All Forum Posts by: Brandon Hall

You don't need to perform any activities "under" the LLC in question to make them valid. An LLC is a pass through entity that simply acts as a shield for your personal assets. Conducting business in the name of the LLC will not give you any more or less authority to write-off certain expenses and take certain deductions.

To answer your questions:

1) Yes but see my statement above.

2) It is tough to say whether you can offset your commission income with prior passive losses as it depends on whether or not you materially participated in the rental activities of your LLC.

The first level of participation is simply "passive" participation. If you and your husband do not materially participate in the LLC, then you are not active participants and the carried forward passive losses can only off-set passive income.

The second level of participation is "active" participation. If you and your husband were active participants, then you receive a special allowance up to $25,000 in which you can off-set passive losses against your ordinary income. You are an active participant in a rental real estate activity if you and/or your spouse owned at least 10% of the rental property and you made management decisions or arranged for others to provide services. "Management Decisions" consist of approving of new tenants, deciding on lease terms, approving expenditures, hiring contractors, etc.

The real question is whether or not your Modified Adjusted Gross Income (MAGI), which is reported on your Form 1040, disqualifies you for the special allowance. If married filing jointly, you may use the full $25,000 allowance if your MAGI is $100k or less, meaning if you have a $25,000 rental loss which you actively participated in, you can use the entire loss to offset your ordinary income. The allowance begins to phase out once your MAGI goes over $100k and is completely eliminated once your MAGI hits $150k.

If you were not an active participant in the activity in prior years, but this year the activity becomes active because you materially participate, then suspended passive losses can be used to offset income from the new active activity, but it must be the same activity as when it was a passive activity. And again, if your MAGI is above $150k, you won't be able to deduct the losses anyway.

The third level of participation is being classified as a real estate professional. If you are classified as a real estate professional, all real estate losses can be used to off-set you and your husband's ordinary income (assuming you file jointly). To qualify, 51% of the personal services you performed in all trades or businesses during the tax year must be performed in real property trades or businesses in which you materially participated AND you performed more than 750 hours of services during the tax year in real property trades or business in which you materially participated.

However, if you are working in the real estate field (i.e. as a broker) and working for someone else (i.e. you are an employee), you do not get to count these hours or services toward the two criteria stated above unless you own at least 5% equity of the business you work for.

So can you offset your prior year passive loss of $10k against your agent commission of $10k? Yes if you and/or your husband are an active participant in the rental real estate activity and your MAGI is under $150k so that you can utilize some of the $25k allowance. And yes if you can be classified as a real estate professional.

3) This can get dangerous. If you claim the business owns your car and you expense everything under the business name, you had better keep flawless records that show the car was used for its intended business purpose. Should you be audited, the IRS may disallow your business expenses and you will be stuck footing a large bill. 

@Mackenzie Wallace That's somewhat of a loaded question only because there are so many tax implications that can be addressed. 

As far as capital gains tax goes, you are only taxed on your profits once the property has been sold. If you held the property for less than a year, you will be subject to short-term capital gains tax which can be steep (up to 35%). If you hold the property longer than a year, you will be subject to long-term capital gains tax (15-20%). 

Also, the general consensus is to never flip properties in a LLC unless it is taxed as an S-Corp. Your earnings in the LLC will be subject to Self Employment taxes but in the S-Corp, you will have some control over the amount of SE tax you pay. A more cost effective method is to simply purchase an umbrella insurance policy.

There are plenty of tax strategies you can utilize to reduce your tax liability. If you have more specific questions, feel free to PM me.

For one, you can never "avoid" taxes. Even through a 1031, eventually somewhere down the line, someone will have to pay up.

You didn't really relay much information so it will be difficult to tell you what to expect come tax time. However on a basic level, only your profits will be subject to taxation. Short/long-term depends on how long you hold the property. How much tax you pay depends on whether you are employing any tax strategies. 

In your specific example, your cost basis originally is $100k. You basis increases to $120k when you add your renovation costs. When you sell it for $150k, your profit is $30k and that is what will be subject to tax.

You should never put your personal residence into a LLC or corporation. If you are looking for extra protection or you are trying to plan your estate, look at putting your residence into a trust or Family Limited Partnership.

*Edit - As previous posters have mentioned, you may lose your owner occupied status and homestead exemption. 

@Nghi Le I'm not going to comment on whether she can "go ahead and make the purchase," but from a gift tax perspective, unless her parents have already gifted their annual exclusion, gift tax will be a non-issue.

The difference between non-family purchases is that they are done at "arms length" meaning that the purchaser and seller do not share an interest of any kind. If the transaction is completed at arms length, it is assumed that market efficiencies drove the price and therefor gift tax will be a non-issue.

It is important to note that two non-family members can still have a shared interest through company ownership, contracts, etc. and if these people were to buy and sell to each other, it would not be an arms length transaction and gift tax would then be a factor.

@Paul Ewing is right in his statement that the equity will likely be classified as a gift by the parents to the daughter. A gift is any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money's worth) is not received in return. Since the daughter is not buying the house at market value, the difference will be a gift.

The current annual gift exclusion is $14,000. Bother parents can use their exclusion, as Paul mentioned, to bring the total annual exclusion to $28,000. The exclusion means you don't have to worry about that portion of the gift being subject to tax. Example: you have a $40,000 gift; only $12,000 (40,000 - 28,000) is subject to tax if both donors (parents in this case) use their exclusion. 

It is important to note that the lifetime gift exclusion for an individual is $5.34 Million, meaning an individual can gift that much in a lifetime without being taxed. Married individuals can combine this for a total $10.68 Million in lifetime gift exclusions. When individuals exceed their annual exclusions (of $14,000), the excess that was gifted will be applied to the lifetime gift exclusion and decrease it. So if you were to gift someone $1,014,000, your annual exclusion would be taken out of the gift leaving you with $1 Million. The $1 Million would be applied to your lifetime exclusion of $5.34, leaving you with $4.34 left to gift tax-free. So even though you gifted someone a huge chunk of change, you don't pay taxes on it since you had your lifetime exclusion available for use.

I don't know the financial situation of your friend and her parents, but unless she is dealing with a multi-million dollar property, her parents likely won't need to worry about paying gift tax currently.

When I say "tax losses" I mean "loss for tax purposes." Think of it as a tax loss creates the ability to take a tax deduction. They are not necessarily interchangeable since a tax loss will not always create a tax deduction. 

Referring to my example above, if you are an active investor and report a $30,000 loss for tax purposes, you will only be able to deduct $25,000 of the loss in that year and you will have to carry forward the remaining $5,000. 

So they can be used interchangeably, but they do not always mean the same thing. Let me know if you have any more questions. And feel free to PM me.

@Paul Ewing Simply calling yourself a business owner vs. investor will not allow you to qualify as a real estate professional. The IRS has stringent guidelines that must be met to be considered a RE Pro.

@Fred Stevenson Being an "Active" investor vs. a "Real Estate Professional" does not affect the treatment of your real estate expenses. If you replace a roof, both an active investor and real estate professional capitalize and depreciate that roof. For your examples, both an active investor and real estate professional would expense travel expenses and capitalize and depreciate the cost of the computer (generally). 

The difference between an active investor and real estate professional is the amount of tax losses you can deduct against your ordinary income. An active investor may deduct up to $25,000 of tax losses against ordinary income (assuming you meet Modified Adjusted Gross Income thresholds). A real estate professional will be able to deduct the full amount of tax losses against ordinary income since it is essentially that person's business.

Example: You own a apartment building and you have a tax loss of $30,000. The active investor will only be able to deduct $25,000 and will have to carry over the $5,000 tax loss into the future. The RE Pro may deduct the full $30,000. In this case, it will be more beneficial tax wise to be classified as an RE Pro.

Being an RE Pro becomes very helpful when you are married filing jointly because you can deduct your tax losses against your spouse's income. 

You can always deduct your expenses against the related income. I think you are trying to ask if you can deduct real estate losses against ordinary income.

Assuming you meet the IRS's activity rules and you are in fact an "active" participant, it really boils down to what your Modified Adjusted Gross Income (MAGI) is. You mentioned you  are married, and I am going to assume you file jointly. If this is the case and your MAGI exceeds $150,000, then you have exceeded the deductibility threshold and you won't be able to deduct  losses. You can however carry them forward indefinitely.

 If your MAGI is below $100,000, you can deduct up to $25,000 of real estate losses against your ordinary income. This is sometimes referred to as the "Mom and Pop" rule as it obviously helps limit ones tax liability. 

If your MAGI falls between $100 and 150k, then you may deduct 50% of the difference between the top threshold and your MAGI. Example: your MAGI is $120k. You may deduct $15k of real estate losses against your ordinary income ($150-120=30/2=15).

Flipping houses is not a passive activity. The houses are essentially your inventory and you are operating a full blown business rather than "investing."

That being said, you can drastically reduce your SE taxes by flipping houses in an S-Corp. An S-Corp allows you to pay the owner a "distribution" as well as a "reasonable salary." Distributions are taxed at your ordinary rate and will not be subject to SE taxes while the salary you pay yourself will be subject to SE taxes.

Example: S-Corp generates $100k and you estimate that a reasonable salary for someone in your profession and area is $60k. You classify $60k as a salary and $40k as a distribution. The salary is subject to SE tax while the distribution is not. You have effectively decreased your SE tax liability by 40%. **Note that there is a bit more that goes into this, but think of this as a high-level example for your general understanding.

I'd also like to note that S-Corps can be costly to establish and operating. You will need an accountant/tax planner, lawyer, etc. Depending on the caliber of property you are flipping, you may be better of sticking with an LLC and paying the SE tax.