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Choosing a real estate investing strategy can be a huge dilemma, especially when you are just starting out. Should you invest in short sales, note sales, or flips? Should you invest for cash flow or appreciation? 

Do you invest in your home town or nationally? Trying to decide where to start can be difficult and confusing. Every 'guru' promises to deliver never ending riches with their strategy, but at the end of the day, it all comes down to what you are ready to take on, and how you want real estate investing to fit into your lifestyle.

Here are some points you may want to consider first:

Some strategies, like buying foreclosures, require huge amounts of cash. Others, like wholesaling or buying at builder auctions, require little or no cash. In general, cash makes your investment life much easier.

If you cannot handle stressful rehabbing situations or hate negotiating with contractors, then rehabbing may not be the right strategy for you. Always play to your strengths and hire others to help you with your weaknesses

Different strategies require different amounts of time or require that you be available for particular hours of the week. For example, rehab is extremely time-consuming. Anything involving the government, like buying at sheriff's sales or appearing in court, generally requires that you be available during business hours on week days. 

f you have a full-time job or do not want to give up all of your after-work hours for real estate, you must not choose a time-consuming investment strategy. If you work at a regular salaried or hourly job during business hours, you probably cannot pursue a strategy which requires you to do real estate stuff during business hours.

 

Take a minute to think about this. It's incredibly important to get this right, or you may regret ever investing when it takes over your life in a way you cannot control.

• What do you want your day to look like?

• How do you want to get your income – in large chunks, or monthly payments?

• Do you want employees, or do you want to go it alone?

Once you write down your 'vision' for the future, you are taking control of your life and business and you'll have a better idea of what you should and should not do with your investments. It's important to narrow down the options to really fit your life.

 

• Do you want something short term or long term?

• Do you want cash flow or equity growth?

• Do you want to be hands on or hands off?

• How much time and effort can you put into your investments?

These are all important considerations which should be thought out in advance of your first transaction. Once you get clear on what you're looking to get out of your investment, you can start to seek out the right strategy.

 

Make a list of Pros and Cons for each strategy and narrow it down to the ones that meet all your lifestyle criteria

 

For each of your top strategies, find someone who is an expert on that strategy and speak with them. Many veteran real estate investors are happy to share their knowledge with new investors, and hearing all about the pros and cons of their particular strategy will give you unique insight into whether or not it will be a good fit for you. 

Once you've done your homework, you will feel a lot more confident about your decision and less likely to make expensive newbie mistakes.

 

• Am I a strong negotiator?

• Am I handy with a hammer and nail?

• Am I a good networker?

• Can I deal with forms, applications and red tape?

• Do I have good organizational and follow up skills?

• Am I a good manager?

 

• Do I have good credit?

• Can I qualify for conventional financing?

• Do I have any cash for repairs and/or holding costs?

• Do I need fast cash or a tax shelter?

• Can I get money from a private lender?

 

• Can I conduct business during normal business hours?

• Do I have more than 20 hours a week to devote to this business?

 

• Wholesaling

• Fix and Flips

• Rehabs

• Short Sales

• Subject To/Lease Options

• Commercial

• Land Development/Construction

• Buy and Hold

• Tax Liens

• Bulk REO

• Note Buying

• Private Money Lending

• Syndication

 

If you have plenty of time, poor credit, no cash and wanted to invest for fast cash you might choose wholesaling.

If you have no time during the day, good credit and lots of cash you might choose private money lending or note buying since you can do that for the most part on the weekends.

Choose a strategy that matches your skills, and personality and you will have your best chance at success. For example, if you are a handyman, and enjoy working with your hands, perhaps buying and rehabbing homes to flip for a profit is a strategy for you. Research the markets you wish to operate in to see what opportunities presents itself.

The good thing about real estate is that unlike traditional businesses, you are not confined to opportunities in a specific area. If there is a strategy you think may work, but you don't have the skills, or expertise for that strategy, learn those skills, or partner with someone more experienced in that area.

Overall, be realistic, do your homework and don't put all your eggs in one basket. Real estate investing is a wonderful vehicle to build wealth and make fast cash, but you must know what you are doing and make intelligent decisions to succeed.

QUESTION: I am in the process of acquiring a property with a partner. We are paying cash but will turnaround and get a HELOC pretty quick on it. The mortgage will be in his name, therefore the property will need to be in his name as well. We cant create an LLC and put property in it because he will be getting the heloc in his name only. Any ideas how we can structure it so we both ownership interest in it? Thanks for any feedback!

ANSWER: After closing, you can add yourself to the Deed

 

QUESTION: Ihave a rental property in Colorado and have created a Colorado LLC to hold it. However, I bought the property under my own name and have a small mortgage under my name. The mortgage company won't let me tranfer itle to the home to the LLC with the mortgage in my name. I could pay off the mortgage, but that would leave me more cash poor than I care to be. A friend suggested that I lease the property to my LLC (it's a single member) and that would give me the legal umbrella of the LLC and still keep the mortgage company happy. Anybody ever done this or heard of it being done?

ANSWER: Usually, the mortgage company will not let you transfer the title without triggering the due on sale clause. I have usually just transferred without getting them involved and as long as the mortgage is being paid, then you are fine. Going on almost 10 years of my properties being in an LLC still with a mortgage in my name.

Not sure how leasing gives you protection when it still shows your name.

 Want to learn  more about building the right real estate investing business to suit your lifestyle? Register for my FREE webinar HERE

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.

• 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

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. I can highly recommend my personal specialist – TJ Bencho from Aurora Real Estate Investment Services in Pittsburgh, PA. You can reach him at  www.investinpittsburgh.net

 

• Spends 60% or more of his/her practice doing only real estate

• Has been practicing real estate law for at least 5 years

• Is recommended by other real estate investors

• Is an active member of your local REIA

I can recommend Robert C. Brandel, PA. He is an Attorney at law and specializes in real property and corporate issues. His services include: entity formation, business sales and real property matters. You can email him at bob@stonegatetitle.com.

I also recommend Gideon Obi at Fidelity Law Firm. You can reach him on Phone: 866-576-6567

 

• Must be experienced in business and investing

• Must be a role model (someone you respect and admire)

• Must have the time to teach you

• Must be active in business and investing.

I can recommend my business coach, Sherman Ragland, CCIM. He is a commercial real estate advisor and mentors his students on how to raise money to do deals. He specializes in showing small business owners how to use their businesses to acquire commercial real estate through government programs. You can reach him on 301 218 4333.

 

• Check the certificate. Always make sure you know the person you are dealing with is qualified and registered. It's too easy for anyone to print up a fancy business card and call themselves an advisor/planner. Stick with someone who has a well-known designation such Certified Financial Planner or Personal Financial Specialist.

• Look it up. Check out registries with professional associations like the National Association of Personal Financial Advisors or Garrett Planning Network to locate advisers in your area that have gotten training and agreed to the organizations' ethical standards.

Do they offer what you need?

• Know what you need. Not all planners offer comprehensive advice. Some focus on retirement, while others cover everything from taxes to estate planning. Decide what you need and expect from your adviser.

• Know what they actually do. Some financial advisers are actually tax accountants or insurance salesmen who decide to offer general investment advice to broaden their businesses. Consider their other incentives when they start to sell you a new tax strategy or insurance policy.

• Interview, interview, interview. When hiring a planner, interview at least three pros. Don't shy away from asking them for referrals from clients and don't fall in love with the first one you meet even if he or she was recommended by your best friend.

If you are looking for a financial planner, I highly recommend Mark Mollon of LBG Financial Services. You can reach him on 301-440-0073 (D) mmollon@lbgfinancial.com

 

Real estate investment clubs or associations are a powerful way to build up your real estate deals portfolio. Particularly if you're new to property investing and do not have much experience in buying and selling houses to make money. Here's what to look for in a good real estate club:

• Has regular, weekly or monthly meetings. These are often free, or charge a nominal fee to attend.

• Attracts a wider range of investors (money lenders, real estate investors, brokers, bankers, contractors, realtors, city officials, property lawyers)

• Hosts real estate investing experts that are well known and respected in the investor world.

• Offers workshops and seminars on all topics relating to investing such as: investing strategies, financial planning, asset protection, marketing and taxes.

• Has lots of networking opportunities for you to socialize, find mentors, partners and build a power team.

 

Also known as 'private lenders', hard money lenders are not hard to find, but you do have to know where to look and what to look for. Here are some tips to find a good money lender to help you fund your deals:

• Talk to other investors and ask for referrals. This is a great way to weed out the 'bad' and find the gems.

• Ask settlement/closing attorneys

• Accountants can be a good source for HML

• You can often find lenders attached to deals at the courthouse

• Insurance agents and mortgage brokers are both good sources

 

QUESTION: When converting a property from personal use to a rental property, I understand you use the lesser of the adjusted basis (AB) or FMV. I've looked at comparable sales in the neighborhood at around the time of conversion. However, what is the best way to determine what portion of the AB or FMV is depreciable, i.e. non-land.

ANSWER:I use the tax assessed value

 

QUESTION: So my GF is going to be coming up on 2 years in her house, I'm talking with her about renting it out after 2 years, and then buying another house to live in for another two years. My question is, does the capital gains tax stay off of the property even if she is renting it, because she lived there for two years? Or does it come back onto the property because she's renting it out?

ANSWER: Capital gains only occurs when the property is sold so it will be when the property is sold to a third party. Also, when she does sell, she can exclude portion on the gain based on the home sale exclusion according to the number of days she used the home as her primary residence. If it is less than 2 years that she used it when she finally sells, then you would prorate the home sale exclusion.

Need help building your Power Team? Book a free consultation with me today HERE

Your business return is a report to the IRS and to your State Department of Revenue. It says a lot about your business and about you. But it also says one really important thing of which you might not be aware. Your business return says whether you should be audited or not.

Here's a brief outline of eight mistakes that you want to avoid on your business return by Diane Kennedy CPA:

 

Mistake #1: Selecting the wrong business type for your business.

There are some basic rules when it comes to selecting the right business type for your business. Don't put appreciating assets inside a corporation. There are a few (very few) instances where you might need to use a corporation to hold assets like real estate, but for the most part - don't do it!

Think about the tax election for your LLC. If you go with the basic default of Sole Proprietorship (single member) or Partnership (multi-members) you might not get what you want. Definitely get good tax advice before you make important elections with your tax return.

 

Mistake #2: Selecting the wrong NAICS code for your business.

The IRS will compare your selected NAICS code with other businesses with the same code. If your business is being compared with a different type, you'll look off and that's a bad thing when it comes to the IRS.

 

Mistake #3: Failing to elect to amortize your start-up costs.

You get a choice with start-up costs - amortize them over 15 years or taking an election to expense up to $10,000 in cost in the first year. But you have to make the election on your return!

 

Mistake #4: Not selecting the correct accounting methods.

There are three types of accounting methods: cash, accrual and hybrid. It's amazing how many get this one wrong.

 

Mistake #5: Not taking the full amount of loss in the start-up year (or for that matter any growth year).

It's easy to get lulled into a trap of "I don't owe taxes, so I don't need to look for deductions." The problem is that when the business starts being profitable you've lost out on possible carry-forward losses. And if it's not profitable and you have to shut it down, you've lost out on possible losses.

 

Mistake #6: Not reporting inventory for a retail business.

This is a huge red flag for a retail business. If you sell stuff, you can't take an immediate deduction for inventory you buy. Inventory is an asset, not a deduction. When you sell it, it moves from asset to cost of goods.

 

Mistake #7: Making a mistake with your salary.

There are two things you can do wrong:

1. Pay yourself a salary when you're in a structure like an LLC or LP or

2. Not pay yourself a salary when you're in a structure like an S Corporation.

 

Mistake #8: Not setting up an audit defense.

There are five things a good CPA will do to prevent an audit:

• Avoid Red Flag Triggers on the initial filing,

• Be over-achievers when it comes to disclosures,

• Keep overall reporting consistent as far as line items (unless obviously wrong)

• Coach our clients on what to keep, how long and why, and

• Proactively react to any IRS inquiry or audit notice.

In today's audit climate, it's not just about audit defense. It's about audit survival!

 

QUESTION: Staples doesn't appear to have the 2012 1099-misc contractor kit available yet--will IRS mind if I just use the 2011 forms?

ANSWER: You can only use 1099's that apply to the year that the money was paid. I am not understanding why you need a 2012 1099 when we are in the 2011 tax season. Check online at filetaxes.com. You can file electronically there for only $4.58 and it's real simple. I am not sure about filing the 2012 1099 because it is way too early.

 

QUESTION: Growing our RE business in the US certainly has its growing pains. In structuring our entities, (we function in Florida, Georgia and soon in Texas), we have been informed that, "...your company is a dealer in real estate sales and purchases, not an investor (1031 exchange tax deferral is not allowed for dealers)".

A more detailed discussion will take place with our CPA, but I would like to hear from some others who "deal" in rehabs within an LLC, s-corp or c-corp.

How are your 1031 exchanges handled? Is this an entity focused restriction, or an activity focused restriction? I see the reasoning on an individual basis, but how many flips does it take before you are considered a dealer?

ANSWER: It all boils down to intent. If you intent is to buy, fix and flip then you are a dealer and cannot 1031 exchange. If your intent is Buy, hold but then decided to flip, then you can 1031 exchange and there is also a holding period requirement when next you want to sell the replacement property for another one. 

Most people usually recommend 12-18 months but if you are flipping within a short period of time, then you are a dealer and subject to S.E. tax. You could come up with an entity structure that minimizes not eliminated your Self Employment taxes.

 Got Tax questions? Book a Free consultation with me at http://thewealthbuildingcpa.com/index.php/about-us/contact

There are many ways to reduce your chances of being audited by the IRS. As we've discussed in previous articles, the IRS has red flags for certain industries and tax filing behavior.

 

Unfortunately, real estate investors and business owners stand a far greater chance of being audited than their salaried counterparts. In this article we will look at some tips on how you can avoid these red flags:

• Try not to use whole numbers on your return such as $15,000. This can look suspicious and raise a red flag. Always file the exact amount spent.

• Avoid using a Schedule C for your business. This is a huge red flag because business owners can hide income and claim personal expenses as business expenses. If you file as a partnership or S corporation, you will reduce your chances of being audited considerably. 

Partnership tax returns are the least audited type of tax return. LLCs are usually taxed as partnerships and are a great option as they also offer limited liability and flow-through taxation.

• Home office deductions can raise suspicion, but this can be avoided by filing a partnership or corporate tax return instead of using Schedule C.

• Ensure that your return numbers match the 1099s you receive from your broker, employer etc.. For example, if your 1099 from the broker shows $26,987 in proceeds from stock sales, the proceeds on your Schedule D of your tax return should be $26,987.

Tax returns are flagged for IRS audits for a number of reasons. They can be picked at random, or set apart by discrepancies in the numbers (your clients report $96,709 in gross income but you report only $65,000), or they can contain certain warning signals. 

Although the IRS doesn't disclose exactly what signals send up the red flag, here are a few ways to lower your chances of being audited.

The IRS rule of thumb allows you to deduct the cost of items commonly used by others in your profession—"reasonable" and "customary" are the keywords. It's perfectly reasonable for consultants to deduct cell-phone service—your clients need to be able to reach you, and you wouldn't otherwise have a fixed office number. 

If you have your own office, supplies are also common, but a second cell phone for your teenager is clearly not deductible, and a new stereo system for your office is questionable.

Deductions that exceed your business income, even in a start-up year, raise a red flag. Of course, if you're losing money, you'll want to take every possible deduction you can. Just be conservative with your deductions, especially if you can't avoid some of the other red flags.

Unfortunately, a real estate investor's income can fluctuate wildly. Just beware that if you lose on a lot of deals or take some time off – a big drop in income will get the IRS's attention.

If you report $200,000 in income one year and $53,000 the next, the IRS might come looking for the missing money. If you report a loss, the IRS may suspect that your business is a front for a hobby or other nonbusiness activity.

Although you can't guarantee all your deals will be a success, you can at least do the following when you know your income is going to drop:

• Try to avoid taking large deductions or shift them to a year of higher income. For example, if you know by April 15 that you won't make as much this year as last, you could decrease last year's net income by making a much larger retirement contribution than you had planned—perhaps even the maximum amount allowable. 

In effect, make both this year and last year's contribution now, decreasing last year's net and increasing this year's. Similarly, postponing large equipment purchases can help.

• Be prepared for an audit and ensure you have excellent record-keeping in place

QUESTION: The other day I stumbled upon articles on segmented depreciation and how it increases the depreciation in early years by doing this. It sounds like little bit of work to segment the depreciation amounts but seems worth it if we have positive cash-flow. I am trying to reduce my positive income on schedule E and this seems like good way to do it at least for few properties

ANSWER: It can be a pretty simple or completed process. The main task is to look at the rental property and to see if you have any items in the property that are considered personal property or leashold improvements. Personal meaning moveable, does not cause structural damage, etc. Items like Fridge, Stove, cabinets would qualify.

Leasehold improvements are alterations to a building to make the space more usable. Some examples of leasehold improvements include: painting, installing retail counters, partitioning, replacing flooring, and building dressing rooms, among many other things.

If you determine that you have the above two items, you can now depreciate the personal property over 5 or 7 year and the leasholds over 10-15 years. This accelerates the depreciation because before now, the whole property cost was being depreciated over 27.5years.

I have also had clients who have used reasonable methods such as allocating a % to personal property like 20% and 20% to land and the 60% to the building. Then any rehab is considered improvements.

There is also a website that can help you gather your data if you want to be more sophisticated and they charge you for that.

http://www.taxsegexpress.com/

http://www.biggerpockets.com/forums/51/topics

QUESTION: I am a 60% owner of an LLC with 20 or so rental units in it. If this LLC were to buy a property and rent it to me, would this be a problem tax wise?

ANSWER: Because you own the LLC, it will be considered a personal use dwelling and subject to limits. Bottom line is that if you rent to yourself, you are not allowed to deduct expenses in excess of income

Learn more about how to prevent an IRS Audit on my FREE webinar 

Here are some IRS court cases featuring real estate investors that show how important tax documentation and preparation is to protect you from huge penalties.

Real estate activities are considered passive by default. Passive losses, of course, may generally only offset passive income.

Unless, that is, you qualify as a "real estate professional" under Section 469(c)(7), in which case you can deduct rental losses in full against nonpassive income.

In order to qualify as a real estate professional, a taxpayer needs to pass two tests under Sec. 469(c)(7)(B). The taxpayer must satisfy both of the following tests:

• More than one-half of the personal services performed in trades or businesses by the taxpayer during such tax year are performed in real property trades or businesses in which the taxpayer materially participates.

• Such taxpayer performs more than 750 hours of services during the tax year in real property trades or businesses in which the taxpayer materially participates.

Furthermore, Section 469(c)(7)(A)(ii) provides that each interest owned by the taxpayer in rental real estate will be treated as a separate activity unless the taxpayer makes an election to treat all rental real estate activities as a single activity.

In this case, the taxpayer owned several properties. He failed to meet the 750 hour test and did not qualify as a real estate professional because the taxpayer could not prove the hours test was met with a detailed log, and the court did not find his testimony credible.

Analysis of Petitioner's Claimed Hours of Participation Petitioner did not maintain a contemporaneous log of time spent participating in his real estate activities. In 2008, in preparation for respondent's audit, he attempted to reconstruct the time he spent in his real estate activities. 

He claims to- 17 - have spent months going through his records to arrive at these reconstructed estimates, but petitioners have not demonstrated the evidentiary basis or methodology for these reconstructions.

At trial petitioner testified that on the basis of these econstructions he estimated spending 1,270 hours managing his real estate properties in 2003, 1,421 hours in 2004, and 1,648 hours in 2005. As discussed in more detail below, the contemporaneous records that petitioners have offered into evidence do not credibly support these estimates.

We conclude and hold that petitioners have failed to establish that for any year at issue petitioner meets the 750- hour requirement to qualify as a real estate professional forpurposes of section 469(c)(7). Consequently, we sustain respondent's determination that the losses at issue are In the light of this holding, it is unnecessary to decide

whether petitioner spent more than 50 percent of his time in real estate trades or businesses or whether he materially participated in them. attributable to per se passive activities and are subject to the section 469 limitations. Read the full case at http://www.ustaxcourt.gov/InOpHistoric/harnett.TCM.WPD.pdf

In a recent case of Tom and Nancy Miller v the Internal Revenue, it was established that Mr Miller (despite having a full time job with a tugboat company) should be classed as a real estate professional based on documentation and number hours logged in real estate activity. The findings showed that Mr Miller:

• Established that he spent more than 750 hours performing significant construction work as a contractor and on his rental real estate activities.

• He also performed a number of additional real estate tasks including researching properties, bidding on properties, finding tenants, collecting rent and performing maintenance work at rental properties.

• Mr. Miller presented contemporaneous work logs for his construction and rental activities and provided compelling testimony and witnesses.

Petitioners state in their petition that they acted with reasonable cause and in good faith, and we so find. Petitioners prevailed on the threshold question of whether Mr. Miller qualifies as a real estate professional. They also prevailed on the question of whether they materially participated with respect to two of their rental properties.

 As for the remaining properties, petitioners provided evidence and gave credible testimony but simply failed to meet their burden of proof. Nevertheless, petitioners provided extensive records of their rental real estate activities, including contemporaneous timesheets. We find that petitioners acted with reasonable cause and in good faith in claiming rental real estate losses for the years at issue. Accordingly, we decline to impose a penalty upon petitioners.

You can see the full court findings at http://www.bradfordtaxinstitute.com/Endnotes/TC_Memo_2011-219.pdf

 

In this case the petitioners could not prove they spent the necessary 750 hours per year on real estate business due to lack of appropriate documentation. As a result they were disallowed the deductions they had claimed on their tax return.

Rental or Lease of Business Property - Petitioners claimed on their 2006 ACI Schedule C a deduction of $14,500 for the rental or lease of business property.

Respondent disallowed the deduction after petitioners failed to provide substantiation. At trial petitioners admitted to having no document On the basis of the record, we conclude that petitioners have failed to show that Mr. Bosque meets the 750-hour service performance requirement of section 469(c)(7)(B)(ii) for the years in issue.

Because petitioners have failed to show that Mr. Bosque meets the 750-hour service performance requirement, we hold that he is not a real estate professional for purposes of section 469(c)(7) and that petitioners' rental real estate activities must therefore be treated as a passive activity under section 469(c)(2).

Read more on this case at http://www.ustaxcourt.gov/InOpHistoric/bosque.TCM.WPD.pdf

• Mr. Agarwal worked full-time as an engineer

• Mrs. Agarwal worked as a license real estate salesperson

• The couple owned two rental properties in which Mrs. Agarwal managed

• The rental properties expenses exceeded the income so a loss was generated

• The Agarwal's used the loss from their rental activity to offset other income

• The IRS disallowed the deduction of the rental loss as they said the rental properties were a "passive"activity thereby only allowing the loss to be deducted in an amount not to exceed the total passive income.

Because petitioners concede that they are not entitled to certain deductions, see supra note 1, the Court finds that respondent has met his burden of production and that petitioners were negligent. Petitioners did not establish a defense for their noncompliance with the Code's requirements. See sec. 6001 (requiring taxpayers to keep records sufficient to establish the amounts of the items required to be shown on their Federal income tax returns).

Read more on this case at http://ustaxcourt.gov/InOpHistoric/Agarwal.SUM.WPD.pdf

QUESTION: In 2005 I entered into a partnership with my brother and a couple of friends. We purchased a single family house to rent out. We (over)paid around $127,000 for the house. The property is titled in my brother's name, as is the mortgage on the property, with a current balance of $102,000. A few years back, as the partnership began to lose money, I bought out two of the partners. I now own about an 80% interest in the partnership.

I would like to buy out my brother's interest so that I can eventually either sell the house utilizing a 1031 exchange or re-finance the house at current low interest rates (I can qualify for a conventional mortgage). I don't want to sell the house out of the partnership and get stuck paying depreciation recapture. The house will sell for $130k - $135k. In order to do a 1031 exchange or re-finance the house, I need it to be deeded in my name. Can I buy my brother's share of the partnership and then have the partnership deed the house over to me without triggering any tax consequences? Will the partnership (a general partnership, we never filed formation documents with the secretary of state) cease to exist if I buy out my brother's interest? Will there be some seasoning period required, or should I be able to re-fi right away if I acquire 100% of the partnership?

ANSWER: The partnership can certainly sell relinquished property held in the entity's name and then purchase like-kind replacement property to be held by the same entity and still qualify for 1031 Exchange treatment. So even if it is owned just by you or you and your brother, you can still do it in the name of the llc. Now if you need to refinance then you would need to deed it out of the LLC back into your name.

QUESTION: I had a new water heater installed in the rental (before I placed the rental in service, if that matters). Do I have to depreciate the water heater like I would a kitchen appliance, or is it okay to treat it as a repair and add it to the property's basis?

ANSWER: If the old water heater was not working then you can treat it as a repair. Other alternative is to treat it as a fixture and then elect the section 179 to expense it all in the first year.

Worried about your real estate tax documentation and the IRS? Book a free consultation with me for excellent advice http://thewealthbuildingcpa.com/index.php/about-us/contact

In part 3 of our series on audit-proofing, we will explore what tax expert, Al Aiello advises investors to do to get over the dreaded FEAR of an audit and to know your rights in case you are ever audited.

1. Taxpayers' Rights. As a taxpayer you have rights, which have been expanded under The IRS Restructuring and Reform Act of 1998. Taxpayers can sue the IRS for damages caused by an IRS employee who "recklessly or intentionally" disregards provisions of the code or regulations in connection with collecting taxes. 

You can collect attorney's fees and related costs (such as expert witnesses) if you prevail in a case in which the court determines that the IRS acted without "substantial justification". (Refer to IRS Publication 1, Your Rights as a Taxpayer.)

2. Know the IRS hidden weaknesses. In the event of an IRS audit, there are IRS "hidden weaknesses" that can help you. Use "time". IRS auditors are under time pressure to close cases. 

They are rated by how many cases they close. So if your records are organized and you are persistent in your arguments on viable issues, the auditor may just want to move on to another taxpayer's case.

3. If necessary "appeal" your case to win. If the IRS auditor is still not agreeable, you have a better chance of winning on appeal. Statistics show that the average results on appeal are a 40% reduction in taxes, penalties and interest. However, only one out of sixteen audited taxpayers goes to Appeals. 

The Appeals (or "Appellate") level of the IRS is not a court, but an informal hearing with an "Appeals Officer", who has a different job than auditors at the examination level. Their job is to settle cases and avoid the "hazards of litigation", such as the cost of going to court and the IRS losing.

Appeals officers have better credentials and training than office auditors.

Thus, they have more power to negotiate a settlement of a tax dispute, considering the strength of the evidence. For more about the appeals process, refer to IRS Pub.1, Your Rights as a Taxpayer.

4. Knowing your rights gives you more confidence. Knowing your appeals rights from the outset of an audit can give you more confidence and strengthen your position throughout the audit. Again, IRS auditors are evaluated by how many cases they close. They therefore do not want your case to go to Appeals.

5. Knowing your rights from the outset and knowing how the system works, can have an impact on your taxes before you are ever audited (if, you are ever audited). 

For instance, if you discreetly take aggressive positions on questionable areas of the tax law, you will know that you have a good chance of winning by actually going to Appeals (or by stating that you will go to Appeals), with the good possibility that the IRS auditor will back off, as per the above.

• Appeal the decision

• On average, appeals result in a tax bill that's 40% lower

• The appeal delays your tax bill for several months giving you time to get the funds together in case you lose

• Appeals Officers are hired to settle a case which means they are open minded to your situation and eager to settle.

• Have your tax attorney write a formal protest letter

• Request the IRS auditor's file

When it's time for the appeals hearing, you and your tax attorney will meet the appeals officer, present your case and answer questions. T

hey will usually negotiate a settlement right away and write it up on IRS Form 870. Some people opt to do all this alone, but it is advisable to have an experience tax attorney back you up

QUESTION: I own a duplex rental property in which I live on 1 of the floors? I am married, and our AGI is $125,000. Can I deduct half the PMI insurance paid on our monthly mortgage on Schedule E? Or is our AGI too high?

ANSWER: Yes, because this is tied to your rental and not subject to the AGI limitation. Only the piece for your residence is subject to the AGI limit. In general, you can deduct PMI premiums in the year paid. 

However, if you prepay PMI premiums for more than 1 year in advance, for each year of coverage you can deduct only the part of the PMI payment that will apply to that year. In addition, PMI premiums paid in connection with the acquisition or construction of rental property may instead be required to be capitalized and depreciated as part of the property's basis.

Register for my upcoming FREE webinar on 'How to Prevent an IRS Audit' HERE