Taxes and Legal Structure Questions

2 Replies

Hello Everybody,

I am a newbie in RE. After conducting some research, I have decided to begin my real estate journey by wholesaling. I do understand the process but there are two topics of interest that I have not yet heard discussed about, for someone like me who is just starting out, that I would like some insight on:

1. When you take your profit after the double escrow, what records must you create/hold/archive to report that profit to the IRS and should I set some of that profit aside, just in case, to handle any tax burden that might arise?

2. Should an individual investor create a legal structure (sole proprietor, LLC, etc) before making that first deal or is it ok to engage in wholesaling solely as an individual investor; provided you maintain the proper records needed to file taxes to the IRS?

Thanks in advance for any insight you can provide on this issue as it is the only concern, that I have, that is really holding me back from taking the plunge into wholesaling.

Hi Steven,

Welcome to BP and congratulations on getting started.

Here is what I can contribute to your questions:

1.) You should receive tax documents at the beginning of the year from whoever handles the closings. These will include any income you made and will need to be given to your CPA or included in your tax returns if you do your own.

2.) Entity forming is largely a matter of opinion. For instance, here in California I would not recommend someone start an LLC if they are just starting out in wholesaling because it will cost you $800 just for the privilege of doing business in the state as well as an additional return fee from your CPA for the business. I would recommend a SP for tax purposes however this will not give you any kind of legal protection. Each state is different and some states you can form an LLC for as little as $50, some even less possibly. In that case it may be more worthwhile however you'll still have an additional fee to file the tax return if you use a CPA.

My opinion for someone who is just starting out and who may not be doing a lot of deals right away would be to have a RE attorney who understands wholesaling look over or draft your contracts for you so you know that you have a solid contract that will hold up. Once you start doing more deals then possibly look at forming an LLC. Again, this is my opinion and others may disagree. As I stated, it's up to you and what your comfort level of risk is.

Best of luck!

Eric

DISCLAIMER: This is neither legal nor accounting advice. Please consult a qualified tax and legal professional for more information.

(1) Your CPA will ask for copies of the settlement statement(s). If you get the property under contract and then assign the contract (or sell your equitable interest for a fee), there will only be one settlement statement. If you do two closings, there will be two settlement statements. In addition, keep any receipts of any out of pocket expenses which wouldn't appear on the settlement statements, such as buying signs, any notary fees, etc.

As for setting aside any of your profits to pay for taxes, definitely consult your tax advisor on this. If you have absolutely no income, your standard deductions may offset a few wholesale deals. But as your income increases, so too does your tax obligations. If you are bringing in $60,000 a year at your day job, then you may want to save about 25% or so to pay for taxes on your profits. Depending on which legal entity you use to conduct your wholesaling, you may have to pay extra self employment taxes on top of ordinary income taxes.

(2) I put together a great YouTube video a while back to answer this exact question. Since I can't put the link in this Forum thread, the way to get to it is to go to YouTube and then search for "Best Legal Entity for Real Estate Investing". This video will show up #1. It covers the legal and tax pros and cons of sole propreitorships vs LLCs vs S Corps for real estate investors.