Best Structure For Tax Purposes?

[Harry Tommas]

Hey all,

First post on BP and I'm a relative new comer to RE investing so be gentle. Here's my current setup:
-a long held rental property (condo) in my name with a loan in my wife and my name jointly.
-a recently acquired two family rental property in my wife's name with a loan also in her name.
-Last year my wife and I filed taxes jointly when I owned only the condo.
-My wife earns a good income and I am not currently collecting any income although I plan to do so from the rental property income (as soon as I get our entity setup).
-I am focused full time on running our rental properties and growing our portfolio of property so I believe I qualify as a RE professional.
-We are using her income to qualify ourselves for all of our investment loans on properties we buy going forward.

Here are my questions:
-What ownership structure (LLC, Sole Proprietorship, or Land Trust) is best from a tax perspective? I'm leaning towards LLC or Sole Prop.
-Will I be better able to write off expenses if I transfer both properties into an LLC, or is an LLC unnecessary from a tax perspective?
-If there is no tax benefit to an LLC, should I hold both properties in my name, or her name for maximum tax benefit?
-When I start paying myself income, is there anything I should do/know about how I disburse it?

I am especially interested in how to maximize our ability to qualify for loans going forward by keeping her debt to income ratio low.

Thanks in advance folks, I'm glad to join the community!

[Dave Toelkes]

Harry,

As a general rule, a pass-through entity structure (parnership, S-corp, most LLCs,etc.) is tax neutral. That is, your income tax liability is not affected by the presence or absence of the business entity. Entity structures (if and when needed) are put in place for legal reasons, not tax reasons.

Legitimate rental expenses can always be claimed whether you have a business entity or not. Having an entity does not give you any more deductions than you would have without the entity. However, the costs of establishing and maintaining the entity will most likely increase your expenses and reduce your net cash flow.

If you are filing a joint tax return anyway, it does not matter whether title to the investment property is held in joint name or an individual name. Some lenders require all persons on the title to also be on the loan. If your wife's income only is being used to qualify for a loan, then the lender may have some say in how title is held. Please note, that your wife's DTI ratio will be determined by her income and her liabilities -- how title to the rental property is held does not affect the DTI calculation for loan qualification purposes.

Rental income is passive income that is not subject to self employment income taxes. If you hold the properties in your own name or in an LLC (disregarded entity or partnership), your net rental income is taxed on your personal tax return regardless of whether you have "paid" yourself or not. I guess the answer to your question is really: if you have net rental income, you have already paid yourself.

Don't equate net positive cash flow from your rental activity with taxable income. Many just starting in the rental property business don't realize a net taxable income for many years. It is possible to have positive cash flow and a net taxable loss from rental operations at the same time.

Lastly, don't get all hung up on establishing an entity structure that you probably don't need right away, and don't make taxes the determining factor in your investment decisions.

Personally, I can't wait for the day when my income tax bill goes over $1 million because when that happens my gross income will probably have been at least $3 million.