Question Regarding Taxes
I'm in the early planning stages of my real estate investment career. I am starting a business and I would like to take the profits from my business and purchase investment real estate with it without paying taxes. So I have a question:
Can incorporate in some way and take all the profits I make from my business and purchase rental property with it? If so, what is the best business structure to do this in? LLC? Corporation?
I read the phrase, "It's not what you make, it's what you keep" on the forum description, is that a clue that the answer to my question above is "yes"? I'm reasonable sure I'm on the right path, just want to make sure.
Thank You!
Joe
Joe,
there may be different opinions on this, but I think the following is generally true.
1. If you are buying and holding property, for rental, then an LLC is a good business structure. For flipping and rehabbing, some people prefer an S corporation.
With an LLC, you can deduct all relevant expenses, including the depreciation on the rental property, and then only pay "pass through" taxation on any profits that remain. For many people, the depreciation and expenses exceed the rental income, and so you would not, in that case, pay any tax - rather you would gain a tax benefit. Otherwise, you would pay a small amount of tax.
e.g. You have a house worth $100,000. Your property tax notice shows an 80/20 split, meaning that 20% of the assessed value is the land, and 80% is the property on it. You can only depreciate the property (called "Improvements" probably on the statement - land is not considered to depreciate), but you depreciate that over 27.5 years (for residential, 39 or so for commercial). So, the depreciation allowance is 80% of $100,000 i.e. $80,000 split over 27.5 years, which is an allowance of $2909 per year.
Let's say you pay $1000 per year on repairs to the house, $500 management fees, $200 on property management software, $400 on accountant's fees
Let's assume you rent the house out for $500 per month.
So, annual rental income = $6000
Expenses = $2100
Depreciation = $2909
So, 6000 minus 2100 minus 2909 = $991 of taxable income, at your normal tax rate, (pass through taxation).
Assume your tax rate is 23% - you pay $227.93 tax on $6000 of income - not too bad.
That is a rough approximation of how it works, but I am not a tax professional - and you should consult one.
A couple of books on the subject that I can recommend:
_Real Estate Loopholes_ by Diane Kennedy/Gareth Sutton
and
_Inc. & Grow Rich_,by Allen, Hill, Kennedy and Sutton.
They should give you a good overview.
Hope that helps,
Glyn
Thank you for your reply glynnor.
But my main concern was reinvesting real estate by writing off the purchasing of real estate as an expense.
I want to take the profits from one rental property and use it to buy another rental property without paying taxes on it. Do you or anyone know if this is possible?
Also, would it be possible to take the profits of a business and buy real estate to avoiding paying taxes on it (by using the purchase of real estate to offset the profits, leaving no end profit for the business)?
You've heard the saying about death and taxes? Both are a sure thing.
The nice thing about real estate investing is there are ways to reduce and/or postpone when you pay those taxes.
If you are going to resell a property in less than a year, and that is your business, it is considered inventory and you cannot write of the cost of buying and rehabbing the property. Instead, you capitalize these expenses, effectively increasing you base for when you resell it. You'll pay ordinary income taxes on these.
If you hold the property as a long term investment (more than one year), you may be able to postpone paying the taxes by utilizing a 1031 exchange. Look into it before you sell the current property, because you have to follow the procedures exactly, and they are time critical.
If you are flipping some, and holding some, there are ways to load your expenses onto the flip properties to reduce your high tax profit and increase your low tax or delayable tax profit. I don't recommend these as they are deceptive and could result in expensive fines if an audit proves it.
If you do things right, you'll be making enough money that you won't mind paying some taxes!!!
Good luck!
As I understand it, you will be taxed on such income (after deductions) whether you spend it or not.
The fact is, you have made a profit, and so the IRS thinks you should be taxed for it. Even if you left it in the account, or bought more properties, or bought jewelry with it, makes no difference.
The fact that you are using the profits to buy more properties is irrelevant to them.
Glyn
No, there is no tax vehicle which allows you to postpone earned income. Corps, partnerships & LLCs all generate taxable income which is taxed in the current year.
You mean you can't buy more property and write it off as an expense? But if you own a business, and you purchase an office building, that can be written off. I cannot write off buying more property?
This real estate thing isn't looking so lucrative after all.
Warren Buffett has averaged 22% a year in the stock market and he is the second richest man in the world. You're telling me that you can make 25 - 30%? Obviously not so. If you could, the real estate folks would be far wealthier than they are.
But I just found more about it on the Internet. Apparently you need to devote 100% of your time to it for it to be considered "nonpassive activity." Then you can treat it like a normal business, writing off expansion (buying more property) as an expense.
MrPennyBags,
I don't know what you were reading, but buying a capital asset is never an expense. You are just converting an asset (cash) into equity in real property (also an asset). No business expense here.
You expense the costs of ownership such as taxes, insurance, and mortgage interest. If the property is depreciable, you may recover some of your cost through depreciation.
Being a full time real estate professional does not change the picture except for turning a passive activity into an active income business.
Ok, I'm following you now. You still can't avoid taxes then. I'll have to talk with a accountant and read up on this. I have an obsession with real estate, just want to make sure it is worth my time.
You can write off the cost of the property, but not all in one year. It's depreciated over 27 yrs for residential and 39 yrs for commercial. If you have one property that generates income and you use that income to buy a second property, the income from the first is still taxed but you take a depreciation deduction for both (in addition to other operating expenses).
What most people think of as tax "savings" is the deduction generated by depreciation but depreciation will generate more gain when you sell. So, it's not true "savings" but postpones taxes.
Are apartment buildings considered commerical or residential?
Apartment buildings up to 4 units are considered residential and qualify for residential financing i.e. you may be able to borrow 90-95%.
More than four units and it's considered commercial, for which you usually need at least 20% down.
Glyn
For tax depreciation, apartments are considered residential.
You don't really have a tax question, but a legal issue. Consult an attorney.
Perhaps you will get a more helpful response if you put your question in the legal forum.
You should have an attorney help you prepare and place a "mechanics lien". Strange name, I know, but that is what it is called.