All Forum Posts by: Naseer Khan

@Catherine Ashley I think I may not have been too clear on how the S Corp status works. Let me try again - After a person chooses their business entity (LLC or C corp), only then can they elect to be treated as an S Corp, which changes the structure of their entity and how they will be taxed. They do this by filing form 2553 with the IRS. When they elect to be treated as an S corp, they will have to follow the S corp guidelines (pass through taxation, one class of stock, less than 100 members, etc).

If a person's end goal is to have an S Corp, then they are better off opening a C Corp initially and then electing the S Corp status. If one chooses the LLC first, then that person may have to file an additional form (8832) to be classified as a Corporation first and they may have to amend their operating agreement.

However, the LLC is a more flexible entity, so if one doesn't need the tax benefits of the S corp, then the LLC is easier to operate, as it has less requirements.

Let me know if I can help with anything else or if I need to clarify more. 

Disclaimer:This response neither constitutes legal advice nor establishes an attorney-client relationship. Inquirers must seek the advice of their own legal counsel prior to undertaking any course of action related to this inquiry.

Costs, such as property taxes, architectural fees, HOA fees, etc. are deductible costs that should have been deducted the year that they were incurred. Those costs will not come into play when determining your loss on the sale of property.

Selling an asset, such as a lot, will trigger capital gains tax or a loss. When determining a gain/loss, you have to figure out your cost basis (purchase price + capital improvements + selling and closing costs). Then you subtract your cost basis from your sales price and that will give you your gain/loss amount. 

Fortunately, the IRS provided IRC Section 1231, which treats losses from the sale of real estate as ordinary losses, as opposed to capital losses. Ordinary losses can offset any income and is not subject to the capital loss restrictions. Thus, the loss on the sale of a lot can be used to offset even your regular wages. 

However, if you previously sold real estate in the past 5 years and took a loss, you may be subject to a lookback rule that will re-charaterize your future capital gains as ordinary income to the extent of the losses taken in the previous 5 years. I know...that probably did not make any sense and it's likely that it does not apply to you. 

But if you want a detailed explanation, check out my article: Calculating Capital gains and losses for real estate 

This response neither constitutes legal advice nor establishes an attorney-client relationship. Inquirers must seek the advice of their own legal counsel prior to undertaking any course of action related to this inquiry.

@Lois Walker

@John D. If you use the property as your primary residence for an aggregate period of 24 months in the past 5 years (does not need to be consecutive), you will qualify for the full capital gains exclusion ($250,000 single filer, $500,000 if married). 

However, as a previous poster mentioned, the sum total of allowable depreciation deductions (whether you took them or not) while renting out the property will be taxed at 25%. 

Example: You purchased a rental property in July 2005 and rented it for 3 years, taking $30,000 in depreciation deductions. In July 2008, you moved into the property, using it as your primary residence for the next 2 years, so you qualify for the IRC Sec. 121 capital gains exclusion. You sell the house in July 2010 and realize a gain of $80,000. Only $50,000 ($80,000 gain minus $30,000 depreciation deductions) of that gain may be excluded under section 121. The $30,000 of unrecaptured depreciation will be taxed at 25% ($7,500). Accordingly, you will net $72,500 from the sale of the property ($80,000 gain minus $7,500 depreciation recapture tax).

Check out this article I wrote on IRC Sec. 121 Capital Gains Exclusion

And check out this article on Depreciation Recapture 

This response neither constitutes legal advice nor establishes an attorney-client relationship. Inquirers must seek the advice of their own legal counsel prior to undertaking any course of action related to this inquiry.

@Catherine Ashley The type of entity that you choose depends on what you will be doing within that entity. If you are simply looking to buy and hold, then an LLC is perfect for that since rental income is considered passive income and not subject to self-employment tax (unless you are considered a "real estate professional" - see this article Active vs Passive Income) 

If you are going to be flipping houses, then an LLC with an S Corp designation will provide you with the most tax benefits because you will be able to reduce your self-employment tax with proper accounting.

A C Corp is not something you need as an average investor, as that entity has additional requirements/restrictions and is subject to corporate tax (unless you elect the S Corp status).  

An LLC will provide you with liability protection because it will separate your personal assets from your business assets, so long as you follow the guidelines of maintaining a proper LLC structure.

An LLC is considered a flow through entity, so there is no additional tax at the entity level and all income flows directly to you, as if the entity is not even there. If you choose the S Corp election, then you can possibly reduce your taxes more, depending on your business structure (see above).

Regarding loans - some lenders are reluctant to loan to an LLC and will require a personal guarantee from you.

Let me know if I can help in any other way - I am an attorney and an investor, so I understand a lot of the issues that you will be facing.  

This response neither constitutes legal advice nor establishes an attorney-client relationship. Inquirers must seek the advice of their own legal counsel prior to undertaking any course of action related to this inquiry.

Hi Allen, I'm an attorney who works mostly with real estate investors. Although I am not in your area, I am in CA and contract issues are generally the same in all of CA. As an investor myself, I am familiar with real estate investor issues. Let me know if I can help. 

It seems that cost plays a big factor in whether or not to establish an LLC. In California, there is an annual franchise tax of $800 to maintain your LLC, which is on the high end of the spectrum; whereas Florida only charges $138 per year. Obviously, you want to keep your costs down and if, after looking at your current situation, along with the pros/cons of each option, you feel that the umbrella policy is sufficient protection, then you may just be fine with that. But if your state has low costs to maintain an LLC, like Florida, then I think the $138 annual fee is a drop in the bucket compared to the additional protection you receive (assuming you follow the guidelines to properly run the LLC).

Regarding the Capital gains exclusion on multi-family units - if you use one of the units as your primary residence, you can still qualify for the IRC sec. 121 capital gains tax exclusion for that one unit. The other units will be subject to long term capital gains tax and you will have to sparse out the value of your primary residence unit from the other unit(s) to get your tax liability. 

Regarding transferring your personal residence to an LLC - if it is a single member LLC, it will be considered a disregarded entity by the IRS, thus, it will still qualify for the capital gains exclusion (see 26 CFR 1.121-1(c)(3)(ii)). However, if you have more than one member in your LLC, it will become a partnership and it will no longer qualify (this includes adding your spouse to the LLC).

@Penny Clark An S corp is not an entity in itself, it is an election to tax an entity as a pass-through entity, meaning you don't pay corporate tax. You can elect to treat your C-corp or your LLC as an S-corp for tax purposes to obtain certain tax benefits - i.e. reducing self-employment tax. There is no point in electing S corp status if your LLC is only holding rental property because rental income is considered passive income and is therefore not subject to self-employment tax. If you had an active real estate business (short term renting, airbnb), then it would make sense to elect S corp status.

Regarding LLC vs. Umbrella Policy - I think its better to have both if you want to limit your liability as much as possible. The LLC shields your personal assets and provides you with piece of mind. The Umbrella policy ensures that you don't lose your property or other assets when facing a judgment. Umbrella policies do have limitations and restrictions, and if your situation falls within one of those limitations, you can have your LLC to protect you. Insurance companies are going to do whatever they can to avoid paying out and there may be some provision in your policy that allows them to avoid just that, so why not have a backup.

This response neither constitutes legal advice nor establishes an attorney-client relationship. Inquirers must seek the advice of their own legal counsel prior to undertaking any course of action related to this inquiry.

@Brandon Duncan I would recommend establishing the LLC for liability purposes. The LLC will prevent someone from going after yours and your partners' personal assets in the case of a lawsuit/judgment relating to the properties. The $800 franchise tax seems like a lot but it is worth it for peace of mind IMO.

The IRS will treat the LLC as a partnership for tax purposes, so you will need an accountant to provide you with K-1 statements at the end of the year.

If you decide not to use an LLC, then you would just form a General Partnership and each member of the partnership is liable for all debts and obligations of the partnership. It is basically an agreement on how to split profits and losses but does not provide any liability protection.

@Michael Merritt Hi Michael - I am a California real estate attorney that works primarily with real estate investors. I am an investor myself, so I am familiar with the needs of real estate investors. Let me know if I can help in any way. Thanks, 

I work in the Bay Area as a real estate attorney. Perhaps I can help answer your question. Feel free to message me