It’s nearing the end of the year…should you prepay some 2023 expenses?
As the end of the year is less than 2 months away, you may want to consider prepaying certain 2023 expenses before 2022 concludes. If done properly, this would allow you to deduct the expense against your 2022 business income even though the benefit of the expense will not be had until the next tax year. In doing so, your 2022 income will be reduced and your 2022 tax bill decreased.
Example: Real Estate Team ABC pays $750 per month ($9k annually) for Brivity, its CRM. ABC contacts Brivity in December 2022 and asks if it can prepay for all of 2023. Brivity loves this idea because it not only gets to capture cash flow many months in advance, but it also locks ABC in as a client, at least for 2023 (as ABC is unlikely to switch from Brivity if it has prepaid for the services). ABC pays the $9k in 2022, and now has a $9k expense. Using 30% as a rough tax rate, ABC saves $2,700 on its 2022 taxes as a result of this transaction.
Now, a few things to note:
1. Prepaying expenses only makes sense if you have the free cash available to do so. This is really important to consider. It is not worth the savings in prepaying an expense if it is potentially going to lead to a cash crunch at some point in 2023. If you’ve built the required reserves and you’ve funded the various projects, investments, etc. that you have on the docket for 2023, then prepaying some expenses is a great strategy. But do not put stress on your money just because you can save a few bucks today.
2. Check out the “12 Month Rule” as it very much applies here. Under the IRS 12-month rule, a taxpayer can deduct a prepaid expense in the current year if the rights or benefits for the taxpayer do not extend beyond the earlier of 12 months after the right or benefit begins OR the end of the tax year after the tax year in which payment is made. This is important because you may have a certain expense that actually covers more then 12 months (eg a 2 year lease where you pay the entire amount upfront…you’d only be able to deduct 12 months’ worth of expense given this rule).
3. Keep in mind that when pulling forward an expense into the current tax year, you are removing the expense from the following tax year. As a result your adjusted gross income will be higher in the next tax year since you’d now be missing this deduction. Of course, you’d offset this increase by continuing this prepayment practice in future years if you decide it makes financial sense to do so.
4. I am not your CPA! I know this is obvious. But please know I am sharing the information here based on my own personal experience and practice. What works for me may not be right or applicable to you. Please consult with your tax advisor before making any moves.
5. Prepaying expenses is generally only applicable if you use the “cash basis” of accounting. If you are on the accrual basis, treatment of expenses will be different. Most all real estate teams leverage the cash basis system, but be sure to ask your advisor about this as well!
Here are some examples of expenses to consider prepaying before the end of the year:
- CRM Expense
- Car lease
- SOI Event Costs (room rental, etc.)
- Travel Costs
- Property Taxes