Real Estate Investing company for tax advantages..?

Question

Hello everyone, this is my first post on the forum, but I have been reading an learning from many people on this site for quite some time.

So im tired of giving the IRS all of my income, and I have been reading about all of the tax advantages that real estate can provide. I want to know if anyone here has tried setting up and LLC in which they loan the company money out of their income to subtract from the years gross income?

Beyond that, can I loan the company the money over the coming years for the same benefit? and in the event i want to take money from the company, take it in the form of a special dividend distribution since its taxed at a lower rate than regular income is?

I know this is a bit lengthy, thanks in advance.

Will Barnard · Answer

I need to do some more research on how LLC's are taxed in contrast to S-Corps, and figure out which one will best suit my situation. This is a great forum, and I look forward to contributing to it in the near future.

LLC entities are "pass through" entities meaning the income/losses are passed on to your personal return. They do not file seperate returns like S-Corps. As a general rule, LLC entities are best suited for rentals (buy and hold) and S-Corps are better suited for flips. Again, this is a generality and you should consult a tax attorney/CPA for your individual situation.

As for reducing your taxes, one thing that was left out is the depreciation deduction you recieve on rental properties. The improvements (not the land value) on a residential property are allowed to be depreciated over 27.5 years. This will benefit an investor you has W-2 income. Of course it is not the sole reason to purchase, but one of them.

Robert Spence · Answer

Thanks to everyone for all of the insight.

All Cash,

I do understand that the way to reduce taxable income is to record a loss for the year. I am willing to do that in exchange for assets that I can sell for gains further down the road.

I need to do some more research on how LLC's are taxed in contrast to S-Corps, and figure out which one will best suit my situation. This is a great forum, and I look forward to contributing to it in the near future.

Alex W · Answer

All Cash,

My comments were intentionally broad as I am not a CPA nor an attorney and was only giving some "food for thought" scenarios to bring up with the respective experts. Thanks for getting into more detail as this is very helpful.

Cheers!

Jon Holdman · Answer

I don't think anyone addressed this question.  Loaning someone or some company money will not affect your gross income.   If the person or company is paying you interest on the loan, you will actually increase your income.

Others have explained some of the considerations for real estate investing taxes.  Real estate investing does have some tax advantages, as has been explained.  But, there's no miracle that's going to make a dramatic adjustment to your regular (job) taxable income.  Once upon a time, there were ways to do that, but those have largely been eliminated by the reduction in the ability to offset regular income with passive losses.  If your income is (IIRC) under $100K for a couple filing jointly, you can deduct up to $25K in passive losses.  Over $150K you can't deduct any passive losses.  In between, the $25K number phases out.

Alex W · Answer

First question is what type of income do you have? I'm assuming earned income (salary) since you are paying too much taxes. If that is the case I'm not sure how you can have "tax savings" by loaning money to an LLC to invest in RE. That means you will be lending after tax $$.

I could think of 2 possible scenarios that can save on taxes if you are earning a salary.

1. Instead of lending money to an LLC, why not just use that money as a down payment to buy rental property held by your LLC? The income you receive will be considered passive income and is taxed lower. Hence you save on taxes. Then repeat the process and buy more rental properties. Next thing you know you don't have to work because all your income is coming from your passive investments. Typically LLCs are flow through entities anyway and its income flows through to you as the member.

2. Second scenario is to maximize your pre-tax contributions to your retirement plan, and self direct it so you can invest in RE with your pre-tax $$ through your retirement plan. The more you put into your retirement plan, the less taxable income you will have, hence you pay lower taxes. The only thing is you won't have easy access to profits unless you pay the penalty for early withdrawal. There are ways around this for sure. Make sure you consult an expert in this matter.

Lastly, you should consult experts (ie. CPA, attorneys) regarding the things I mentioned above.

It's just something to chew on which you can bring up with the right people.

Good luck!

Frank Adams · Answer

Well atlinvesto let's kind of review where we are, first you say;

BTW, if you're making that much, congratulations, you're making about FOUR TIMES the national average. If you're married filing jointly you have to have about $200K of TAXABLE INCOME in order to get up to 24.3%.

But enough preaching from reverend Frank. Back to your question. Be very wary of anyone who tries to sell you on an investment due to its supposed "tax benefits". The quickest way to pay lower taxes is to have lower income. "Tax benefits" tend to accrue to LOSSES, which none of us want.

However, any income that you acquire other than by "earning" it (ie; by doing "work"), does have the great benefit of of being exempt from Social Security/Medicare, and as RChristie pointed out the total hit (both employee and employer "contributions") is 15.3%, which is higher than the income tax % for way too many folks.

Earning money via long term capital gains, buy, hold one year or longer, improve and resell, comes with a tax rate of only 15%, and no social security contributions. One year we earned over $200K but our "average" tax rate was below 15%. Everything was long term capital gains and a little bit of (work kind of) income. Schweeeet.

I also want to jump in on something SROC4 said, that read a little confusingl:

1. You don't need to hold rental property in an LLC for tax reasons, although it may, or may not be a good idea from a liability protection standpoint.

2. In order for the income from the rental activity to be "passive" you cannot "materially participate" in the income generating activity. This means you're using a property manager (probably 10% of gross rents, minimum), and paying an electrician if a light switch needs replacing, probably $75 vs. $5.

3. It's not that passive income is taxed at a lower rate than active income, it's just that you can use passive LOSSES (there's that L word again) to OFFSET THE PASSIVE INCOME, without regard to income limits. That's not the same thing as "lower tax rate". Although, you don't pay the Social Security on the rental income.

The above reasons are why I never worried about the passive losses limitations. I've never seen a "good" property manager, although like Leprecauns my not seeing them doesn't mean they don't exist.

Rental property can be a great investment. In order for that to happen you need to; (a) buy it right, (b) manage it properly, (c) minimize your expenses and (d) know when to sell it.

If you're 25 years old and you acquire just one rental property every five years by the time you're 55 you'll have 7 rentals. If you own them, no debt, and each rental brings in 20% of the "average" working guy's wage, you'll be able to spend the rest of your days wondering; "do I sail north, or south today", and that's a good place to be!

all cash

Robin Christie · Answer

Atlinvesto,

What do you know about the tax structure of LLC's? You need to be very careful about active (non passive) income going through an LLC because of the 15.3% self-employment tax on income you take.

You may want to consider an S Corp or an LLC taxed as an S Corp if you want to take dividends as part of your compensation (dividends not subject to 15.3% self employment tax).

I've been where you at, I changed my companies tax structure to avoid the very things your dealing with. If anyone else can add to this, please do. Saving $$$ is what it's all about.