Where to put expenses for efficient tax prep?

Question

My husband and I have an LLC for our flip business, which is also a licensed general contractor business, in Oregon.  I personally also have my Oregon real estate broker's license, which I obtained to help with the business of finding and selling these flips.

My first question is, we set up the LLC as a 2-member LLC, so I will need to file the taxes on that as a Partnership, correct?

Second question is, can I put my real estate expenses under this LLC, so I don't have to prepare a separate Schedule C for that?  All real estate expenses are ONLY for our flips, I have not done, and will not do any outside transactions.

I think that's it for now!  THANKS!

Tracey in Oregon

Brian Schmelzlen · Answer

Hi @Tracey Hamilton,

By default, your LLC is taxed as a partnership.  If you choose, you can elect to have it taxed as a corporation going forward.

It hasn't been discussed yet, but as a flipper you (meaning the entity doing the flips) are considered to be a "dealer".  The IRS defines a dealer as anyone who purchases real estate and sells it to customers in the regular course of business".  Therefore, the real estate is inventory to your business, and as inventory upon sale it is taxed at ordinary income rates (not capital gains).

That is not a problem for your business; that is the correct treatment.  The problem is if you also have rental properties.  You want to be able to depreciate your rental properties, and eventually when they are sold have the sale count as a capital gain and not be taxed at ordinary income rates.

Therefore, you want the dealer status to be contained within your entity.  An LLC won't do that; the dealer status will attach to you as an individual.  However, as an S-corporation the corporation itself (as a separate legal entity) would be the dealer, not you.

There are other advantages to operating a flipping business as an S-corporation.  The main one has to do with self-employment taxes.  You don't have to worry about self-employment taxes with rental real estate so an LLC is fine for that, but ordinary income through an LLC would have self-employment taxes.  Therefore, you might want to consider setting up an S-corporation and paying yourself a "reasonable salary".  That salary would be subject to payroll taxes, but any additional distributions would not.

Not exactly what you asked, but I hope this helps.

Michael Plaks · Answer

@Tracey Hamilton

To your first question - yes, partnership.

Your second question is trickier. From the federal tax angle - yes, all the Realtor expenses will be incurred for the flipping/GC business, and therefore they must be paid by the partnership, as @Nicholas Aiola stated, and ultimately deducted by the partnership.

A problem might arise with you being a licensed Realtor. As a Realtor, your commission income will be your personal income and will be required to be issued to your personally and will be reported to the IRS under your personal SSN. Unless Oregon allows a partnership to hold an agent license (which I doubt, but not 100% sure) - there will be no way to report your commissions under the business tax ID, called an EIN. The IRS computer will be searching for this income on your personal return, and you will have to jump thru some hoops to re-route the income to the partnership and avoid being flagged.

And even without commissions, the Oregon Real Estate Agency might have an issue with you, due to their potential exposure to legal liability from your flipping. I don't know if they are strict about that, but it's worth checking.

In the end, it may be worth it to still treat your Realtor activities as your personal ones and create a Sch C. You can even formally have the partnership hire yourself as a consultant - but this step warrants a discussion before implementation.

Nicholas Aiola · Answer

@Tracey Hamilton yes, a separate partnership tax return will have to be filed for the LLC since it is multi-member and Oregon is not a community property state.

If your flips are being conducted through the LLC, the expenses should be paid through the LLC. Most, if not all, of the expenses related to the flip will be added to basis and used in determining the taxable profit upon the sale, so flip-related expenses should be noted as such, separately stated from other, non-flip-related expenses.

Michael Plaks · Answer

@Tracey Hamilton

I can see some of my colleagues expecting you to make huge profits from flipping. I sure hope so, but I'm more reserved about it. 95% of new flippers lose money initially. You having your own GC business should help, but you still have a lot of hurdles to clear.

I never recommend structuring for tax advantages (like an S-corp) from the get-go. I suggest starting simple (just a partnership LLC in your case) and then maybe transitioning to an S-corp when the numbers warrant it. Otherwise, you will quite possibly get the extra hassles and limitations of an S-corp without benefits.

Tracey Hamilton · Answer

Ah yes, that's something that I had given some thought to, and in fact, have intended to set up as an S corp, and do the salary.  We were waffling on it, though, because we hadn't found a flip, but we just got our offer accepted yesterday, so I will proceed with that.  THANK YOU for reminding me of it!!!

I am SO GRATEFUL for the masterminds here at BP!!!  You guys rock!

Tracey Hamilton · Answer

OH, wow, excellent replies!!!  Thank you!!  Lots of things I hadn't thought about.

I did call both the Oregon Contractor Board and the Oregon Real Estate Agency, and they both said there were no rules or regulations against being both a contractor and a broker, and doing flips.  So, that was good!

I will see if I can get in with my tax prep mentor (I am also a licensed tax preparer, lol, but I'm a newbie still), to see what his take on it.

LOVE the advice, guys, thank you again!

Natalie Kolodij · Answer

@Michael Plaks hit the nail on the head here.

My first instinct is that I would separate these into two different LLCs.

LLC 1- Flip houses

LLC 2- Real estate sales

LLC 2 can be a single member LLC, just in your name. This makes it a disregarded entitity and means there is no separate tax filing. It still just gets reported on your schedule C same as before. If you are the closing/listing agent or any related expenses happen with flips- we can formally move the funds between the two.

With the flips the accounting is often incorrect. I amend a lot of returns for this. Also, this is a huge planning strategy are due to it being active real estate income, large incurs of cash, and subject to self employment tax.

I would also suggest sitting down with your tax professional sooner rather than later and kind of talking through all of this.

Both are excellent options and offer some great tax strategies- and now you can qualify as a RE pro. Which once you throw rentals into the mix will be a HUGE benefit.

Good luck! Feel free to PM with any questions.

Where to put expenses for efficient tax prep?

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