Taxes due for flip with married couple both with W-2 earnings

Indianapolis, Indiana
Tax, SDIRAs & Cost Segregation
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Taxes due for flip with married couple both with W-2 earnings

Daniel Schiff
Member since 2022 · 7 posts · 4 votes

My spouse and I have a real estate pass thru LLC we are 50:50 partners / owners of. We are in the middle of a flip which will sell in 2024 and have a second one lined up. Estimate to make 80-100k from both deals. For 2023 we both had W-2 earnings where my spouse (Pharmacist) exceeded the social security earnings threshold and will do so again in 2024. I'm an IT Director and am just under the threshold in 2023 and will be also be under by in 2024. If after the flips we pull $40k out and reinvest the remaining profits with our original capital, do we get to choose which member to allocate the $40k income to avoid self employment tax on my remaining cap, or would it split and I pay self employment tax for both social security and Medicare and my spouse only pays the Medicare tax? I don't mind maxing out my Social security - but it really won't push my eventual benefits up much so I'd prefer to keep the cash. We do take advantage of deductions- maxing out both 401ks, HSAs in 2023 and itemizing deductions and will do so in 2024 - so we fall at the lower end of the 24% federal bracket (MAGI of $240-260k- so additional ordinary income is 24% income tax plus whatever Medicare/Social security we must pay on the $40k
I know I can retain all the earnings in the LLCand 1031 exchange until we no longer have W-2 wages to reduce our taxes, but I plan on using the $40k for a personal home improvement - replace two HVAC systems and install a new wood deck and landscaping). Any info on the SE tax split is appreciated- I could t find any specifics to splitting between married members with w-2 earnings.

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Michael PlaksPro Member
Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
2y

@Daniel Schiff

The way we read your post on taxes is the same way you would read our posts on IT. ;) As in - you're asking questions about a specific higher-level issue while missing the basics.

So, basics first. Your extra taxable income is $80-100k, not $40k. It does not matter what you pull out and what you reinvest, you're taxed on the entire amount that the LLC made. (Unless your LLC elected to be treated as a C-corporation, which is highly unlikely.) Also, flips are not eligible for 1031 exchanges, so it's not an option.

To your specific question, you're apparently in Indiana. In Indiana, husband-wife LLCs are required to file as partnerships. You probably cannot allocate your income (and, with it, SE tax) other than 50/50, however you may be able to achieve your desired result via a "guaranteed payments" system. A real answer requires examining your LLC operating agreement and the actual facts of your operation. Not doable in an online forum, takes an actual consultation with a tax professional.

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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    2y

    @Daniel Schiff

    The way we read your post on taxes is the same way you would read our posts on IT. ;) As in - you're asking questions about a specific higher-level issue while missing the basics.

    So, basics first. Your extra taxable income is $80-100k, not $40k. It does not matter what you pull out and what you reinvest, you're taxed on the entire amount that the LLC made. (Unless your LLC elected to be treated as a C-corporation, which is highly unlikely.) Also, flips are not eligible for 1031 exchanges, so it's not an option.

    To your specific question, you're apparently in Indiana. In Indiana, husband-wife LLCs are required to file as partnerships. You probably cannot allocate your income (and, with it, SE tax) other than 50/50, however you may be able to achieve your desired result via a "guaranteed payments" system. A real answer requires examining your LLC operating agreement and the actual facts of your operation. Not doable in an online forum, takes an actual consultation with a tax professional.

    3Reply
  • Basit SiddiqiBusiness Member
    Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
    2y

    Depending on the operating agreement, if one partner is a non-managing member within the LLC, his/her income may potentially be deemed not subject to self-employment taxes.

    His actions regarding the LLC would then have to match what the LLC Agreement says.

    I.E. if the LLC Agreement mentions one member is a managing member and the other is a non-managing member.
    The non-managing member would not have a say in the operations of the company.

    best of luck.

    [email protected]917-280-8544
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    0Reply
  • Daniel Schiff
    OP
    Member since 2022 · 7 posts · 4 votes
    2y
    Quote from @Michael Plaks:

    @Daniel Schiff

    The way we read your post on taxes is the same way you would read our posts on IT. ;) As in - you're asking questions about a specific higher-level issue while missing the basics.

    So, basics first. Your extra taxable income is $80-100k, not $40k. It does not matter what you pull out and what you reinvest, you're taxed on the entire amount that the LLC made. (Unless your LLC elected to be treated as a C-corporation, which is highly unlikely.) Also, flips are not eligible for 1031 exchanges, so it's not an option.

    To your specific question, you're apparently in Indiana. In Indiana, husband-wife LLCs are required to file as partnerships. You probably cannot allocate your income (and, with it, SE tax) other than 50/50, however you may be able to achieve your desired result via a "guaranteed payments" system. A real answer requires examining your LLC operating agreement and the actual facts of your operation. Not doable in an online forum, takes an actual consultation with a tax professional.

    If I 1031 exchange the balance within the LLC doesn't that reduce my taxable amount to the $40k I propose removing from the LLC as personal income. (Ie defer the balance until a future date for taxation).

    I am in Indiana and our LLC is an Illinois Series capable one. I reviewed  our operating agreement and it does state distributions would be paid out equally- so I believe I have the answer.

    This has been a useful thought exercise for my planning purposes for 2024. I do have a CPA and attorney for compliance and will meet in the coming month for my 2023 taxes. I know better what questions to ask in that meeting- and to have the operating agreement in hand for that discussion, thank you.

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  • George SkidisPro Member
    Rental Property Investor · Belleville, IL · Member since 2017 · 875 posts · 529 votes
    2y

    50/50 partners is a partnership. 

    For the most part a single member LLC is a pass through. Without specific "Spouses" language in the LLC Operating Agreement a multimember LLC is not a pass-through entity. So, unless you hired a great attorney your LLC is probably a Partnership and is required to file form 1065 and issue K-1s to the partners. Partnership returns are due on the 15th of March.

    On a 1040 Personal Income tax return Schedule C is for a sole proprietorship. It is assigned to one spouse and it stays that way. Schedule E is vague on the matter.

    You need a good attorney and a great tax preparer. Don't have one PM me.

    Good Luck and Good Investing!

    George

    1Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    2y

    No. You cannot "1031 a balance."  1031 is for exchanging one rental property for another rental property.

    0Reply
  • Daniel Schiff
    OP
    Member since 2022 · 7 posts · 4 votes
    2y
    Quote from @George Skidis:

    50/50 partners is a partnership. 

    For the most part a single member LLC is a pass through. Without specific "Spouses" language in the LLC Operating Agreement a multimember LLC is not a pass-through entity. So, unless you hired a great attorney your LLC is probably a Partnership and is required to file form 1065 and issue K-1s to the partners. Partnership returns are due on the 15th of March.

    On a 1040 Personal Income tax return Schedule C is for a sole proprietorship. It is assigned to one spouse and it stays that way. Schedule E is vague on the matter.

    You need a good attorney and a great tax preparer. Don't have one PM me.

    Good Luck and Good Investing!

    George



    You are correct it is a partnership return, not a pass-through - I reviewed my TY22 returns and saw how they were filed.  Honestly, it was "perfunctory" at the time since I had just formed the entity and had no income in TYT22 - I was happy to have it filed and compliant.  Planning now that I have a rental active in the portfolio and two flips on track for 2024 to be more active in the planning.

    For background - we formed the LLC in June 2022, did our first deal in fall 2022 ($180k purchase ($140k mortgage + LOC for $105k rehab) and put it into service March 2023 (2 unit rental). Appraised at $450k and did a DSCR Cash out refinance into $300k mortgage.  Cash and original capital going into a flip now.

    CPA did TY2022 partnership return in March 2023 which included two separate K-1s for my spouse and I splitting the losses (~$2111 each).  We filed a Joint Federal Return in April, plus State returns in Indiana and LLC one for Illinois.

    Tax forms for LLC return:

    8879-E File, Form 1065, Form 1065 Schedule B, Form 1065 Schedule K, L, M-1, M-2, Schedule K-1 Form 1065 for Husband and separate one for wife, Schedule B-1 Form 1065, Partners Basis Statement 1065 for Husband and separate one for wife.  

    Joint Tax Return-
    1040, Schedule 1, Schedule 2, Schedule 3, Schedule A, Schedule E, Form 4952, Form 8889 -Husband individual HSA, Form 8889 -Wife individual HSA
    Form 8959 Addition Medicare Tax (Wife), Form 8283 Charity, Form 8582 Passive Activity Loss Limitations (all Zeros since no property was in service yet)

    1Reply
  • Daniel Schiff
    OP
    Member since 2022 · 7 posts · 4 votes
    2y
    Quote from @Michael Plaks:

    No. You cannot "1031 a balance."  1031 is for exchanging one rental property for another rental property.


    Sorry for my short comment "1031 the balance" but in essence if I exchange a property sold for $300k with a $150k basis and buy one that is $250k with intent to rehab ($75K with an ARV of $425k)- I'm deferring part of the gain ($100k) from the first property via the exchange and paying tax on the $50k I take out. My reference to my scenario is this (from IRS):

    https://www.irs.gov/businesses/small-businesses-self-employe...

    "Generally, if you make a like-kind exchange, you are not required to recognize a gain or loss under Internal Revenue Code Section 1031. If, as part of the exchange, you also receive other (not like-kind) property or money, you must recognize a gain to the extent of the other property and money received. You can’t recognize a loss."

    Am I reading this incorrectly?

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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    2y
    You are. 
    1031 exchanged are not applicable to flips. They are for hold properties.
    0Reply
  • Daniel Schiff
    OP
    Member since 2022 · 7 posts · 4 votes
    2y
    Quote from @Michael Plaks:
    You are. 
    1031 exchanged are not applicable to flips. They are for hold properties.

     Understood - so if I hold for a year as a rental would open the option for 1031 (and also to sell as capital gain versus ordinary income).

    0Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    2y
    Quote from @Daniel Schiff:
    Quote from @Michael Plaks:
    You are. 
    1031 exchanged are not applicable to flips. They are for hold properties.

     Understood - so if I hold for a year as a rental would open the option for 1031 (and also to sell as capital gain versus ordinary income).

    If you use this property as a rental, then yes, it changes its character to a rental property, and it opens the door to capital gains treatment and to 1031 exchanges. 

    Doing it purely for tax purposes is risky though. Remember that you will need to secure long-term financing, deal with tenants who can destroy your newly rehabbed property or refuse to leave, and a host of other potential issues.
    2Reply
  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    2y

    @Daniel Schiff

    Seems like you are honing in on it...  flips are dealing in inventory and not investment property so you can't 1031..  actually, I believe partnership are considered pass-through entities. It may file a 1065 return, but the actual tax is on your personal returns of the partners who receive the k-1.

    If you've maxed out your fica, then you pay your respective medicare parts.  So, its not that much.  

    You mentioned about "..reinvesting the remaining profits with our original capital.." It really doesn't matter if you 'keep the profits' in the company.' Because of the taxation, the tax liability it handled on your tax returns. It doesn't matter if you withdraw funds from the LLC. Common misconception. The term/concept of "reinvesting the profits" has nothing to do with taxation.

    Good luck.

    3Reply
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