How to pay less taxes? 1 silent funding-1 active proj manager

17 Replies

Hi.

I understand with flipping you have to pay ordinary income taxes on the profit.

Could anyone explain how taxes would be for a partnership, in which profits would be divided 50-50 in the following scenario: 

==one partner (the funding partner) is already in the top income bracket and completely funding the deal, but is not active in the management of the flip. He has his own W2 and jobs separately and is not an active flipper.

==one partner (the project manager) found the deal and completely manages the project, etc. he's more of an active investor and is in a lower income bracket than the funding partner.

Let's just say the profit is $100k on a 1 year flip.

Are there ways to reduce taxes for the higher income funding partner?  Could the funding partner possibly pay the project manager a salary to reduce the funding partner's taxes? 

 Or could funding partner set it up as a loan in which the split profit is payment for the debt? (would debt in this case be taxed as long term investment / capital gains?)

Are there any other ways to avoid income taxes on the profit?

The only easy easy to reduce taxes (other than proper planning) is to make/generate/earn less money. 

He's welcome to give me all his profits... Which should reduce his tax burden to zero.  😉

He can be paid interest payments on his investment. Should be taxed at a lower rate.

Originally posted by @Jared Irby :

He can be paid interest payments on his investment. Should be taxed at a lower rate.

I don't believe that's true.  Interest is still considered ordinary income from the IRS' standpoint...

Ok I am not a tax attorney or a tax advisor , However I have read a TON of books on business taxes, and I own my own company.  If your a partnership then you are taxed within your own tax bracket as an individual. If your an llc its very similar to this because most llc are treated as pass thru entities you can write off more than a partnership though. However, if you set up a C Corp (which is treated as a separate entity tax wise and has their own tax code), The first 50k is taxed at 15 percent, where as the individual is taxed at like 35 percent for that bracket. not to mention you can set up the company to pay salaries and Health benefits and put some of the profits in a company set up 401k and other huge ways to get around pay taxes on profits. I would find a Business attorney that sets up C corp and see if he is willing to discuss some pros and cons, It may cost you a consult fee (1-200) but at least you will be more educated in What may be a better way then paying 35 percent personal tax. Good luck.

If they fund via a SDIRA, they can defer the taxes.

Percy N.

This post has been removed.

Originally posted by @J Scott:
Originally posted by @Jared Irby:

He can be paid interest payments on his investment. Should be taxed at a lower rate.

I don't believe that's true.  Interest is still considered ordinary income from the IRS' standpoint...

 But interest does not require self employment tax. However a high income earner may already be above the limit where that will help. 

Originally posted by @Ned Carey :
Originally posted by @J Scott:
Originally posted by @Jared Irby:

He can be paid interest payments on his investment. Should be taxed at a lower rate.

I don't believe that's true.  Interest is still considered ordinary income from the IRS' standpoint...

 But interest does not require self employment tax. However a high income earner may already be above the limit where that will help. 

 Yup, I was assuming he was already making more than $110K...

@Percy N.

Yes one option would be to have one of the partners (the one that is not doing any of the sweat equity work) loan his IRA or 401k to the business in a form of a promissory note. Effectively, the 401k or IRA would be acting in a lender capacity so the note payments would flow back to the retirement account and continue to grow on a tax deferred basis.

Thanks for advice, I will look more into C-corps and SDIRAs as well.

Isn't intent to hold or flip what dictates regular income taxes vs capital gains taxes?

For a 1 year rehab could the partners set it up as a buy and hold, do a schedule E etc, and try to rent the property out for a high rent.  This is justifiable as they are fixing it up to rent it, and given they do receive a high luxury rate rent, they will keep it as a long term hold. 

 If they make an attempt to rent the house out at a high rent and cannot, could they then sell the property and pay long term capital gains?

As long as they provide schedule Es and make an actual attempt to rent the property out, then couldn't this be looked at as a rehab/long term rental thus paying long term capital gains?

In this scenario the intent was to rent it out long term, but given that the rent does not reach the criteria, they can sell it and pay capital gains taxes on the profit?

Also assuming the partners do not do many flips so aren't considered dealers.

50k income is 50k income, deferred or not, you have to pay it. If he is on the 34% bracket, and you are on the 10% there is an aggregate as you climb, if your final bracket is 28%, and you are ok with sharing the 6% (say you only have the 50k income for the whole year and nothing else), then you maximize it at say 75k - and be still at 28%, then he could save 6% on the 25k.

Figures above are examples and does not constitute the right tax rates on the brackets.

What you are trying to do, is in your eyes the right way, even if you hire professionals, the eyes of the irs are sometimes different. Try to put yourself in their shoes, while you are looking for loopholes, they will also look for ways to prove you wrong, and since they deal with these everyday, I suggest that you don't take it lightly and hire a professional. If you do not want to, just pay the right taxes, if you are wrong, you will have to pay them anyway plus penalties.

Originally posted by @Will F. :

Thanks for advice, I will look more into C-corps and SDIRAs as well.

Isn't intent to hold or flip what dictates regular income taxes vs capital gains taxes?

For a 1 year rehab could the partners set it up as a buy and hold, do a schedule E etc, and try to rent the property out for a high rent.  This is justifiable as they are fixing it up to rent it, and given they do receive a high luxury rate rent, they will keep it as a long term hold. 

 If they make an attempt to rent the house out at a high rent and cannot, could they then sell the property and pay long term capital gains?

As long as they provide schedule Es and make an actual attempt to rent the property out, then couldn't this be looked at as a rehab/long term rental thus paying long term capital gains?

In this scenario the intent was to rent it out long term, but given that the rent does not reach the criteria, they can sell it and pay capital gains taxes on the profit?

Also assuming the partners do not do many flips so aren't considered dealers.

 If the intent is to hold, it would be taxed at capital gains.  But, keep in mind that if it was audited, the IRS would want to see the hold part substantiated.  For example, did the renovations you did be more common with a flip or a rental?  Did you hire a property management company to try to get the property rented?  Did you get insurance coverage as a rental?  Did you post in a public forum about how you were actually planning to flip the property before writing that you were looking to hold?

Tax questions are always best answered by a local tax pro.

First and foremost, understand that if you purchase real property, fix it and sell it within a year even if somehow you could get that asset to be recognized as a capital asset the short term capital gain will have those funds taxed at the same rate as each investor's ordinary income.  So there is really no beneficial tax treatment.

Investors who purchase more than three real properties and sell it, regardless of hold time, will most likely have to treat all that profit as ordinary income because the actions taking place are that of a dealer.  A dealer status means the real property is treated as inventory and distributions will always be treated as ordinary income.  

Real property used for investment purposes is not usually considered a capital asset.  Therefore not subject to capital gains treatments.  Only ordinary income treatment.  Now real property purchased as a primary residence can be treated by that owner as a capital asset subject long term capital gain after 705 days of ownership (or some number close to that).  The key idea there is the real property is not purchased as inventory to be sold for profit/loss it is purchased to be enjoyed.     

Investors can qualify for certain passive status and those gains and losses can be used to off set other passive gains and losses.  However the treatment is within that group and usually doesn't extend or attach to other non-passive investments.

The investor can join the LLC by giving capital in the form of debt. The interest paid to the investor is still treated as ordinary income but the LLC will have an interest expense which will lower the net profit.

If a non-taxable entity made the investment then that entity would receive the distributions and since that entity is non-taxed, so is their distributions. 

Beside the above there is no way to avoid taxation.

If you are getting into the business of buying real property, fixing and selling it you are a getting into being a dealer.  Accept it.  Embrace it.  While there are stories about rules which apply to dealer definition like less than 3 per year or holding for more than one year, those are not entirely correct nor universally applicable.  The IRS closed many of the real estate tax loopholes over the past two decades.  

It is not a great idea to try and be 'creative' with this stuff.  See your tax pro.

@Mark Nolan undefined

Your response got me thinking about a question I've had for awhile. Can someone make a loan out of their SDIRA to their own business? I was looking into this issue regarding lending out of a SDIRA to a disqualified person's business entity  but the ARISA lawyers I spoke with could help one bit.

Originally posted by @Neal Collins :

@Mark Nolan undefined

Your response got me thinking about a question I've had for awhile. Can someone make a loan out of their SDIRA to their own business? I was looking into this issue regarding lending out of a SDIRA to a disqualified person's business entity  but the ARISA lawyers I spoke with could help one bit.

The only "legal" way I know to do this would be a way that the IRS refers to as a "ROBS":

https://en.wikipedia.org/wiki/Rollovers_as_Busines...

I had one for a couple years, but was very uncomfortable with the level of documentation, regulation and perceived risk associated with it, so I shut it down.

Back in the old days we did one like this.

A young  investor who was renting commercial space from wanted our help to buy several properties at a tax lien auction. His intent was to rehab & flip.

Because the properties were all in the same county (including his free & clear principal residence) we were able to write a blanket mortgage note on all properties with a high interest rate, origination fee & pre-payment penalties.

As each was sold the blanket mortgage was effectively paid down with the mutually agreed prepayment penalty. But he also had access to further draws on the note as he bought more properties & needed financing for the subsequent rehabs.

It ran very profitably for some years then he decided to hold some as rentals after paying down the note completely from those that he sold. 

He then bought some acreage from us & we held the financing @ 16%. He paid that off in 5 years & then built a new 4500 sq ft home on it. By that time he was 36 yrs old.

Our tax consequence was 'passive' interest income per the annual 1098. 

We ran into him several months ago at the Cadillac dealership when my wife picked up her new vehicle & he was taking delivery of a new Escalade that he paid cash for.

Originally posted by @Jim Murphy :

Ok I am not a tax attorney or a tax advisor , However I have read a TON of books on business taxes, and I own my own company.  If your a partnership then you are taxed within your own tax bracket as an individual. If your an llc its very similar to this because most llc are treated as pass thru entities you can write off more than a partnership though. However, if you set up a C Corp (which is treated as a separate entity tax wise and has their own tax code), The first 50k is taxed at 15 percent, where as the individual is taxed at like 35 percent for that bracket. not to mention you can set up the company to pay salaries and Health benefits and put some of the profits in a company set up 401k and other huge ways to get around pay taxes on profits. I would find a Business attorney that sets up C corp and see if he is willing to discuss some pros and cons, It may cost you a consult fee (1-200) but at least you will be more educated in What may be a better way then paying 35 percent personal tax. Good luck.

 you will still pay individual income tax on any money that the corp distributes to you.  many advantages to a corp structure, but avoiding personal income tax is not one of them.

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