Tax Strategy, Construction LLC?

Question

I'm a newbie investor in the Baltimore market, and am fairly hands on rehabs and construction process. I plan to act as the General Contractor, sub-contract some rehab work and take on some myself to keep my rehab costs low to start. My thought is these activities are active in nature and I'm looking for strategies to move some of my expenses move from the passive category to active so I can get some tax benefits against my W2 income.

Would creating a Construction LLC be a good idea to implement this strategy? Any other recommended strategies that will help offset W2 income taxes?

Thanks all!

Would creating a Construction LLC be a good idea to implement this strategy?  Any other recommended strategies that will help offset W2 income taxes?

Thanks all!

Bob Norton · Answer

@Robert Fernandez In your statements above, I didn't see where you would have any passive income.  If your intent is to fix and flip properties, then that is active income.  On the other hand, if you intend to fix and rent your properties, then that is passive income.  Since passive income is not subject to self-employment tax, I generally do not recommend paying yourself as a contractor on projects that you fix and rent.

As for setting up a Construction LLC, that's a separate issue.  If you plan to fix and flip properties (or act as GC for other customers) then you probably want to setup the LLC for liability protection.  For that to work, you would have to get the proper types of insurance and separate your business banking transactions from your personal banking transactions, at the very least.

Also, when you fix a property to either flip or rent, the costs of fixing the property are generally capitalized and depreciated over many years.  So, you would not be able to deduct your rehab costs against your W-2 income as you mentioned.  You would be able to deduct any general overhead costs that you incur.

Michael Plaks · Answer

Correct

Daniel Hyman · Answer

If this is an active business, which it seems to be as @Michael Plaks mentioned, you might want to look into other strategies like a solo 401k.

Bob Norton · Answer

@Robert Fernandez Yes, the expenses of running the business would be considered overhead expenses.

If you are running a fix and flip business, then the overhead expenses that you mentioned would be deductible in the year that you spent them. Even if you did not have a property sale.  (The rehab costs would be deducted in the year with the property sale.)

However, if you are running a fix and hold rental business, then the overhead expenses would be included as rental expenses during the year.  And, if these overhead expenses resulting in you having a rental loss for the year, then they would be treated as a passive loss and subject to the passive loss rules.  Which means that if your W-2 income is higher than $100,000, then some or all of the rental loss will be suspended and carried forward to subsequent years.

Robert Fernandez · Answer

@Michael Plaks  thank you!  Makes sense.  Honestly it’s what I thought, but needed some confirmation.  Thanks again...

Michael Plaks · Answer

@Robert Fernandez

A legitimate construction business is active and should generate positive income, LLC or no LLC. This increases your taxes, not decreases them.

If you're talking about having rental properties, and you mention GC in the context of exclusively doing your own rehabs - your separate GC business has to have an intention to make profit and operate accordingly. Otherwise, it is not legit and cannot have losses. You cannot simply state - oops, wanted to make money but lost my shirt working on these rehabs that just happened to be mine.

Robert Fernandez · Answer

@Todd Goedeke , thanks Todd.  Yes I’m contributing to my TSP up to max of my company match.  The rest I’d like to use to invest for cash flow rather than waiting for retirement.  I have a buddy that took the contract/self employed path and he is seeing a lot of the benefits of also investing in rental real estate.  Unfortunately I cannot switch, too vested.

Todd Goedeke · Answer

@Robert Fernandez, have you explored ways to reduce your W2 income thru 401k  and/or 401k contributions? Can you convert your W2 income to self employment income by working as a contractor /advisor for your current employer? That would allow you to reduce taxable income by up to $56,000 depending on your age.

Robert Fernandez · Answer

@Basit Siddiqi   Noting @Bob Norton comments, I am above 100k in W2 income.

Robert Fernandez · Answer

@Basit Siddiqi   Thanks Basit.  That makes sense.   What I’m struggling with is the amount of taxes on my W2 income.  I’d like to reduce them so I can reinvest on buy and hold rentals.  I know W2 is not the best income from a tax perspective, it’s better to be on the investment or business income sides.  I’m looking for pass thru strategies to get some “paper” losses from rental investments to my W2.  Things like depreciation, overhead, etc.

Sounds like I’ll have to suspend any passive losses above my net until I sell a property to free the suspended losses.  I believe the sale event would allow me to pass thru passive loss to my active W2 income.  Please correct me if I’m mistaken.

Tax Strategy, Construction LLC?

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