in court, he likely would have got the deduction allowed. Even a written statement from these recipients would have made the case stronger for Mr. Ngai.

On the flip side, I do understand why Mr. Ngai is reluctant to call these recipients to court. If they were to appear in court, they probably would be questioned as to whether they reported the gifts in their income tax return. What if they didn’t?

Lessons learned? Make sure that when you are providing gifts to referral source, you have them properly documented. Certain gifts are tax-free from the recipient’s point of view, but certain “gifts” such as rebates of commission can be taxable, depending on what you are buying.

Talk to your accountant to recognize the risk of deducting cash gifts without proper documentation. Maybe it’s not worth it to take the risk? Maybe getting a receipt from them is sufficient.

5. Gifts to a clients’ son’s wedding likely can’t be deductible

Mr. Ngai also deducted cash gifts for a wedding that he attended.The wedding gifts $1,000 was written as a cheque. It was the wedding of the son of an important business contact.

The judge cited two previous court cases before they made the decision to disallow it.

In the judge’s point of view after reviewing the two court cases, a wedding is considered a social event, not a business event. Just because there could be an element that the taxpayer could hand out business cards, “(b)ut it could not be argued (except under possibly the most extreme circumstances that are not easily evident to me) that going for a cup of coffee, mowing the lawn, or attending the wedding was for the “purpose of gaining or producing income from the salvage business”. (comment from the court case Ace Salvage)

Lessons learned? If you are attending a social event, costs of wine, wedding gifts, etc. cannot be deductible. If you are going to hand out business cards or other marketing materials at the event, then the materials are deductible. But anything else, whilst you’re there, isn’t.

6. Referral fees are deductible

I mentioned in previous blog posts that referral fees could be deductible.Technically speaking, referral fees are tax deductible. But remember the general guideline, reasonable expenses are deductible if you incur them to earn the specific income.

It’s worthwhile to note that the Real Estate Council of Ontario may not allow you, as a real estate professional, to pay referral fees to anyone outside of the deal itself. But that’s beyond the scope of a tax court case.

Mr. Ngai was able to deduct referral fees paid to various referral sources, with proper documentation provided.

Lessons learned? Write down the name of the referral, write down the deal that the referral fees are related to and ideally mark it on top of the cheque, also keep a copy of the cheque for deduction.

7. Rebates are also deductible

Many realtors give a rebate to their clients, in the form of cash, cheque, gift cards, or an exhaust fan in this court case! Seller or buyer rebates are fully deductible with proper documentation provided.

Mr. Ngai was required to provide the listing documents (MLS Listing) to the court for him to get the deduction that he made on a $1,500 rebate to one of his clients.

Mr. Ngai also bought an exhaust fan for one of his other clients after closing. The court treated this expense as a buyer rebate. He was able to establish in court that the buyer would not purchase the house because of the exhaust fan and Mr. Ngai agreed to pay for the replacement of this exhaust fan to complete the deal.

Lessons learned? Documentation matters. Follow the KISS principle above.

Hopefully, all of us can take away something from Mr. Ngai’s case.

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA