New here... LLC or no?

Question

Yikes. This is my first post on BP tho I've been lurking about for a few weeks. Here's the quick rundown:

My husband and I live in Nashville, TN. We also own a rental house in Ann Arbor, MI (the house we lived in for many years) and one in Bradenton, FL (a house we bought in '03 for my daughter to live in. She no longer lives there.) For a variety of reasons (mostly that we don't like being out of state landlords), we are ready to unload both houses. We are heading up to Michigan next week to prep that house for sale and will try and sell the FL house in the fall.

Our plan is to use the profit from the sales to buy a rental here in Nashville (or possibly join forces with someone to flip.)

We have many questions about how to proceed, but wanted to start with this one:

We are about to lose our current health insurance and are looking for a new plan. Because we are both on track to earn a little less this year, we could qualify for a subsidy under the ACA.  BUT, the profit from the Ann Arbor house will raise our income significantly for the year. If we were to form an LLC and put the profit in there, would that solve the problem?

More questions to come. THANKS! Whit

Dave Foster · Answer

@Whit Hill

You've got the jist of the 1031 just fine.  The devil's in the details though so you're wise to research more.

The answer to your question about multiple properties is this - In order to fully defer all tax you must first of all purchase at least as much as you sell (This is the gross sales price minus costs of closing - the net sales price).  Secondly you must use all of your proceeds from the sale (the net sales price minus whatever mortgage was paid off) in the next purchase ...or purchases.  If you sold your MI house for $400K and 200K of it was debt then you would need to purchase at least $400K of real estate and use all $200K in proceeds.

The number of properties does not matter - the dollar amount does. So yes you could sell one and buy several smaller properties.  You could also sell two and consolidate them into one bigger property as long as the valuations are correct and you can make the timing work.  The problem with consolidation is that both properties have to sell within 180 days of the first one so that you can complete your purchase within 180 days of the sale of the first one.

Another option you could look at is a partial exchange. You can purchase less than what you sell but you will pay tax on the difference.  Depending on how much profit you have and what your cash needs are this might be an option.

Bill Exeter · Answer

The LLC is a pass-thru entity, so any and all income would pass-thru to your individual income tax return and would not solve your problem.

A few comments regarding the 1031 Exchange option.  First, the properties that you buy must also be held for rental purposes, so if you decide to go down the rehab and flipping (i.e., held for sale vs. rental) you will not qualify for 1031 Exchange treatment.  Second, the 1031 Exchange would allow you to defer all of your income taxes as long as you meet the requirements, so it could be used to keep your taxable income down so that you might still qualify for the subsidy.  Third, yes, you are correct, you must trade equal or up in value based upon your net sale price (not profit, taxable gain or equity).

Linda Weygant · Answer

I believe there is a provision for multiple properties, but I am not an expert on this topic.

Bill Exeter · Answer

I just thought that I would weigh in here.  You do not necessarily have to pay the taxes.  If you defer them for your entire life, your heirs will inherit the property at a step-up in cost basis so that there are no capital gain taxes to pay.

Dan Sifuentes · Answer

Check out this article on the 1031 exchange.  Forbes Article

If you really want to do a 1031 exchange then you should speak with a professional about it.  One thing to know is that you will have to pay the gains taxes on it someday.  All the 1031 exchange does is defer the taxes to a later date.  But you can theoretically defer them for your entire life.

Whit Hill · Answer

And thanks for the LLC advice. Obviously, we have a lot to learn...

Whit Hill · Answer

Wow! Thanks for all the responses. Abhishek: on the whole, Ann Arbor has been great. Our house is right downtown, within walking distance to town and campus so we never had trouble finding good tenants. Had a mix of medical residents (best tenants ever) and grad students (also OK). But we are now realizing how out of step with the market we've been renting it for. Could have priced it higher, but opted for keeping the peace and holding on to responsible tenants.

Thanks to those who mentioned the 101 Exchange. We've been trying to learn about this option.  My son (a budding RE investor who encouraged me to join this site) has been pushing for us to explore this option. My understanding, tho, is that we would have to reinvest the profit in a property that costs the same as we sell for. Is this accurate?

Rookies that we are, when we first heard about the 1031, we thought we'd be able to take the profit from the sale (say $100K, just for argument) and then buy a house outright here in Nashville for $100K and be off to the races. But, as you all know, it's not that simple. As I understand it now, if we sell our Ann Arbor house for, say, $400K, then any Nashville house we buy would have to be $400K (putting the $100K down and getting a mortgage.)

Big question: could we do the Exchange and instead buy TWO $200K houses? FOUR $100K houses? So complicated.

I keep thinking it might just be best to pay the tax and be done with it. Sigh.

Linda Weygant · Answer

An LLC is a pass through entity meaning the profits still show up on your personal tax return.  There's also an issue of quit claiming the property to an LLC which can trigger your mortgage company to call the note, meaning they will ask you to pay the full mortgage right away.  Since you're selling anyways, it may not be an issue, but it sounds like a lot more headache than it is worth

Since you are planning to reinvest in additional rental properties, look into a 1031 exchange.  This will allow you to sell the first property and defer the gain (and thus the taxes) into the second property.  You'll need to work with a 1031 agent for a full explanation and they will guide you through the process, but it sounds like the best solution for you overall.

Dan Sifuentes · Answer

@Brandon Turner posted a great blog article about LLCs recently.  You should start there.

Blog Article

In general LLCs are pass-through when it comes to income.  To have a corporation that isn't pass-through and has it's own tax ID you would need a c corporation.

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