All Forum Posts by: Karolis Matulis

Jane you are correct in saying that $600 is the magic number for issuing a 1099-misc and that $400 is the magic number for SE tax. 

If the kids pitch in and both do $1000 amount of work and have no other income they will likely not have any income tax due. The amounts are below the standard deduction for both and their tax return will only reflect the SE tax. With some planning, depending on their other income and dependency status you could pay them quite a bit more and not generate any income tax. Some level of SE tax (should be around 14.x% at such income levels) is largely unavoidable without business expenses on their end. 

Schedule E is the right place for rental income/expenses. Pure rental activity is considered to be passive by the IRS. As such Schedule E does not even provide a line for wages/compensation (employees), the implication is a passive activity cannot have employees. This does not preclude you from having contractors perform work when necessary and bill you on a per job basis (what your sons would be doing). 

The home office deduction is a popular deduction that people try and be aggressive with but in my experience it is extremely difficult for people to qualify for when everything is done by the book. There is a significant amount of rules and case law that make it very difficult to pass IRS scrutiny in that regard. 

How much are you looking to pay them over the course of a tax year? The pitfalls of these kind of scenarios is generally proving to the IRS that the payment was for actual work done. The easiest way to make this work is to treat the kids as contractors. Have them perform specific tasks and issue invoices that the LLC would pay. This would leave a paper trail and a record of work actually done. Everything needs to be reasonable and payment/cost needs to be similar to what you would see in an arms-length transaction with an unrelated party.

At the end of the year you'll need to issue 1099-MISC to both kids for the total payments through the year. They will have to file individual 1040 returns and report that income. The income will be subject to the self-employment tax (medicare and social security) as well as income tax (they can claim expenses if there were any in them performing their services). 

Generally estate planning attorney's and estate planning CPAs have very close relationships so if you find one you'll find both. 

My firm does a lot of estate planning but we aren't exactly in your area. Perhaps some others can chime in who deal with this more locally to you. 

As far as the transaction goes it shouldn't be too painful as she'll be under the lifetime exclusion so everything can be shifted over to the trust painlessly. 

An LLC is a legal entity to establish limited liability and not a tax one.

For tax purposes LLCs can be taxed in 3 ways based on circumstance:

-Partnership (default for multi-member LLCs)

-S-corporation (works for both multi-member and single member LLCc [needs an election])

-Sole proprietor (reported on personal 1040)

S-corporations are extremely tax disadvantageous when it comes to buy-hold real estate. Limitations exist for loss deduction and there is a potential for two layers of tax upon disposition.

My advice would be to keep an excel (or google drive spreadsheet) and just keep tracking of all income and expenses. Have two running lists for expenses, one for expenses relating to the whole duplex (real estate taxes, interest, sewer, etc.), and one for tenant expenses (maintenance, improvements, etc). As long as you document everything you can always backtrack to arrive at the right place. 

Easiest approach would be to report all activity on your 1040 until it grows a bit. The information you'll need at tax time will be income (all rent collected), expenses (100% of the tenant expenses and 50% of the common expenses). You'll also have to calculate depreciation on the unit (Bought the duplex for $500,000 1/1/15 and rented it out the same day). You would have an allocation of 50% to the rental unit for basis of $250,000. After an allocation of land of lets say 10% you'll have depreciable basis of $225,000 with a recovery period of 27.5 years. You will have annual depreciation expense of $8182 ($225,000/27.5). The only expense that is not "deductible" is the principal portion of your mortgage payment (interest is good). Major improvements are also not deductible right away. A $25,000 addition to the building would have to be capitalized and depreciated over the 27.5 recovery period. 

That should be enough to get your started but if you need help sleeping at night you can read IRS Publication 527 here.

Like someone mentioned these kind of disproportionate partnerships (as far as money contribution) rarely work. I would likely recommend setting up some sort of commission structure with your investor. You'll do the work, you'll put up the money and expenses as far as the repair work goes. You are essentially invested in the success of the flip, if no money is made on it you don't get paid for the rehab work; if the property makes money you get a portion (say 50% if that is the agreement) as payment for the rehab work. He can take an expense for a "rehab" payment to you, and you would pick up income in that amount thru whichever entity you want to do the work thru. Unfortunately, the money you collect would be ordinary income (not subject to preferential capital gain rates) just like any other money you collect as a contractor. 

A typical partnership scenario where one individual puts up $$$ equity and the other puts up sweat equity is tough to work in a tax scenario. It can be done. 

In order for the LLC to be legitimate from the legal standpoint no co-mingling of funds must occur; meaning the funds of the LLC are to be separate from all other activities. Think of the LLC as a box which you can put money in and take money out.

Once you have created the LLC and come up with a partnership agreement you have an empty box. I would advise opening a bank account in the LLC's name. The startup money can then be deposited into the bank account. That money is the partner's contribution into the partnership and by extension his basis in the LLC. All of the activity (income and expenses) must happen from within the box. In a similar regard that bank account cannot be used to pay for expenses that are outside the box.

You can continue putting money into and out of the LLC by means of this bank account. Each transaction is a corresponding contribution/distribution.

You mentioned that you live out of the country. In addition to the real-estate matters, I would advise finding a CPA who is comfortable with the IRS/FinCEN requirements for foreign disclosures. While the IRS and FinCEN disclosures do not generally generate tax there are a range of penalties that can get imposed in the event of non-compliance. 

Hey Mike,

An LLC is a legal concept which provides a great deal of limited liability protections. The Revenue Code allows an LLC to be taxed in many different ways: a corp, partnership, disregarded entity. Generally an s-corp is the absolute worst vehicle for real estate investing. It creates potential for two-layer taxation and creates tax deductibility issues for losses.

A partnership has the absolute best tax characteristics for multi member LLCs.