All Forum Posts by: Nathaniel Busch

 Chris,

It's required by law.

IRS Publication 527

When you change property you held for personal use to rental use (for example, you rent your former home), the basis for depreciation will be the lesser of fair market value or adjusted basis on the date of conversion.

 Ryan, 

Why not structure this as a loan to partner? Doing so would create an asset to the company instead of a draw of equity. As long as your other partner doesn't look at you as a credit risk, you're reducing the risk placed on him by releasing funds to you, disproportionate of your 50% ownership. Plus, the partnership receives a return on its investment, in the form of interest you're paying back.

The interest you would pay back would be deductible to you as business interest.

Nathaniel Busch, CPA

 Landon,

The $1,000 is NOT your expense. That's why it's not coming out as a debit to you. The $1,000 is an expense that belongs to the seller, but you'll end up paying for it at a later date.

The appropriate treatment would be to classify the $1,000 as a liability called "property tax payable". When you end up paying the full year tax bill, apply $1,000 of the check to the liability, and the rest of the debit will go to your property tax expense. 

As for the prepayment of property tax, is that shown on your closing statement anywhere? Or did the seller pay this outside of closing?

Nathaniel Busch, CPA

Loren, 

Be very careful when toggling a property back and forth from rental to personal. 

When depreciating as a rental, be sure to use the lesser of Fair Market Value or your cost basis. Furthermore, when you sell the property any and all depreciation taken as a rental property must be recaptured as ordinary income regardless of whether you move back into the property or not. 

Any gain on the property would be excluded as taxable, just as long as you can show you used the property as a primary residence for any 2 years of the past 5. There is no rule requiring consecutive year ownership. 

Nathaniel Busch, CPA 

Eric,

The IRS is going to look to the legal owner of those profits. An indication of legal owner is usually who is on title at closing and/or who is the owner of the bank account receiving the profits at the time of deposit. 

Simply having an LLC in existence that has not yet established its own bank account would not be enough to argue ownership of the deal. In this situation, you would want the paper trail to back up the story in order for ownership to be successfully proven to belong to the LLC.

I would advise getting a bank account and EIN in place ASAP. 

Nathaniel Busch, CPA

 Joseph,

Putting the properties into a standard LLC will not have any affect whatsoever on the passive loss rules or NII.

The LLC taxed as S-Corp scenario is beneficial for placing flip / wholesale properties into. As for rentals, there are no real immediate tax benefits for placing them into an LLC, rather only legal benefits per most attorneys.

Check with insurance agent re: umbrella policy question. I'm not one. 

Something to clarify - your wife qualifying as a real estate professional does not necessarily hinge on her being a licensed real estate agent. Having a license could help in an audit, but the real determination of her status as an REP is dependent on her meeting the participation and hours tests involved in any field of real estate, whether it be flipping / wholesaling / landlording / etc. 

Nathaniel Busch, CPA 

The original poster mentioned he needed to begin this activity for purposes of generating capital, not withdrawing the capital.

Thus, they could initially incorporate the activity and actually avail themselves of ANY self-employment tax in the first few years if they end up reinvesting all of the profits back into the company as capital necessary to do more deals. Theoretically, a salary and all of these payroll forms wouldn't need reported until several years down the road when the client actually begins drawing upon the capital versus reinvesting into the company. 

I usually find this scenario to be representative of flipping clients looking to use the activity to shore up capital over the first few years of activity. Why not defer employment tax into later years if the activity turns out to be profitable, yet draws are not taken? 

Nathaniel Busch, CPA 

Steven, 

Note that I used my language carefully. I said using an S-Corporation would LESSEN the impact of employment tax, not eliminate it. Yes, there must be a reasonable compensation paid. 

Nathaniel Busch, CPA 

Joe,

You've got several different items at play here. 

Is your wife pursuing her license to receive commissions for others? Or solely to keep commissions from sales / wholesales of your own properties? Or both? 

In either instance, most state licensing boards for real estate agents wouldn't permit you to mix one's sales commissions activities into an LLC that is also generating wholesaling / flipping income. I have no idea what Michigan's rules are - you may want to inquire with their board for realtors.

But, if you see yourself getting into wholesaling / flipping any time soon, there is tremendous value in setting up an LLC and potentially electing it to be taxed as an S-Corporation. Doing so can lessen the impact of self-employment tax (i.e. dealer tax) and give you greater control of when and how you pay it.

In the absence of an LLC / S-Corp, you could find yourself routinely paying the full 15.4% dealer tax on top of your normal income taxes on any and all profits from wholesaling / dealing.

Establishing a separate LLC for the sales commissions / real estate agency stream of income likely wouldn't be worth it unless she's receiving commissions from representing outside investors in addition to your properties. So, it may be worth keeping that activity as a sole proprietorship, outside of the wholesaling / flipping LLC.

Lots of moving pieces here. Make sure you're working with a tax accountant that knows what they're doing in this respect.

Nathaniel Busch, CPA

Ana,

It's not so much a function of how much time you spend at each location.

Rather, the IRS is concerned more with the necessity of having each location and what work is being performed at each location. 

If you can show that the need for having the out of office location is for certain tasks (like the ones you mentioned), whereas your home office is necessary to complete tasks that can't be done at the rented place (say, performing work in total privacy with no distractions), then the IRS will permit you to deduct the cost renting out of home space with the deduction for your home office. 

But again, you must show the additional office outside of the home is absolutely necessary for administrative and purposeful reasons. Otherwise, the home office deduction will be lost.

Nathaniel Busch, CPA