All Forum Posts by: Michael Plaks

@David Sisson

As often happens, your question mixes several separate issues together.

1. One tax return or two? If you own the LLC outright, you might decide to treat it as a disregarded entity. In this case, you would report your property the same way as if it was owned directly by you: on Schedule E. Business and personal are combined on a single tax return. The whole concept of separate accounts, reimbursement etc becomes blurry, and drawing a line between personal and business is kind of optional.

2. Paying someone else's bills. Assuming that you do separate the LLC from yourself and file 2 tax returns, the two become "strangers." In your scenario, you are paying expenses of someone else, the LLC. This is not normal. (If it is, then I have some bills for you to cover.)

3. When would you ever pay someone else's business bills? When you're either investing in this business or lending to this business. In both cases you first give the business cash, and the business pays its bills with your cash. You never pay the business bills directly in lieu of an investment or loan.

4. For the business to deduct en expense, it must both incur and pay the expense. The LLC did incur the expenses, since it owns the property, but it did not pay them, you did! Consequently, the LLC cannot deduct them.

5. To fix the problems described in #3 and #4, the LLC should reimburse you for these expenses. This way, the expenses become business expense of the LLC. There should be a written reimbursement policy and actual reimbursement: detailed report of expenses and transfer of money.

6. Since the LLC does not have cash, it can only reimburse you with an IOU. The transaction still should be documented as reimbursement, in order to make the expenses deductible by the LLC.

7. The IOU should appear as a Current liability (Short-term notes payable, Expense reimbursement, or a similar account), and the corresponding expense either as an expense (if deductible) or a fixed asset (if capitalized).

8. Timing. If reimbursement does not happen until 2018, then the LLC cannot expense or capitalize it in 2017. If this is the desirable result, then you can delay reimbursement. Be careful however, because excessive delays can become a problem.

9. Insufficient income in 2017 shall not prevent qualified expenses from being deducted. Even if your losses end up limited, the overflow will transfer to 2018 automatically. 

10. ... there's more, but I'm tired :)

@Yas Tahir

Answer from a Houston accountant here. No SE tax on net rental income - that is not even debatable. If what you're saying about your tax return is accurate, then your CPA messed up.

You got some bad answers on this thread about flips though. If they are actual flips, the result is not capital gain but ordinary income PLUS SE tax. It does not matter how long you held the flip, even if more than a year. 

Sometimes, flips can be treated as investments with capital gains, but it is case-by-case and requires a longer discussion.

@Dave Foster

What if he is making improvements on the land he (his LLC) is buying from JS? And just ignore "his" 50%?

I cannot see how he can sell his 50% interest and repurchase it in an exchange.

@Shane H.

Yes, a 1031 with a construction loan is more complicated, so I'm not surprised it is more expensive, too. I know it is possible but have never been involved in one with my clients. 

Timing can be a problem with the existing duplex. While it is not against the tax law to exchange after only 3 months from a previous exchange, a lot of intermediaries will not want to touch it, due to the IRS challenge risk.

Ditto for the former residence. 2 months are probably not enough to establish investment intent which is a requirement for the exchange. The IRS is likely to consider it a trick to slide an otherwise prohibited property into a 1031. I probably would not take such case if you wanted me to defend it in an audit - which tells you about my view of this strategy.

@Shane H.

We'll have to close some gaps in your story and address some basic concepts before arriving to an answer.

1. I assume that you have owned your current duplex for some time, that it was a rental and it is currently under contract to be sold (as opposed to under contract to be purchased)

2. It is also my understanding that the land is owned 50% by "A LLC" and 50% by JS.

3. 1031 has to have the same owner on both ends, so you can only 1031 within "A LLC"

4. If my two assumptions are correct, "A LLC" will be exchanging its current duplex into a combination of 50% interest in the land (purchasing it from JS) and a duplex to be built by "A LLC" in the future. Your existing 50% interest in the land will stay outside the exchange.

5. The above scenario is possible but complicated. Need help from 3 professionals: a 1031 intermediary, an accountant and a lawyer.

6. If a 1031 is planned, you must engage a 3rd party 1031 intermediary (like @Dave Foster) ASAP, and absolutely before you sell the duplex.

7. Personal residence cannot be a part of this plan in any form.

@Fletcher Caulk

Before you look into tax strategies, let's make sure you understand capital gains. You mentioned $200k equity - which has nothing to do with taxes upon sale.

You will be taxed on your capital gain - which is calculated as appreciation of the property from 2014 to 2017. I.e. if you bought it for $400k in 2014 and selling for $450k now - you are only taxed on $50k minus closing costs, including commissions. Equity is irrelevant. You may not have as much taxes as you fear.

In addition, you will also have taxes on the previously taken depreciation - which is the case even if you qualify for homestead exclusion. The only way to duck depreciation recapture tax is thru a 1031 exchange. And a 1031 may not be warranted if your expected taxes are modest.

I have couple blog posts on my website that give examples, but BP won't let me link them, so you have to google it.

@Account Closed

Deed recording date (which you call vesting) does not matter for tax purposes, and neither does the funding date - both of which are after the date of closing. It is the date of closing when the documents are signed. 

Disclaimer: I'm not an attorney, so it is possible that my understanding is not legally accurate.

Welcome aboard, @Jacob Rhein.

There's a major demand for investor-friendly RE lawyers, at least here in Texas, so you should have plenty of opportunities. Especially when you are an investor yourself. I'm a RE accountant, so my reply is based on complaints/praises I hear from my clients.

• Investors prefer to have one lawyer for everything REI: LLC formation, closings, private money deals, evictions, litigation and whatnot, even though it's often best handled by specialists.
• Number one complaint is accessibility. They want to be able to reach you anytime and not have to leave VM without a specific response time. You can be at a closing or on vacation, but they do not care. :) The tendency is to wait until the last moment when it really is an emergency. Expectations are sometimes unrealistic.
• Most investors expect free legal advice, at least from time to time. Expect calls like "I saw you on BP, and I just have couple questions for you." However you plan to handle it - just be prepared.
• Number two complaint is delivery by the promised deadlines. It's unfortunately very common for lawyers to miss deadlines, sometimes resulting in costly consequences and even lost deals. If you can consistently deliver on time - you will be in high demand.
• Cost of legal services has not been a frequent complaint, by the way.

Best luck!

@Bilal A.

I cannot comment on the legal technicalities of your question - i.e. whether a contract clause is needed, but my non-lawyer understanding is that deposits and pro-rated rents legally belong to the buyer and must be transferred at closing.

On the practical side, having processed thousands of closing documents over 20+ years, I can tell you that this transfer happens on less than half of the closings. This is because the title company can't care less, the seller is not motivated to give up extra cash, and the buyer does not know better. 

When you're a buyer, it's 100% your responsibility to ensure that you receive credits for this money at closing. I would first check with the title company and ask if they're going to take care of this automatically. If they say yes, it should be good enough. If they say no, then ask a real estate lawyer how to make it happen. Again, I'm not a lawyer, so cannot give you legal advice.

@Dave S.  It's not whether you have more cons than pros. It's which ones of them apply to your situation. You have not clarified whether these are rental properties. If not - there's nothing to discuss, as the whole depreciation concept ONLY applies to rentals.

If they are rentals, the one major benefit is less taxes - which is the whole point here. But, depending on your situation (other sources of income and their nature and size, your REI strategy etc.) - you may or may not benefit from higher depreciation.

If you do benefit from more depreciation - then is the time to ask about specific depreciation methods. And that is not a DIY project, in my opinion. You either hire a cost segregation pro like @Yonah Weiss if the properties are big enough to justify the cost - or you hire a competent real estate accountant for a simplified approach. Specific depreciation methods can be implemented thru your software if you're brave enough, or with professional help.