All Forum Posts by: Kory Reynolds

The piece to be aware of with seller financing that can readily bite someone - depreciation recapture.  The regular straight line depreciation is fine, that receives the normal treatment.  But if you have done cost segregation studies and have 1245 / ordinary recapture to deal with, all of that income is taxed in the year of the sale, regardless of what you received for proceeds.

Not previously as big of an issue, but in this world that we have had the last few years of 100% bonus depreciation, it is rearing its head more and more often.

 You have two steps available to you here, and you might be able to do both of them, you can at least do number 1.

1) Given you already have the cost segregated on your building, assuming you had a good quality cost seg study that breaks out the different pieces of the roof, dispose of the old roof and take a loss on that old roof.  Given you have a disposed of asset, you would have a requirement to capitalize the new roof.  Move on to step 3.  

2) Consider the Tangible Property Regs - how much of the roof did you replace? What components did you replace? Was it in a state of disrepair when you acquired it?  And it goes on...I would recommend running through this with your CPA/EA.  Point being, perhaps the roof work could be considered just a repair, and you write it off, and ignore my options 1 and 3.

3) For a commercial property that is a "trade or business", you can take a 179 deduction on the new roof.  A roof is a special class of property under 179 allowing you to take it (assuming you meet the trade or business requirement).  If I recall correctly (I'm sure the internet will correct me if I'm not!) HVAC, security, and fire systems also fall under the same.  The trade or business analysis is a whole separate problem.

Your answer to those questions will be "it depends" - it depends on the state and local jurisdictions that you and your real estate investments (or other business ventures) are subject to.  The CPA themselves don't need to be local, what is important is that they (or their team) can address any specialty concerns of your locality.  And even then...many state / local jurisdictions require effectively no specialty knowledge.  

There is definitely no one size fits all for how to look for a CPA / firm - it is going to be highly individualistic.  

 I'll offer a different opinion here - on the first question, consider the rules of your local jurisdiction.  If you live in a state with highly specialized or locality rules - NY, OH, NH, it is worth either considering local, or at least firm that has on board expertise within your jurisdiction.  75% of the time when I work with a NH investor that was previously working with an out of state accountant...they've made errors (in some cases costly ones) on the NH business tax returns.  Many states are not that complicated though.

Choose an accountant that focuses in your area of specialty, preferably choose a firm that can address most of your needs and where you want to grow.  If one doesn't have dynamic needs, then just focus on that specialty.  If you expect to have a more dynamic need - say you'll be investing nation wide and will need to address State and Local Tax issues in a number of different jurisdictions, or you'll be buying a property in the Caribbean, or you want tax advice on your estate/trust/gift planning, or now you are hiring employees and you want to ensure you are getting help when it comes to tax considerations of your employee benefit plans, or whatever avenue you go - maybe a Regional firm or one specialized in real estate all over will be your best fit over the more mom and pop practitioner.

I always disagree with needing to work with an accountant that invests.  It might give you peace of mind as a newer / smaller investor, but in the end you have a problem you want to solve (taxes and being compliant), and if your tax guys owns a duplex will have no impact on his ability to address those issues.  If you have cancer...you don't care if your oncologist has had cancer, you just care if he is the best to solve your problem.  Your CPA/EA isn't selling you a dream of real estate investment that they somehow don't believe in since they don't own any - they are selling you a solution to your problem.

(I'm biased, I have no direct ownership in real estate outside of my own home,)

His only income on the sale of this property would be the difference between the selling price and what the FMV was as of his mother's passing - is there really that much appreciation here?

Seller financing allows what is called Installment Sale reporting for IRS purposes.  Very simply - collect x% of the proceeds in a given year, recognize x% of what will be the total gain.  The gain is recognized proportionately over the life of the note.

If he will recognize more tax or not is going to be dependent on his own fluctuating income tax brackets over the he is collecting on the note and recognizing gain.  He'll also be collecting (and paying tax on) interest income.

If I didn't have much gain to recognize, I know as a seller I would rather just get all my tax, pay the gain, and not have the risk or hassle of a seller financing note.  If those are the only buyers  he can find, or I can get a premium for it, maybe do the seller financing.  But with a single family home, demand is still quite high.

This scenario does avoids the issue of being named as a part owner. What instead is happening is that for estate tax purposes, instead of directly holding real estate your father would hold an interest in Real Estate HoldCo LLC - a partnership interest. So his step up in basis would be in his partnership interest, which by some tax elections lets you make that step up in the basis of the assets to whatever his FMV share of those assets is upon his death.

Any of the partnership that you and your sister own when he passes away would not receive a step up to FMV. So if at death it is worth $5m, and of that $5m based on the waterfall agreement you and your sister would get a combined $800k - that $800k does not get stepped up, just the $4.2m that belongs to your father does.

If your father is subject to estate taxes, and there are substantial discounts taken on the valuation of partnership interests in his estate - that cuts back on the step up, but it saves steeper estate tax, so it is a worthy trade most of the time.

Just one idea, but probably a dozen ways to accomplish this. 

1) Father drops the property into an LLC, if it isn't already

2) You and Sister are introduced as "profits interest" members of this LLC

3) You can then structure how the profits are shared, but Dad owns all of the appreciation that has already occurred, and would get a step up upon death. You arrange the LLC deal so that in the waterfall, you and Sis get the majority of profits over this baseline threshhold. Maybe give Dad a preferred return to reflect how much capital he has locked up on this deal.

IE say property is worth $4m with no debt (keeping it simple), and cash flows $800k annually. The below terms are near infinitely flexible from what I have below, but the idea is that you and Sis only share in the future profits - no part of Dad's original appreciation. Operating Cash Waterfall looks as follows:

1) Dad gets 10% pref on his unreturned capital ($4m * 10%) = $400k

2) Dad / You / Sis split the next profits 20 / 40 / 40 - $80k / $160k / $160k

Cash Waterfall on a capital event (cash out refi or sale) as follows - lets say it sells for $5m in a few years

1) First dad is paid back on his unreturned capital + any unpaid preferred returns - $4m

2) Then balance is split Dad / You / Sis   20/40/40 - $200k / $400k / $400k

You could do management fees for additional involvement, fees upon a sale, etc - can go wild.  Just think of Dad as an LP investor and this is a syndication, and he is contributing property.

If Dad passes away before it is sold in this structure, his Partnership interest is what is stepped up to FMV, which can allow for a step up in the basis of his share of the assets to FMV. IE in above if instead of selling for $5m, your father passes away when it is worth $5m. Effectively his share of the building is stepped up to $4.2m (his share of the FMV). Discuss valuation discounts as they may apply with your estate tax experts.

S-Corps are terrible for buy and hold real estate 99.99% of the time - all investors should burn this into their mind! Even for flips/brokerage/wholesaling - there is minimal benefit in many cases to an S-Corp over just being a LLC subject to self employment tax, but getting the benefit of a 199A Qualified Business Income Deduction.

Effectively all structures have very similar, if not identical, tax results. Owning directly, owning in a Single Member LLC in any state, owning multiple single member LLCs, owning layers of LLCS....in all of those cases, the tax results just flow straight to your personal tax return and are reflected there. An LLC doesn't provide any advantages tax wise, it is just a liability mitigation tool (consult your attorney!).

My general recommendation especially when someone is just getting started...keep it simple. Create an LLC in your home state, use that.

I work with a significant number of hotel entities, I can address this from a tax perspective, I'll leave the liability issues to the attorneys.

The lessee / lessor entity structure can be used for a few different tax reasons:

1) There is a REIT investor - in which case they can only have "Rental" type income, while hotel operations generates "Ordinary" income. Thus they split out the Rental, and use a C-Corp blocker to eat up the Ordinary.

2) The activity would generate self employment income.  In which case, splitting out the rental portion of the activity from the operating portion would help reduce the exposure to self employment tax

3) One is a qualified real estate professional for tax purposes...but wouldn't be a material participant in the hotel activity.  By splitting out the rental, voila, now you have rental losses which are automatically aggregated with all your other rental activities and are non-passive, even if you don't materially participate on it's own.  This is a rather narrow set of circumstances, but it is out there.

For your situation, sounds like you would just be considering items 2 and 3 for tax purposes. The barrier is the additional complexity - now you are operating two sets of books, and filing two tax returns, and have more operating agreements, more state registrations, etc, need to manage cash better, need to keep in constant mind that your rents need to be a supportable FMV, which may require getting third party certification on your rents so that in the event of an IRS audit, what you have done is supported.

In short...the size of the project, and the taxable income, need to be of enough scope to make all the additional costs and annoyances worth it.  My inclination on a smaller boutique hotel, not likely worth it.

Agreed - no issue with refinancing AFTER the 1031 exchange has occurred.

The only problem one has is if there is cash out on the actual exchange itself.  But theoretically no problem at all with doing a cash out refinance the week after an exchange is complete.