All Forum Posts by: Michael Plaks

The operating agreement is not just for taxes. Taxes are a minor part of its purpose. It controls how you run things and what happens under various scenarios, especially when things do not go as planned. And they rarely go as planned.

Do you mind expanding on what are the tax benefits of forming an LLC in GA and PA?

@Jacob Trimble

What you call "having a hard time finding the right CPA" sounded more like finding a cheap CPA. Unless I missed it, his charges were the only issue mentioned.

Now, I'm not suggesting that the cost does not matter, it does. But it's not the only thing that matters, and it very much depends on the scope of the services provided and their quality. Just like anything else you pay for.

Monthly bookkeeping cost of $125 for a 24-unit property sounds cheap to me. So does $750 for annual tax preparation with 3 properties and 2 states.

Using QuickBooks for multiple rental properties can be more complex than you realize. I'm not recommending it. If you're determined to do bookkeeping yourself, look at simpler software such as Stessa which is free. But before you go that route, make sure that your tax person, whoever you choose, will be OK with it.

Wrong question to start with. The first one should be - what are the business consequences? Specifically, you're looking at receiving more money overall but not right away. Is it an attractive trade-off in your situation? 

The second question should be - what are the risks I have to take? Starting from the buyer defaulting on his note and including the current global uncertainty.

Only then should you consider taxes. Generally speaking, taxation on owner-financed sales if beneficial to the seller, but your mileage may vary.

@Naz Hossain

Your CPA did not explain to you what pass-through means? It is not an alternative to a partnership, it is a feature of the partnership.

Pass-through is a three-step process:

1. The partnership files a tax return reporting all shared income and shared expenses. For example: we made $100k from wholesale fees and spent $40k on marketing, technology, education etc. - resulting in a $60k net taxable income.
2. The partnership splits this result between the partners and sends each of them Form K-1 that basically says: you made $30k from this partnership (assuming 50/50 split).
3. Each partner adds his respective $30k to his personal income on his individual income tax return and pays taxes on his combined income from everything.

So, the calculations of profit/loss are done on the partnership level, but the resulting taxes are paid on the personal level. Hence the term pass-through.

Next, you suggested that your expenses could be higher than your partner's. Need to proceed carefully here. There're two types of expenses: business expenses of the partnership and business expenses of the individual partners. The difference is in whether the partnership as an entity agrees to pay for a particular expense from the business money that belongs to the partnership. 

Actually, we have 3 kinds, not 2 kinds of expenses. Personal expenses are divided into expenses that the partners are required to pay on their own, from their personal money, and expenses that the partners simply choose to pay on their own.

The 1st group, shared expenses, are deducted on the partnership tax return. The 2nd group, called unreimbursed partnership expenses, are deducted on the partners' individual tax returns. The 3rd group, let's call them elective expenses (there's no technical tax term for them), are not deductible at all.

As you can see, the distinction is important. It is regulated by your operating agreement. For example, it may require that the partners pay themselves for driving their personal vehicles for business purposes and for maintaining their home offices. The operating agreement must also say whether or not these expenses will be reimbursed by the partnership. So study your operating agreement and see if maybe it needs more work.

And I must say that, since you have a CPA and a lawyer on your team, it's their job to set all this up and explain it all to you. Otherwise, you should consider upgrading your advisors.

Then you are focusing your energy on the wrong things. Lining up reliable contractors is way more important than worrying about tax deductions. 

But as far as deducting your repairs - no, you don't have to advertise, as already stated by my colleagues.

Then you're probably set. You would have 20 out of 24 months - well above what you need for an under $100k gain. I'm still saying probably because there could be other complications we have not uncovered.

@Nathan Hood

Sorry about your job loss.

You never mentioned whether you moved into the property - seems like you have not. If so, then all of this conversation about unforeseen circumstances is pointless, even though I agree with @Eamonn McElroy: you situation should qualify as unforeseen circumstances.

Here's how the exclusion works. If you're married and lived in the property for 2 years, you have up to $500k of your gain tax free. If you lived there less than 2 years, say only 1 year, normally you cannot exclude anything. However, if you moved out of the property after 1 year due to unforeseen circumstances, you do the pro-ration:
     1 year out of 2 years = 50% 
     $500k max x 50% = $250k
so now you can have up to $250k of your gain tax free.

But if you never lived in the property, your ratio is zero days out of 2 years = 0%, resulting in zero exclusion, even with the unforeseen circumstances checked.

Now, some technical stuff for the tax geeks. The above is my interpretation of the somewhat ambiguous language of the law: "...such property has been owned and used..."  I read the "and" as BOTH owned and used at the same time. It could potentially be construed differently, as allowing the ownership period to be counted on its own. I doubt so, but some of my colleagues might feel differently.

You may come across a popular notion of "how would the IRS know that I never moved in"? Especially since you would not even report the sale of the property on your tax return if it is excluded. True, the IRS will not know and probably will never raise the issue. But should they do so, you will be in trouble. I cannot endorse misrepresenting the facts to the IRS, it is illegal.

The good news is that, if you hold this property for longer than 12 months, it should qualify for long-term capital gains treatment. The rate on your gain is likely to be a very reasonable 15%, and it can even be 0%, depending on your total income for this year.

All of the above is generic and based on the limited facts we know. To be sure, always get an advice from your own tax professional.

Totally missed my point. Which was - it takes years to learn this. Hoping to "learn it" or "research it" on a public forum is like learning medicine from Facebook. Which is done a lot these days.

@Hyung Lee

There was some real good input from @Ned Carey, @Eamonn McElroy and @Katie L.. The reason why all of that may sound overwhelming and confusing to you is because these people spent many years learning this business and became experts. You hope for a shortcut and some simple answer to a potentially very complex situation - and it's not realistic.

The only (relatively) simple setup is if you own the entire deal under your name, and your buddy is your private lender. But once you start talking about splitting the costs and the profits - you enter major complexity. You are only thinking about taxes, but taxes are the least important of the 3 areas that you need to consider:

1. Dividing responsibilities, costs and benefits under numerous possible what-if scenarios. You're already mentally dividing your future profits, but what if I told you that 95% of first-time flippers lose money on their first deal?
2. Legal protection from third parties and from each other
3. Taxes

All three need to be thoroughly considered before giving you a responsible recommendation. And such planning is an art, not a science. My eventual recommendations will almost certainly differ from those of Eamonn, and both of ours are likely to be different from Katie's. Not to mention - from that company that you already engaged.

So either a) follow the KISS principle b) accept the complexity and the need for one-on-one quality help or c) play the Russian roulette and take your chances that things will work out fine on their own