Agents Beware

Real estate agents serving the Hamptons number in the thousands. This occupation represents one of the largest sources of employment in the area. Based on 2014 figures, agents in the Hamptons achieved income totaling approximately $167 million. This is an enormous amount of income that supports local families and fuels our local economy, yet too much of it is wasted because of poor financial planning.

How often have you heard this tale? A home described as a four-bedroom, three-and-a-half-bath residence on a quiet street in East Hampton south of the highway near the village and ocean beaches. It’s the idyllic weekend summer house for a New York City family who five years ago bought it for a little more than $2 million. Last month, this little slice of heaven sold for close to $6 million.

The sizzling real estate market in the Hamptons has brought with it a wave of spec houses, competitive one-upmanship between buyers and builders alike, and a dramatic rise in commissions for the area’s real estate offices and their agents.

According to Miller Samuel Inc., an independent real estate appraising firm, the average sale price of a Hamptons home in 2014 exceeded $1.7 million, with over 2,400 total transactions through the year. That brings a total transaction value for 2014 of over $4.2 billion. This represents an increase of almost 2.5 times the total transaction value in the five years following the financial crisis; 2009’s total was $1.7 billion. These figures do not include the commissions generated from rental properties, which is a very significant business in itself.

In most instances, real estate agents are not employees of the firms they represent; rather they perform their services as independent contractors and are therefore not offered benefits including health care and retirement plans. There is also no opportunity to earn equity in the firms they support. Agents simply receive cash compensation upon the closing of a transaction. The challenge, then, is to structure their businesses in order to take full advantage of the tax savings available to business owners.

Agents own and operate their own businesses; it is therefore essential they create a well-thought-out financial planning strategy. Agents should consider setting up a limited liability company to receive the revenue generated from commissions and, similarly, use the L.L.C. to pay for all work-related expenses, from taxes to professional services. Use of an L.L.C. can help keep personal and business assets segregated, which provides the added benefit of protecting the agent’s personal assets from liability in the event a client decides to sue.

Agents should also consider setting up Simplified Employee Pension, or SEP, I.R.A. plans. These are retirement savings vehicles for self-employed individuals and are a great way to reduce taxable income and set aside money that can be invested and increase in value on a tax-deferred basis. Every dollar contributed to a SEP plan is deducted right off the top line of taxable gross income. The contribution limits in SEP plans are high, $53,000 in 2015. This is dramatically more than what is allowed inside a traditional I.R.A.

As independent contractors, agents must take it upon themselves to understand their planning options in order to save as much of their hard-earned dollars as possible. After all, everyone should have an opportunity to purchase a perfect slice of the Hamptons, especially those who live and work here full time.

Andrew Stern is a financial adviser with Lebenthal Wealth Advisors in Bridgehampton.