All Forum Posts by: Jim Kennedy

Thanks Raj. 

If you go from S corp to partnership under your LLC umbrella, you may want to do it on 1/1. When you chage business entities, you have to close your books on the day of change and start a new set of companiy's books. If you close your books tomorrow, your 1120S will be for the short year from 1/1/121 to 12/17/21, and your partnership will report on the short inital year also from 12/18 to 12/31. Do you really want to go thru all that additional bookkeeping? Also, frequently, filing an 1120S and a 1065 are two separate engagements that could cost you two separate billings. Why do that if you don't have to? From only the few sentences you posted, it sounds like you'd do better with the 1/1 change - but continue doing your homework now.

Hope that helps. Happy investing!

Jim Kennedy

Hi David,

Theres a number of CPA's on BP of which I'm aware, but you need to find one that is experienced, as you stated, but almost more importantly  can teach you what you want to know and also what you need to know. 

STR's and VBRO's have become a thing over the past few years. The IRS likes them because they can ding you for Social Security taxes on the bottom line, and states like them because they drive income tax and sales tax. I note your properties are in TN an income tax free state, so boo hoo for the TN Department of Revenue. There's ways around paying in Social Security. If you have a loss, then there's none due. If you have a day jobs those wages count as you approach the currently $142K FICA max.

Schedule C Requirements for Airbnb and VRBO Hosts Generally, you will file Schedule C for your short-term vacation rental if: The average guest rents the property for fewer than 7 days, OR the average guest stay is fewer than 30 days AND you provide guests with “substantial services”

Schedule E Requirements for Airbnb and VRBO Hosts

Generally, you will file Schedule E for your short-term vacation rental if:

Generally, you will file Schedule E for your short-term vacation rental if:

• The average guest rents the property for more than 7 days and you don’t provide “substantial services”, or
• The average guest stay is longer than 30 days

What are substantial services in short-term rentals anyway?

I’m glad you asked. Substantial services are part of the way the IRS determines whether your management of the property was passive or active. Substantial services include things like housekeeping while the unit is occupied, meals and entertainment, concierge services, linen service, etc.

If guests provide their own linens and you only clean the unit between guests, you are considered a passive owner for tax purposes. Further, maintenance on the property is not considered a substantial service, nor does it qualify you as actively working in the business (even if you’re doing the maintenance yourself).

One more thing: losses. If you have long term rentals, your deductible rental losses are capped at $25K annually, and as your AGI progresses from $10K to $150K your allowable current year loss drops to zero, and is suspended until other stuff happens (different topic for another day) Meanwhile, if you have a loss on Schedule C, you can typically deduct it ALL...offset W-2 wage income, and other types of income too. AT least in the first year, the way to do that is to accelerate the depreciation. I have posted several times over the past five years on this topic in details so if you search you kind find a lot of education, information and tips

Hope that helps. Happy investing!

Jim Kennedy

If you are an LLC you probably lucked out. All you have to do to go from an S to a partnership (or single member LLC) is notify the Fed and State governments that you made that change. You don't need a new company. Your LLC is still your LLC. All it did was decide it wanted to be treated differently for tax purposes. You retain the original Fed ID#, and that's it. Form 8832 helps you do this: https://www.irs.gov/forms-pubs... and it doesn't ask for much information either: https://www.irs.gov/pub/irs-pd...  

The tax side is not complicated once you understand the above information. However, the legal side may call for a little more work. I am not a lawyer and cannot give legal advice, so you might want to check with an attorney to see if you need to file a state registration form, maybe amend your current state registration, and oh yes, pay a fee. States always have a fee. Can't live without a fee, right?

The tax differences are that you can no longer take a salary. In an S COrp the officer(s) are required to take reasonable compensation. Not so in a partnership, so if you have a payroll company, you can let them go. In a partnership, you take no deductible compensation at all. All the net income flows thru to your personal return. real estate is largely passive, so you pay only income tax, and not social security like you did in the S Corp days of your life. That alone is a 15.3% increase in your cash flow!! However, you need to watch out and keep an eye on your income, in case you need to make an estimate payment. Not making when could cause you to owe come $/15, and if its big enough, you could be assessed a penalty for underpaying and another one for not paying quarterly estimates, and then have interest tacked on to all that.

And yes, if you buy and hold get out of an S Corp ASAP!

Jim Kennedy 

I agree with all the previous responses here. You outgrew your $200/yr preparer. Your return wasn't very complicated at that time. Its the old "You get what you pay for".  You definitely need a higher level CPA because you're in the investor big leagues now. 

For instance, lets think about your depreciation. Standard tax protocol is to back out a portion for land (since we don't know how long land is good for) and take the rest over 27.5 years (Congress told us that number). Is that wrong to do that? No, but you may be leaving a lot of money on the table. Your next tax preparer should be experienced with cost segregation, which is a way to accelerate depreciation and get more deductions in the current year, rather than wait 27.5 years, to get all your cost back, especially if its the year of purchase. Then again, if you've had the properties for more than two years, your next preparer should be familiar with how to take a cumulative adjustment in the current year for ALL the years you owned the property, known as a Section 481(a) adjustment, AND how to complete the related 8 page Form 3115.

Next, let's talk about financial planning. If your next CPA is not a Certified Financial Planner, then you should engage one if you have significant assets - real, stocks, bond, cash, etc. A CFP (Certified Financial Planners) should excel at this. They should have the ability to match your goals to one of easily a dozen different types of retirement vehicles, NOT just try to sell you a variety of insurance policies, as well as explain it all to you in one and two syllable words. Fun fact: I'm a CPA but I don't do my own financial planning. I work with my CFP because that's what he geeks out on. Your next CPA and your CFO should work hand in hand to lower your taxes and prepare you for the future. Remember the 5 P's of the Marine's - Prior Planning Prevents Poor Performance

Then there's your state issues. Of the 44 states that have income tax,  no two are completely the same. State tax law does not always tag along with the Federal tax code. Each state is free to write their own rules. In NJ for example, you can deduct medical expenses in excess of 2% of your resident income and your property taxes. If you rent, there's an 18% tax credit for that, too. But you cant do that in Pennsylvania, although you can write off certain out of pocket business expenses there. But you can't in Massachusetts, but you can write off certain Social Security withholding amounts apart from the Federal rules. But you can't in Florida. Know why? There's no income tax in Florida! So your next CPA should be experienced in your states if investment.

So you should no longer be looking for a data-in, data-out CPA since you have a demonstrated level of complexity to your annual tax filing. Obviously your CPA is supposed to help you, but you should be prepared to help your CPA. He/she should ask probing questions whose answers help him/her help you - its the old saying "You gotta let help help you"

Your first question should no longer be, "How much will this cost", but "what is your background, experience, what services do you have available, and how often should we meet?" THEN you can inquire about billing. Why in that order? That way you have an idea of what you're getting for your investment, because you get what you pay for. Are the returns billed hourly, or per form? Do you have a secure online portal for me to upload my tax documents to? Will you bill me for every phone fax  and email? Somewhere here on BP is a list of good questions you should ask when selecting a CPA.

Especially listen to see how often you should meet. This years estimates are based on last years income, so if your income changes a lot either way, your tax outcome might too. While some business need to meet quarterly, others may need to meet only in December to keep an eye on tax results. Others may not need that at all, but instead may need to meet when a property is sold. Property sales are tricky too, because the gain is increased by the deprecation you've taken since you owned it, so the actual gain could be a rude awakening compared to what your expectation was and that's a problem because when I was in college (roughly 100 years ago) , my old Psychology professor taught us that "expectations are pre-planned resentments.

Its been a great year for sellers. I don't think we'll be seeing these levels of prices for many years to come. Me and the Mrs. sold off two duplexes this year (with two more currently on the market) and dumped it all into our retirement kitty, and yes, we took the appropriate related planning steps. All of this comes under the 5 P's of the Marines: Prior Planning Prevents Poor Performance.  Hopefully these seven paragraphs will help have a positive impact on your life. Good luck and happy investing! 

Jim Kennedy

Here's a little education that will hopefully set your mind to rest. 

If you own the properties personally or in a single member LLC, then you'll report them on Page 1 of Schedule E. You list the rental income and then the expense. Google a Schedule E and the phrase irs.gov and pdf, and you'll find a Schedule E. Look at Page 1. It shows a little linear situation - each of the properties across the top and down the side is income and about a dozen of the most common expenses you'll incur. Round up your totals and plug 'em in. Sometimes you get help - mortgage interest is reported to you annually on Form 1098. Sometimes it'll include the insurance and the real estate taxes too if you're paying them thru escrow.

Next comes depreciation of the house. Sounds scary but here's the deal - depreciation is basically deducting the cost of your rental over its useful life, which according to the IRS is 27.5. Allocate some of the settlement sheet total cost to land since you can't depreciate land (a topic for another day). If you rehabbed them you'll have ore additions to depreciate. Some, like tings you can take out and not do major structural damage have only a 5 year life so you can write them off faster, and if you know how to do it you can take their entire cost in the first year! This is just introductory information to give you the view from 10,000 feet and get you off the ledge.

Then watch out. Say you do all this, and thanks to depreciation you end up with a loss, but you don't see it anywhere on your tax return. That's because of something called passive activity loss limitations. As long as you have a day job, and do R/E on the side, the if your income exceeds $100K, your allowable loss slowly reduces and by the time you hit $150K, the current year loss is zero. The good news is that you don't lose that loss. It just waits around on the side until 1) your income drops below $150K, or 2) you sell the house. The losses accumulate and roll forward, getting reported in an attachment to your return called Form 8582.

You'll need to report the rental properties in the state n which they are located. The you report them on your own home state return, too, but to avoid double taxation, your home state lets you take a credit against the taxes paid to another jurisdiction

I could tell you even more, but that's enough for now. The bookkeeping/tax side of your investing is yet another skillset for you to get a working knowledge of, as you wade into real estate, just like negotiating, getting financing, deal analysis, tenant management and contractor management.

Jim Kennedy

Wow. That stinks. 

OK, I'm not a lawyer, so this is just for discussion purposes based on what I know and have experienced in the New Jersey courts: 

1. If he breached the terms of the contract, you can hire somebody else and go after the first guy for reimbursement. 

2. The Judge may give you a judgment  a document indicating you're entitled to the money. 

3. Then you have to enforce it to get the money which could be hard

Thats a lumpy view from 10,000 feet. A real attorney could fill in the blanks. I had a similar situation once and the lawyer I went to asked to see the contract. AS he read it he began laughing as it was just that bad. e pointed out a half dozen things in ten seconds. He pointed out that everybody wants to start work, but you should not fill in stuff later. I would talk to an attorney after reading thru responses here.

Jim Kennedy 

Congratulations! It might be a good idea to pick a CPA who has investor experience, and who might even be an investor him/herself. With the virtual word upon us, you might find one not local that you like so don't lock yourself out. Ask about their experience, what services they offer specifically, and how docs are communicated, i.e office drop off, US mail/Fedex, secure portal etc. Make sure they have a method you like. Ask if they have templates to summarize rental income and expense, and see f they have one you like. Observe their ability to communicate knowledge when you ask specific questions, because you deserve easy to understand answers and there's lots to learn. The theory behind this is that hey - its your money, so you're the goose that lays the golden egg. If you're not happy than nobody should be happy.

Hope that helps. Happy investing!

Jim Kennedy 

@Abhijit Dey  and intern, I do not disagree with you either! You're absolutely correct. It is also a pain for public accounting firm's, like ours, as the onslaught of 1099 worksheets coming by email, fax, regular mail, FedEx and I think one even came in by pony express. Jim Kennedy

@Kuba F. and @Abhijit Dey

while I am a CPA who prpares hundreds of real estate investor returns annually, and while I am also a buy and hold investor, I also spent several years working at the IRS, so I have some perspective on this move.

I spent a couple years working for the IRS at the Philadelphia Service Center, the biggest IRS Center in the world at the time. I started at the IRS in 1996 - twenty one years ago, and after I started I was promoted to the Criminal Investigation Division. All I did, all day, every day, was investigate Earned Income Credit Fraud. And now in 2017, and its 2o years later - two decades, and it's still going on. It is my opinion that since Schedule C self-employeds are often known under-reporters, finding additional unreported income earllier will help identify and limit EIC fraudsters  faster. 

Consider what I saw routinely - a teenage girl has a baby out of wedlock, works part time and gets 1,000 of EIC. The father claims the child and gets $1500 of EIC. The teenage girl lives with her parents (or single mom) and claim $3,000 in EIC, but guess what? Grandmom (64 years old) owns the house and SHE claims the child for EIC for $900. Thats over $5,000 of fraudulent EIC. I did 6-8 cases a day, 5 days a week. Thats about $600,000 a month or $7,200,000 from just ONE CID Examiner. After 20 years, the IRS is wising up and looking for tattletale docs earlier.

Hope that helps explain.

Jim Kennedy, CPA

@Ashok Aletty

I am a CPA who specializes in fileing tax returns for hundreds of investors annually many by email in 31 states, and I am also a buy and hold investor myself. I used to work for the IRS in the Criminal Investigation Division, and I can address your question, which is a good one that I hear several times a year.

Basically, a mortgage is not transferable. The cleanest and legal way to move it is to typically refinance it out of your name into the LLC's name. However, since there is more risk for a bank lending to a property in an LLC (because if you go under the bank is limited to the assets of the company, which are basically a building that/s probably under water) you will probably not get as sweet of an interest rate. However, by doing it you WILL get a better night;s sleep, knowing that you are protected.

And if in fact the interest rate IS higher, the positive side of that is you get a larger tax deduct.

Jim Kennedy