Switch Property to LLC for tax purposes?

13 Replies

Hi all! I have a property I bought through the Duval County Foreclosure website with cash. I am working with 2 people on fixing it up and flipping it. The property is in my name. We are going to split the profit evenly 3-ways when we sell it. We are tracking all of the expenses basically on an excel spreadsheet to track who is buying what, when and we have electronic receipts for everything.

We all work full time and are doing this on the side. I'm reading The Book on Tax Strategies for the Savvy Real Estate Investor and I'm just getting to the Entities Section.

I just made an LLC. Should I switch the property over to the LLC for tax purposes? Should I convert the LLC into an S-Corp?

Also, we're doing all of the work ourselves and it's a bit of a drive to and from the property. In order to write-off the trips to the property, is keeping a log enough? It seems like anyone could just fake a log...

You would have wanted to purchase it in the name of the LLC I would think, for liability more than tax purposes. I was under the impression that a LLC tax status is to "flow through" directly to the owner(s). Document everything and get a good CPA come tax time!

That's awesome that you guys are doing this. 

Should I switch the property over to the LLC for tax purposes? Should I convert the LLC into an S-Corp?

Russ is right, Flipping is a riskier and business entity is a right way to go.  Looks like you are doing a good recording keeping but make sure you dont pierce the corporate vile.

The entity needs to maintain its own books. To get the desired asset protection, you need to treat LLC/Scorp as a separate entity. Don't pierce the corporate Veil:

  1. This can occur if the entity either is poorly capitalized.Inadequate Initial funding of the entity
  2. or fails to maintain a separate identity from its owners ( using the business bank account for business purchases, maintaining separate books)
  3. Conversion of entities Assets for Personal Benefit
  4. Another factor that poses a risk of piercing the corporate veil is the draining of entities assets (such as payments of large salaries to shareholder-employees) that leaves the entity with inadequate resources to pay its debts.

As you earn more income from flipping business, you should definitely elect to S-corp to save on SE tax. but if you are not making around 80k Plus, the benefits are outweighed by the complexity and expenses of maintaining it. ( tax pre-work, payroll expenses and so forth). There is no payroll in the LLC and cheaper professional fees.

If you elect S-crop, you don’t have to pay self-employment taxes on the Corp’s Net Income, but only after the reasonable salary to the employee (which will be you). So salary that you pay to your self is still subjected to Self-employment taxes anyway. So,

a) If you make 20k through S-crop, you have to pay yourself a salary and it must be reasonable, so entire 20k might be your salary. Entire 20k is subject to SE tax. This election did no good and S-corp gives your exact same liability LLC.

b) If you make 100k, you pay yourself, 50k. The first 50k is subject to SE tax, but remaining 50k is not. Thus, S-corp becomes more valuable once you start making more money.

Also, we're doing all of the work ourselves and it's a bit of a drive to and from the property. In order to write-off the trips to the property, is keeping a log enough? It seems like anyone could just fake a log...

There are various Free Apps that actually automatically tracks your mileage (Miles IQ)and that is contemporaneous that IRS has no problem if ever audited. 

Thank you @Ashish Acharya ! This all makes sense.  This tax year, we won't be making much, but I'm trying to plan ahead as we scale. I'm anticipating making +80k in profit next year, so for this conversation let's pretend we are making that now.

I know it's possible to switch my property into the LLC, but what about all the finances we've already spent out of our own bank accounts? Is it possible to start an LLC bank account and some how transfer ~$80,000 of spendings into the bank account? Or is that all too late now?

Also, @Ashish Acharya I tried your website from your profile and the link seems to be messed up.

What are some driving apps your speak of? Maybe you're not allowed to say on the forum...

Originally posted by @Thea Linkfield :

Thank you @Ashish Acharya ! This all makes sense.  This tax year, we won't be making much, but I'm trying to plan ahead as we scale. I'm anticipating making +80k in profit next year, so for this conversation let's pretend we are making that now.

I know it's possible to switch my property into the LLC, but what about all the finances we've already spent out of our own bank accounts? Is it possible to start an LLC bank account and some how transfer ~$80,000 of spendings into the bank account? Or is that all too late now?

Also, @Ashish Acharya I tried your website from your profile and the link seems to be messed up.

What are some driving apps your speak of? Maybe you're not allowed to say on the forum...

 IDK if I could mention here so I messaged you. 

Hi Thea,

As long as you are in the same tax year, it is not a problem to move your expenses into the entity.  The journal entry into the entity's books would be to debit the expense and credit capital contribution (to the respective person).

Here are a few things to add to what Ashish said, LLCs are able to have disproportionate distributions while S-corporations are not.  So lets say you all own an S-corporation equally (1/3 each), but you have spend different amounts on the costs so far.  If you wanted to reimburse yourselves through a distribution, the distribution would still be equal (not in accordance with how much you put in).  Therefore, it is easiest if everyone puts in the same amount (if you have equal ownership interests), but if not  you will want to treat the inequalities as a loan.

Despite that, if you are in the flipping business, I would recommend being set up as an S-corporation rather than an LLC. My reason for that is you want to avoid the IRS labeling you (as an individual) as a dealer. Dealer status means that any property sales you have would be at ordinary income rates rather than capital gains. This doesn't matter while you are flipping as those are taxed at ordinary income rates anyways, but if you also have rental properties (owned personally or through a different LLC) that you occasionally sell you want those to be taxed at capital gains rates.

My general advice is to hold rentals through LLCs, and flip properties and new development through S-corporations.

I would hire a CPA so you can get specific and legitimate advice.  Here's why:

1) Your mileage may OR MAY NOT be deductible.  It depends on whether or not the IRS will classify this as a commuting expense or an actual mileage expense.

2) If your mileage is deductible, you may OR MAY NOT be able to deduct it as a line item.  You might have to capitalize the cost (in the case of a rental) or include it in the basis of the property you are going to sell (essentially adding it to the purchase price).

3) You state you've created an LLC. How you report on that LLC is dependent on how it was formed. If you formed it as a single member LLC for just yourself, that goes on Schedule C of your 1040. If it includes your business partners, then it gets reported on Schedule E. Since the property is in your name, the sale of the property will be treated as a capital gain (Schedule D item) and not on Schedule C or Schedule E being treated as ordinary income. Any losses you take on Schedule C or Schedule E will be passive losses since the house is in your name and the business does not have any ordinary income to offset those losses - and your losses will be carried forward until you either close the business or create ordinary business income to offset those losses.

Hire a CPA - talk to them.  It will save you money in the end.

@Brian Schmelzlen so if I elect the S-corp, which is essentially what I want to do, there's no way to have different members put in different amounts of money? Is there any way around this?

@Ed E. If, in order to split the profit up the way we see fit, can we just file as a multi-member LLC (Schedule E) and have a standard operating agreement that states what each person's responsibilities are and profit shares will be? Our profits would be taxed as ordinary income correct? Although, it wouldn't matter too much if the profit was getting taxed from ordinary income compared to capital gains because we held the property for less than one year, correct?

TWO more questions! (1) If I purchased the house in 2017 in my name, and we aren't going to sell until 2018, does it matter if I put the house in the LLC's name in 2017? (2) Will you ever have to pay capital gains in addition

(2) Will you ever have to pay capital gain tax in addition to ordinary income tax? ** 

@Thea Linkfield

S-corps are less flexible than Partnership entities in regards to allocating income and making distributions.

S-corps need to make distributions based on ownership in the company.
If an S-corp is owned by 3 shareholders who owned the S-corp equally 33% each. Shareholders would get 33% of income/losses and distributions.
another example is if an S-corp is owned 90%, 5% and 5% the shareholders would get 90%, 5% and 5% of income/losses and distributions.

On the other hand - Partnership vehicles are more flexible and can say a partner who owns 100% of the capital would only get 50% of the income.

Also multi-member LLC's would require the filing of a form 1065(partnership return) where the partnership would then distribute a K-1 to each partner/member which they would then report on their individual tax return.
Conversely, an S-corp would require the filing of a form 1120S(S-Corp tax return) where the corporation would then distribute a K-1 to each shareholder which they would then report on their individual tax return.

A flip that took more than 1 year would still be taxed as ordinary income.

Thank you @Basit Siddiqi that cleared some things up for me! I really appreciate the knowledge and clarification everyone is bringing to the forum.

It's my understanding that S-corps have to pay pay-roll taxes for the salaries paid to the members in addition to the income taxes the members pay. If using a multi-member LLC, would there be any taxes on the distributions to each member in addition to income taxes for each member?

@Thea Linkfield

S-Corps are required to pay reasonable salary.
Example
S-corp with 1 shareholder makes $100,000 before wages. Reasonable salary is $50,000
S-corp will issue a W-2 to Shareholder for $50,000.
Shareholder will receive a check for $46,175($50,000 less social security and medicare tax of $3825; not factoring in fed & state withholding)
The S-corp will also be required to issue a check of $3825 to Social Security because the employer matches the employee payroll taxes.
Shareholder will report on his individual return $50,000 of wages and $50,000 of S-corp income for a total of $100,000. 
In a simple explanation he would then net it against any standard/itemized deductions + personal exemptions and calculate his/her tax.


Pass-through entities such as partnerships and S-corps pass-through income as it is earned and not necessarily when it is distributed. 
Yes - there may be an instance if the distribution is above the partner's basis - that he may need to report additional income.

@Thea Linkfield

I think there's still some confusion left as to the partners' expenses, either S-corp or partnership. Reimbursing expenses incurred by the partners are not distributions in the sense of the S-corp equal distribution rule. Example: you bought $200 of paint on your personal credit card, and the LLC pays you $200 back. This does not break any rules.

However, if you had no initial capital in the LCC and you paid $50k of expenses, one of your partners paid $100k, and the other paid $150k - you do not have equal 1/3 ownership of the LLC any longer. You have 1/6, 1/3 and 1/2 ownership stakes, respectively. Such fluid change of ownership can create all kinds of issues and is not recommended.

I recommend you do NOT structure this "working with 2 other people" as a joint venture at all, if possible. Keep the LLC as your exclusive business and document your partners as either lenders to the LLC (if they provide money) or contractors of the LLC (if they provide labor or services.) Too many reasons for this.

If you're unable to agree to this, and your partners demand ownership stake, then you all really need to contribute lump-sum capital into the LLC, instead of buying things for the LLC at random. The latter is a time bomb, and not just for taxes, but more importantly for the general health of your partnership.

Finally, no rush to elect S-corp until your business shows substantial profit - which is not guaranteed in your first year of operation. Besides, S-corp does not necessarily reduce SE tax for you, it depends on your financial situation. When/if you do elect S-corp status - you will only need to pay reasonable salary to those partners who provide services/labor.

@Michael Plaks this is very helpful. I appreciate you reading my exact questions and providing such a relevant response! For now, I'm just going to keep it as a single-member LLC and I will have my 2 partners be lenders, as they are each providing different sums of money. This will also work better as I move forward and do different deals, these partners may not be involved in every one.

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