Can you recommend a guide/book to optimal tax/legal structures for rental income investing?

Question

Where do I start reading about this stuff?
I googled for a while until I found this link: http://www.propertyinvestmentproject.co.uk/blog/using-a-company-to-save-tax-on-rental-income which unfortunately is only valid in the UK. Is there a similar guide floating around for the US? Maybe a book that you all recommend?

Jon Holdman · Answer

Generally, rental income has a pretty good tax treatment.  You can deduct all your actual expenses, including the interest portion of your mortgage payment.  Not the principle part of your payments, though.  You also deduct depreciation.  That's where things get complex.  When you buy a property, part of the price is allocated to "improvements" and part to the land (usually).  Improvements depreciate, land doesn't.  Typically 80/20 unless you have some reason to do something different.  Anything you spend on the property before its rent ready increases the "basis" and has to be depreciated.  Repairs made after its rent ready are deductible in the year you spend the money.  Capital items (e.g., roofs, furnaces) have to be depreciated, even if that money is spent after the property is rent ready.

I believe rental income is not subject to SET (self employment tax - medicare and social security.)  Could be wrong, and this is where I rely on my CPA.  Income from active work, e.g., wholesaling and flipping, is subject to SET.  If you conduct those activities in some sort of corporation (c-corp, s-corp, or an LLC that's elected to be taxed as a corp and OK'ed by the IRS) and then distribute the money as dividends, you avoid the SET.  However, if you're running the company, you have to pay yourself a reasonable salary. The salary is subject to SET.  You can't get away with paying yourself $1 to run the company and then distribution $50K in dividends.  The IRS is wise to that.  OTOH, if $50K is a reasonable salary, you might get away with $50K in salary and another $50K in dividends.  If you have another job, then that income may push you up towards the annual limit on social security, $110,100 in 2012.  Also, this is one of those places where there is a LOT of uncertainty around taxation.

Even though programs like turbotax have all the forms for doing your taxes with rentals, you probably don't have the knowledge to actually fill them out to your best advantage.  I don't, and I've actually read a bunch of IRS publications on this topic.  My CPA, OTOH, does have this knowledge, and has defended his clients with the IRS and won.   I spend about $500 a year on his help (I have complexities beyond rental properties.)  Perhaps I'm fooling myself, but I think its money well spent.

Account Closed · Answer

I agree with Dave T.  There are ways though to transact business between entities that can minimize tax.  I'm not going to get specific because these are often driven by individual facts and circumstances.

Dave Toelkes · Answer

Rental income is ordinary income which is taxed at the taxpayer's marginal tax bracket rate whether the rental property is held in his own name or in a passthrough entity.

As a general rule, the passthrough entity is tax neutral, so there is no tax advantage to be gained by holding rental property in a passthrough business entity.

The choice of whether to use an entity and which one is a legal decision that should be made in consultation with an attorney who has complete knowledge of your potential liabilities.

Account Closed · Answer

One example of using multiple businesses to save on taxes would be when some one is carrying on 2 activities.  An individual is buying rental property say in there single member LLC.  This individual might also have say a retail business.  If the individual decided to purchase a strip mall and lease space to his retail business there would be some tax savings.  In this case income that might otherwise be considered ordinary business income has become passive income in the LLC thereby reducing self employment tax.

Dave Toelkes · Answer

Ben,

Rental activities generate passive income.  Rental income from property you own is taxed as ordinary income, never as a dividend.  It makes no difference whether you have a business entity, the income is still ordinary income and a business entity will still pass the income through to the taxpayer as ordinary income.  You will pay the same amount of taxes whether you have a passthrough business entity or not, so that is why we say the business entity for a rental property activity is tax neutral.

Rental activities are passive income activities that do NOT pay self-employment income taxes.  Jon's reference to the tax minimizing strategies for active income activities that do have to pay payroll taxes do not apply to your passive rental activity.

Ben Bakhshi · Answer

Can you get tax advantages by receiving the income as dividends of assets that you own?

Jon Holdman · Answer

This is a pretty good one:

http://www.nolo.com/products/every-landlords-tax-deduction-guide-DELL.html

The IRS also has documents on this topic.  Go to their web site and search around.

The best answer is that you really need a good CPA.

Can you recommend a guide/book to optimal tax/legal structures for rental income investing?

Most Popular Reply