Financial planning requires a system you can follow to be fully prepared for tax time. It’s imperative that as real estate investors and business owners, you create an accounting strategy that avoids expensive mistakes, gets the most deductions and plans your wealth building accordingly. Here are some tips on how to achieve those goals.
DEDUCTIONS FOR REAL ESTATE INVESTORS
When it comes to maximizing deductions, it is much more beneficial for real estate to be considered a “business” and not just an “investment”. Being considered also a business will give the property owner these advantages over being considered just an investment:
1. Eligibility to deduct start-up expenditures
2. Eligibility to deduct Section 179 first year expensing in certain situations
3. Better eligibility to deduct depreciation in certain situations
4. Better eligibility to claim interest expense
5. Eligibility to fully deduct operating expenses on rental or business schedules as opposed to miscellaneous itemized deductions, where there are limits.
6. Eligibility to fully deduct expenses for a convention, seminar or similar meeting.
7. Eligibility to take advantage of certain fringe benefits, such as a Medical Reimbursement Plan under IRC 105(b).
8. Eligibility to fully deduct rental property losses with less or no limitations
9. Better eligibility to fully deduct losses on the disposition of the property without any limitations
Entity Structures and Record Keeping
If you don’t plan accordingly for your investing goals and choose the correct entity structure, the taxes will definitely hurt your bottom line in a big way. As a real estate investor you need to stay updated on which entities are on the IRS hit list. Recordkeeping also plays a big part in wealth building. Done the right way, you can save yourself a lot of headaches and money come tax time.
Entity Definitions
1. LIMITED LIABILITY COMPANIES (LLC’S): An LLC is an unincorporated business entity filed under state law, in which all owners (called “members”) have limited legal liability. It is a hybrid entity that combines some of the major legal advantages of corporations and the excellent tax advantages of general partnerships. The owners in an LLC are called members or managers.
Tax Status: As a separate legal entity, an LLC can be taxed as a sole proprietor, as a partnership or as a corporation. But for real estate ownership, an LLC should elect to be taxed as a partnership and thereby be governed by the favorable tax benefits of partnership tax law.
2. PARTNERSHIPS: A partnership is an association of two or more legal persons (or entities) joined together in a business.
Tax Status: It is fairly inexpensive and simple to form a general partnership, plus there are no state filings. They can be done informally and verbally (although not recommended). General partnerships are not recommended for real estate transactions, due to the liability exposure.
3. LLC-PARTNERSHIPS: An LLC-partnership is both a legal entity and a tax entity with at least two members. An LLC partnership is the ideal entity for most cases of real estate ownership. They are generally the best for real estate.
Tax status: On the tax side it is a partnership with the favorable tax benefits of partnership tax law, including a lower IRS audit profile.
4. LIMITED PARTNERSHIPS (LP’S): An LP is a separate legal entity formed under state limited partnership statutes with at least one general partner and one limited partner.
Tax status: On the tax side an LP is a pass-through entity, filing partnership tax forms and has almost all of the same partnership tax advantages. Limited partners are totally subject to passive loss limits and are therefore not entitled to currently deduct rental property losses against other types of income.
5. CORPORATIONS: A corporation is a legal, artificial person that is separate, distinct and apart from the owners.
Tax status – C and S Corporations:
(a) C-corporations – A C-Corporation has its own tax rate schedule and pays its own corporate taxes. It is taxed separately with a tax rate of about 40{54c16d4e3dacb164defda86f6704ed01ae35015620e8bb0d315b70fb3b36361b}.
(b) S-corporations – Unlike C-Corporations, S-corps do not have their own tax rate schedule and usually do not pay their own corporate taxes. Instead, income and losses (within certain limits) pass through to the shareholder’s individual tax returns. S-corps offer the same limited liability as a C-corp, yet do not have the disadvantage of double taxation. I recommend S corps for Short Term Cash strategies with significant income. This way, you can pay yourself a salary which is subject to self employment taxes and the rest of your income will not be subject to self employment taxes but the regular taxes.
Generally speaking, the LLC is the ideal entity to start your real estate investing with. If you decide to hold on to the property, stay with the LLC. If you flip or rehab and flip you will want something with S Corp tax treatment. So either elect S Corp for your LLC or start a new company. Here we’ll look at the definitions of various entities.
The State Where You Operate – My Choice
Incorporating in the state of operation is the least complicated and least costly choice. In addition, if you were to get sued, the local laws will govern. So your entity should have a legal standing in the state where you intend to operate your business.
Delaware
Delaware is very popular as an incorporation state with thousands of start-up companies in the US. Delaware has low incorporation fees, low taxes and management flexibility making it an attractive option.
Nevada
Again, Nevada is attractive to new companies because of its favorable corporate laws such as: low taxes, low fees and corporate privacy laws. But, like Delaware it is larger corporations who have the most to gain from incorporating in Nevada. Similar to Delaware, smaller corporations may find more disadvantages than benefits to incorporating in Nevada.
How to Create a Wealth Building Plan
Successful real estate investors and business owners have one thing in common: they always have a team of experts at their disposal. Creating a ‘power team’ is vital to your wealth building strategy, and you will certainly be lost without experts to advise and guide you on your entrepreneurial journey. Your allies will protect you from financial harm, speed up your wealth creation and help you attain your goals whilst avoiding obstacles along the way. Here are a few tips on how to find the right people to join your team.
How to find an excellent CPA
• They are not afraid to use creative, aggressive strategies to save you a TON on your taxes
• They have taken advanced tax courses
• They own real estate and continue to invest on a regular basis.
• They attend real estate conferences and bootcamps to stay informed.
• They have written articles, white papers and reports on tax-saving strategies.
• They have a long-standing reputation for being ethical and knowledgeable.
• They are competent, hungry, energetic and willing to what it takes to help you build your wealth legally.
You can get a free consultation with me HERE
What to expect with a Great Real Estate Acquisition Specialist
They will:
• Locate the undervalued property
• Perform a cash flow analysis
• Determine the cost of renovation
• Estimate the after repair value
• Renovate the property
• Facilitate property management
• List property if it is a flip
An acquisition specialist will half the time you need to build your real estate portfolio. Let them do all the hard work for you and save pennies on the dollar.
Here are some recent questions from my blog:
QUESTION: I recently purchased a 4 unit rental. I took out a HELOC on my primary for the downpayment (3.75{54c16d4e3dacb164defda86f6704ed01ae35015620e8bb0d315b70fb3b36361b} 15 year = unreal!). I use Quickbooks and do my own accounting. This is basically a loan to the business, the business would pay me back within 3.5 years. However, since the loan is on my personal residence I would be getting a 1099 int from the HELOC towards my primary, and would deduct that interest on my personal return. I’m guessing I can not also deduct that loan interest in the business’s P&L? I suppose I could charge the business ADDITIONAL interest and deduct that in P&L but thats just robbing from peter to give to paul – I’m a sole proprieter. Am I thinking correctly here? So do I just record this as a personal loan to the business as a LT liability, no interest charged? Essentially the transaction wouldn’t even show up on the P&L, only the balance sheet. Also, is this actually a LT liability (3.5 yrs)? Any way to show the principal payments as expenses in P&L.
ANSWER: Generally, self-charged interest income and deductions result from loans between you and a partnership or S corporation in which you had a direct or indirect ownership interest. Certain self-charged interest income or deductions may be treated as passive activity gross income or passive activity deductions if the loan proceeds are used in a passive activity.
Here is the IRS’s position: To the extent that a taxpayer receives interest income with respect to a loan to a pass-through entity in which he has an ownership interest, such income should be allowed to offset the interest expense passed through to the taxpayer from the activity for the same taxable year” (H.R. Rep. No. 841, 99th Cong., 2d Sess. II-147 (1986, reprinted in 1986-3 C.B. 147))
QUESTION: What would be the rationale for making a loan with a promissary note from your personal name to your LLC instead of just making a capital contribution? Is there some tax advantage to doing that? It seems simpler to just make a contribution.
ANSWER: It’s whether we want to show the company as highly collateralized or with high equity. Showing a loan has a certain of protection in that debts need to be satisfied first before anyone else is paid off which includes this loan. Having it just as equity means that if there are any lawsuits, you the member is out whatever you invested.
I address many of these issues in my Wealth Building Plan. Make sure you are getting the best tax advice. Let me evaluate your financial and tax situation, then develop a customized tax strategy just for you. Together, we will come up with a strategic plan designed to answer your questions as you build your own customized wealth-building plan. You can get more information at WealthBuildingPlan
