So, I'm active duty military with rentals held under my name and an umbrella. I'm going to start flipping. I was going to start an LLC because I was told that it will limit my taxes to 15%. Currently I'm in the 25% tax bracket. I'm a CA resident, but due to my employment I don't pay state tax in CA or VA. I asked my CPA about flipping within the LLC and his response was this:
"The character of the transaction is retained, whether in an LLC or not. Thus, the LLC will likely not having any effect for tax purposes."
I asked a second CPA and he said:
"Your CPA gave you correct but incomplete advice. The LLC itself is a generic entity. If you did nothing it would be treated as a "disregarded entity" or ignored for tax purposes. If you elected to treat the LLC as a corporation, you could take advantage of the 15% corporate tax rate but this involves planning as the money would be taxed again when you take it out."
There is a lot of confusing info on the internet about how taxes are handled. Can anyone break this down to the third grade level for me?
I have a couple rentals held in my personal name and a couple in an LLC. Your CPA is correct (at least for federal and the states I'm in), that the LLC is a pass through for tax purposes. If you solely or you and your wife will be the only members of this LLC, you do not even need to file a separate tax return - all info could be filed on schedule E of your personal return. (I'm not a CPA, just explaining how I do it)
The LLC will however provide you with some liability protection in the event something happens at one of your properties.
One other note - most banks do not allow you to put title in the name of an LLC. So if your properties are financed through normal banks, this could be an issue.
I was going to start the LLC specifically for flipping because I was told by others (Not CPA's) it limits my taxes to 15%. I'll be using hard money loans to buy and my own cash to finance the flip.
Your first CPA is correct but doesn't understand real estate, especially flipping.
Your second CPA also doesn't understand real estate businesses. Real estate should rarely be held in a C-Corp (or LLC taxed as a C-Corp) which is what he is suggesting. The list is endless for why you shouldn't hold property in a C-corp, and CPAs suggesting domestic owners flip or hold in a C-corp should be brought up on negligence unless there is some compelling reason for that advice.
Generally, flippers should be flipping in an S-corp. Not flipping in an S-corp will subject all earned profits to self-employment tax (15.3%) which is why your first CPA's advice is no good. In an S-corp, you pay yourself a reasonable salary which is subject to the self-employment taxes - the remaining profit is considered a distribution and not subject to self-employment taxes.
You earn $100k on a flip. Taking the first CPA's advice, you will pay $15,300 in self-employment taxes alone.
Taking a real estate savvy CPA's advice, you form an LLC and elect sub chapter S status. You determine a reasonable salary for your skills and level of effort is $50k. Of the $100k profit, $50k is salary and $50k is a distribution. As such, only the salary portion is subject to self-employment taxes and you pay $7,650. So your real estate savvy CPA has saved you $7,650.
Additionally, I have a few clients based out of CA and their entities are subject to the CA franchise tax, a minimum of $800 per year whether your entity reported a profit or not. So keep that in mind as well.
In summary, seek out a real estate savvy CPA.
Although I'm a CA resident I don't pay any taxes in CA because I'm in the military and live in VA. Does that matter? My CPA is saying I'll basically be paying "For 2014, you were squarely in the 25% bracket with room to go. Thus, I would assume @ 31% (25% Fed and 5.75% VA)" for flipping. I will have to pay VA tax for flipping, I do know that much.
Is there anyone else who can break this down Barney style?