How does investing out of state impact your tax status?

Question

I've been investigating doing real estate investing out of state, since where I live (Massachusetts) is not only an overpriced real estate market but notoriously landlord unfriendly and hostile toward small business in general.

I've been looking mostly at markets in Florida (Orlando area, for example) and Texas (around Houston) because I know that they are, for the most part, business friendly but more importantly they don't have state income taxes.

But there are other markets that look attractive as well.  Take Ohio for example, there are a few markets there that look good, Cleveland or some of the smaller cities.  But, they have a state income tax code that defines the meaning of the term byzantine.  At least it looks like that for an outsider.

If I bought a property in Ohio and rented it, then I'm going to have to file in Ohio too?  It would seem to take a lot of wind out of the sails of the idea of investing there.

Out of state investors, tell me your experiences!  :)

Matt Devincenzo · Answer

Found a thread that is where I got some of my info that an actual tax guy chimed in on, hope it helps.

tax-out-of-state-income

Scott L. · Answer

I talked to a real estate investment advisory co. who publishes a guide to commercial real estate investment across the 50 states. It's interesting how much the variations in taxes and customs/fees can affect investment profits across the states.

You can request the guide, it's complimentary, at www.reiadvise.com/50-state-guide by emailing admin@reiadvise.com .

To learn more, I interviewed the tax guide's creator, Alan Blair of REI Equity Partners, for a State real estate taxes blog post. Hope this helps...

Dave Toelkes · Answer

Peter Davis,

If you have rental income from the state, you have to file a state income tax return (if the state has a personal income tax).  You also have to report all your rental income in the state where you reside, or, you may have to exclude out of state rental losses from your state income tax return.

In my opinion, holding rental property in a corporation is the most expensive way to go.  Not only do you bring double taxation into play, but financing (refinancing) is done with commercial loans (higher interest rates, higher debt service, and balloon payments), and transferring a property out of the corporation to yourself is a taxable event at the property's FMV.

Another drawback, since your property is in the corporation, you lose the $25K net passive loss allowance on your personal income tax return.

Mike Neubauer · Answer

Investing out of state is most likely not going to benefit you too much in the tax area. If you reside in Massachusetts, you will need to claim "tell" Mass. how you money you made no matter what state it was in, and they will most likely require you to pay the income tax anyways. The way this doesn't happen sometimes is if a state has reciprocity with another state. However, I can't imagine that Mass has reciprocity with states as far as Florida and Texas.

As an example, I live in Illinois, but do most of my investing in Indiana. I have to claim all my income in Illinois, and any income that was made in Indiana to IN. These 2 states have reciprocity stating that any taxes I pay to Indiana will be deducted from what I owe Illinois. In my case, the tax rate is the same so it is a wash.

The one way to reduce your taxes if you want to invest out of state would be to tax your LLC as a C corp where the corporation would pay taxes and you would only be taxed on the dividends paid to you personally. The only downside is if you want all the cash from your business in your pocket, you will have to take it all out in dividends and hence be taxed anyway. This option may work with an S-Corp as well, but I'm not 100% sure. If you plan to reinvest the money and grow the company then this strategy may be beneficial. Just realize you may also be somewhat setting yourself up for double taxation as the Corp is taxed as its own entity, and then you are taxed on the income personally from dividends.

As always, talk to a GOOD REAL ESTATE CPA for the best options. Maybe Mass does have reciprocity with a state that you would like to do business in, or maybe they have another way to avoid Mass. taking your money.

Or you could move to Florida or Texas.

Matt Devincenzo · Answer

Peter Davis I haven't had to deal with this yet due to being active duty military in CA so I was considered a "FL resident(born and raised)" still and since we have no state income tax had nothing to file.

I am now out and a bon a fide CA resident for the 2013 tax year so I've researched a little on it thus far since this will be the first year in my entire life I have a state income tax. You would file state tax for the rental property location first so say you make 10K in OH, FL and MA each. Then you would file for your state as well and be credited with taxes paid for out of state income already up to your max.

So made up quick example using the 10K per state filed for the individual states.
FL 0% rate          $0 state tax
OH 8% rate         $800
MA 10% rate        $1000

Next you would file with the added out of state income added to your home state using it's interest rate of 10%

Fl $1000-$0(what you paid already) you owe MA $1000
OH $1000-800 you owe MA $200
MA  You already paid what you owed for earnings in state

Hope that helps some, I haven't had to file myself yet but this is the way that thus far I understand it works.

(No legal or tax advise)

Lyall Storandt · Answer

Peter Davis You do not; only federal. However, the lack of state income tax tends to result in slightly higher property taxes, but not enough so to detract significantly from your rental returns or cash flow.

Peter Davis · Answer

Thanks for the replies.  In a state like Texas, Lyall Storandt do you even have to file a personal income tax form since there's no state income tax in Texas?  Just saying, I have never lived in a state where there is not any state income tax.

Lyall Storandt · Answer

Peter Davis Hey Peter, as far as I know income is taxable in the state in which it is "earned." I'm not an accountant and would advise consulting one local to the area(s) you're considering investing in, but by that simple definition, I would assume you'd be responsible for paying a state income tax if you had rental property there. I hope I'm not, but I could also be very wrong...

Jon Holdman · Answer

Yes, you will need to file taxes in every state where you are earning rental income.  You may need to be paying quarterly taxes, too.

Hans Restuccia · Answer

Welcome! Glad to have you!! Let me know if I can be of assistance in any way. (I am new to BP too- smile)

How does investing out of state impact your tax status?

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