Corporate setup for Rehab Flips and Income properties

[Jason NA]

Introduction and background on questions:

Currently we are a 2 man operation that is a 50/50 partnership. We will not have any additional partners in the future and we are not interested in selling part ownership of our company to generate capital. We want to flip properties to generate cash that will be used as down payments to buy income properties that generate positive cash flow. We are not looking for a small-time solution. Rather we are interested in a structure that we can grow into.

The following questions are specific and will help supplement our attempt to answer a more general question: What is the best long term corporate structure for our business? How can we best limit liability on our rentals and save on taxes from our flips AND use that cash to buy more property that must also be protected through separate LLC's?

1. Assume one LLC (with standard pass through tax characteristics) already had 3 properties in its name. What are the full tax consequences of splitting off 2 of those properties into their own LLC's so that all properties have their own LLC's?

2. Assume we have an entity (C corp or S corp or LLC that is taxed like a corporation) which does flips and consequently is eligible for many tax deductions and avoids paying Social Security and Medicare taxes. How do we use the capital that is trapped in that corporation to buy income property that would ultimately reside in another LLC? Can you buy the property with the corporation and then transfer it to its own LLC tax free? Can you start a new LLC and then have the corporation lend the money to the LLC to buy the property and therefore avoid gift taxes or any other taxes that might apply in this situation? The same question in a different way: Is there any way to do flips without paying Social Security and Medicare taxes and use that capital to purchase rental properties that end up in another LLC?

3. Assume there were 3 LLC's each with a single property. Let's say that one of the properties had a cracked driveway or something and a tenant tripped and incurred multi million dollar damages. Do they HAVE to sue "the owner" of the property which is the LLC or is it at all possible to sue us as individuals? When do they have grounds to sue us personally as opposed to the LLC? We understand that if we get into a bar fight and kill someone that all of our personal assets and our interests in the LLC's assets are at risk. We also understand that if we personally installed a water heater (or hired a non-licensed handyman) at one of our properties that blew up and killed someone that we would also have a similar fate (this implies direct personal negligence on our part). But where is the line drawn when it comes to negligence? Is a "slip and fall" or a carbon monoxide leak or anything else of that nature, considered personal negligence on my part? What is the REAL difference between putting properties in their own LLC's as opposed to lumping them all together in one LLC?

[Account Closed]

Originally posted by "HometownProperties":

Introduction and background on questions:

Currently we are a 2 man operation that is a 50/50 partnership. We will not have any additional partners in the future and we are not interested in selling part ownership of our company to generate capital. We want to flip properties to generate cash that will be used as down payments to buy income properties that generate positive cash flow. We are not looking for a small-time solution. Rather we are interested in a structure that we can grow into.

Noted. Assuming long term and stable membership. See below.

Originally posted by "HometownProperties":

The following questions are specific and will help supplement our attempt to answer a more general question: What is the best long term corporate structure for our business? How can we best limit liability on our rentals and save on taxes from our flips AND use that cash to buy more property that must also be protected through separate LLC's?

Best? Best varies based on the business and other factors. Even the best solution in one state could be the wrong solution in another state given the differences in fees at the state level or the value of the properties common in the state (assuming you invest in one state).

If you invest in multiple states you could need a different solution given foreign corporation rulesa at the state level (foreign - any entity that is not set up in the state it operates).

Originally posted by "HometownProperties":

1. Assume one LLC (with standard pass through tax characteristics) already had 3 properties in its name. What are the full tax consequences of splitting off 2 of those properties into their own LLC's so that all properties have their own LLC's?

This is a sale. You could end up paying transfer taxes. In one state that would be 2% of the value for both. In other states there can be exceptions when transferring title between related parties.

There could be a lot of problems having the properties in separate LLCs based on the way the state taxes the LLC. Or there will be little tax impact and there is just the admisntration issues.

Get tax advice from someone who knows the RE laws and tax details for the states involved.

Originally posted by "HometownProperties":

2. Assume we have an entity (C corp or S corp or LLC that is taxed like a corporation) which does flips and consequently is eligible for many tax deductions and avoids paying Social Security and Medicare taxes. How do we use the capital that is trapped in that corporation to buy income property that would ultimately reside in another LLC? Can you buy the property with the corporation and then transfer it to its own LLC tax free? Can you start a new LLC and then have the corporation lend the money to the LLC to buy the property and therefore avoid gift taxes or any other taxes that might apply in this situation? The same question in a different way: Is there any way to do flips without paying Social Security and Medicare taxes and use that capital to purchase rental properties that end up in another LLC?

Yes and no.

There is a limit to how much related entities can assist each other. What you do not want to do is compromise the two entities so that a judge views them as the same and you lose some asset protection.

There are many creative things using loans, options and other things. Rather than go there let me ask why you have an issue?

The C-corp runs activities that generate short term income. It pays for company benefits for the employees. Pension, medical, dental, vision, etc.

Having W-2 income is not a bad things for the two individuals. Knowing that you can show tax returns and stable income helps you get loans for future purchases (outside the C corp).

The C corp can pay all training costs and many of the running costs related to the businesses as long as there are reasonable guidelines.

If the C corp wants to lend money to an LLC that can work but it is still a loan. The C corp will still have interest income and taxes to pay.

Originally posted by "HometownProperties":

3. Assume there were 3 LLC's each with a single property. Let's say that one of the properties had a cracked driveway or something and a tenant tripped and incurred multi million dollar damages. Do they HAVE to sue "the owner" of the property which is the LLC or is it at all possible to sue us as individuals? When do they have grounds to sue us personally as opposed to the LLC? We understand that if we get into a bar fight and kill someone that all of our personal assets and our interests in the LLC's assets are at risk. We also understand that if we personally installed a water heater (or hired a non-licensed handyman) at one of our properties that blew up and killed someone that we would also have a similar fate (this implies direct personal negligence on our part). But where is the line drawn when it comes to negligence? Is a "slip and fall" or a carbon monoxide leak or anything else of that nature, considered personal negligence on my part? What is the REAL difference between putting properties in their own LLC's as opposed to lumping them all together in one LLC?

Where is the line. It depends on what the judge (or the jury) happens to think the day a decision is handed down. There are reasonable assumptions.

1. If indivuduals were negligent then they are liable along with the property owner.

2. Carry umbrella liability insurance. Have the LLC and the corporation purchase business insurance.

3. Operate the entities correctly. No dipping in and out of the cash pots when it is convenient. Document any related transaction. You do not want to appear that the entities really are one and co-mingled with your personal situation. Having legal entities is no block if you do not operate as if they are there and they matter. If they do not matter to you they will not matter to the judge. Pierce the corp veil is the phrase.

Get William Bronchick's Wealth Protection book. Less than $20 on Amazon. An easy read and very much on topic given your interest. Consider it a primer and not the final word. Then use the book to shape your questions for a good tax attorney who has a RE background.

What you want to do is not new or unique. Hence there are clear ways that people have used. Most of the time we are talking about businesses that are larger than the average found here. Expect some overheads and some office processes that make it more work. There are trade-offs.

You also might be overly concerned about liability compared to the reality. Hard to say so investigating the topic is wise.

John Corey