All Forum Posts by: Brian Schmelzlen

Hi @Wai Chan,

You do not need to form an LLC in order to claim the Section 199A deduction. Because it is you and your wife, it would be considered a sole proprietorship. If that wasn't true, it would be considered a partnership which also qualifies.

There are a number of components to this new deduction; it is almost a calculus equation in which you need to figure out one part in order to figure out the rest.  I would recommend talking to someone to figure out if you qualify for the deduction, and to perform some tax planning to best position yourself to take advantage of the deduction.

@Michael Plaks is right that there is a lot we do not know about the deduction yet.  There are over 100 points in the new tax law that specifically says that Treasury needs to issue Regulations on it (which is not a fast process).  However, Treasury is supposed to release something related to Section 199A (the 20% qualified pass thru business deduction) on June 30th, so hopefully we will have a better understanding of it in early July.

Originally posted by @John Spina jr:

@Katie L. and @Brian Schmelzlen I'm also interested in flipping. Especially buy,fix and hold. I have a general contracting business under an S-Corp. I currently do not have rental properties "yet". But when I do, what would be the best way to protect them. Would it be best to put them each in their own LLC? And if they are put into an LLC does that all go into the S-Corp or is it all separate?

Hi John,

It is a bit of a balancing act with the costs and benefits of LLCs. Personally, I would not recommend a separate LLC for every rental property. It means extra, unnecessary costs to you because you would have to file a tax return for each LLC which means more filing fees and more preparation fees. Your CPA would love you, but your wallet would not.

On the other hand, if you own a number of rental properties I wouldn't necessarily put them all into the same LLC (especially if they represent your life's savings). Assuming that there is a liability greater than your insurance coverage, everything within the LLC is at risk if the LLC is the one being sued. Therefore, if you only have 1 LLC all of your assets are at risk.

There are a few ways I would consider breaking it up. 1) One LLC per state that you are investing in. It keeps things a bit cleaner. 2) One LLC per certain dollar value of investments. For example, one LLC for every $5 million of investments (that number was picked arbitrarily).

Also, unless you have a reason to, I would own the LLCs personally rather than through an S-corporation.  There have been times when my clients had a good reason to have their S-corporation own their LLCs (or a percentage of them), but that was because there was a non-tax/non-liability reason to do so.  If you don't have a good reason, it just adds to your tax preparation costs.

Originally posted by @Paul Fagot:

Also if I were to wholesale properties, I should put that in with an S-corporations

If you want an entity for liability protection (probably a good idea) either an LLC or an S-corporation could work. To minimize self-employment/payroll taxes, an S-corporation is might be the right choice. However, to maximize the benefit of the qualified business deduction (Section 199A deduction), an LLC might be the better choice even with the higher self-employment taxes. A CPA would have to look closely at your situation and run the numbers.

I would not have the rentals in the same entity that you are using to do flips. For the rentals, you would either want to own them individually (with large insurance policies) or through an LLC.

California taxes LLCs and S-corporations differently, so you will want to work with a CPA.

Hi Paul,

Flipping is not something that you want to do in your own name or through an LLC. As a general rule, you want to use an S-corporation.

While liability concerns are an issue, that is not the main reason I am saying to use an S-corporation.  There are 2 main tax reasons why you will want to use an S-corporation.

1) Flipping houses either individually or through an LLC will generate self-employment income, which is subject to a 15.3% tax. If instead you use an S-corporation, you avoid self-employment taxes. You will pay payroll taxes, but you have more control over that.

2) You do not want a "dealer" classification attached to you by the IRS. If you are deemed a dealer, all your properties will be considered inventory and taxed at ordinary income rates when sold. That is fine if you are flipping because that is the proper treatment there, but it is a major problem is you eventually also have rentals that you occasionally sell (you also cannot 1031 inventory, so dealer status is also problematic there). If you use an S-corporation, the dealer status is attached to the S-corp and not to you personally. If done through an LLC, the dealer status attaches to you personally.

1) Crushing It by Brian Murray 2) Give and Take by Adam Grant 3) Bowling and spending time with my family 4) Treating your real estate investments like a business (ie not like a job, or like a passive investment).

Originally posted by @Rachel Cox:

WE have a client that is putting their 2nd home in an LLC, they do not reside in the state of the 2nd home, so this is for liability protection of their investment. Eventually they will retire to this home, my questions are:

*Can they depreciate this home and if so or if not why?

*what is tax benefit or negative of the home owned by the LLC

*should they leave the home in the LLC when they make it their main home for retirement?

Thank you,

Rachel

Hi Rachel,

In the context of a "2nd home", there are 3 general ways that the property can be classified: 1) personal, 2) investment, and 3) rental.  Only the rental properties can be depreciated because they are the only ones that have been "placed in service" within the meaning established by the Internal Revenue Code.

For tax purposes, there isn't a benefit to having the property in an LLC. This is especially true if it is a single-member LLC because the IRS will disregard the entity, unless it elects to be treated as a corporation. The benefit is in asset protection which your clients should discuss with an attorney; they should also discuss if a trust would serve their purposes better.

There are potential disadvantages to having a 2nd home in an LLC. These include any filing fees owed to the state and tax preparation fees. There are other potential disadvantages.

As to whether they should have the property in an LLC when they eventually convert it a principal residence, no. No, they should not.

Hi @Chad Bilstein,

I agree with you that your private lender was likely a con artist.

You have an interesting situation.  Investing in marijuana real-estate is likely to be highly profitable, but it is so much riskier than most investments given the federal government's position on it (and the Trump administration's harder line).  Obviously as a result of that, you won't get a bank loan.

I think if I was in your position and wanted to move forward, I would ask the seller to finance the deal.  You would likely have to pay a high interest rate to entice the seller, but with that and the tax benefits to the seller of recognizing the profit over time rather than all at once you might get the deal done.  It would also buy you some time to line up legitimate private financing from other sources if the seller does not want to finance it over a long period.

Being risk-adverse is a good thing, it makes you analyze a deal more carefully to ensure that it is a good one before you pull the trigger.

Yes, my recommendation would be to use your savings to make real estate (or other) investments rather than paying down your mortgage at an accelerated rate.  I don't think paying off your mortgage early is a bad thing at all; it will put you on very safe footing.  I just think it will stop you from ultimately making as much money as your could and eventually being on even safer financial footing.

In terms of increasing your cash reserves, I don't think that is a bad idea.  I think 6 months should be fine, but if you are more comfortable having 12 months of reserves that just makes your more secure.  You could also tap into those funds if you need reserves on any of your investments.

For down payments on your rentals, I think you should put down as little cash as you can.  That largely depends upon what the lender wants you to put down.  However, the caveat with that is that you should not leverage it to the point where it is too risky; you don't want to put yourself at risk of losing your rental.  You would have to run the numbers to see where that is.  Putting down less cash lets you scale up faster by being able to afford rental #2 sooner.

In terms of a 15 or 30 year loan; I think if the rental can support a 15 year loan I would do that.  It would have a lower interest rate than a 30 year loan, and given that you hate debt it seems like it would work better for you to pay it off faster.  Your cash flow on the deal would have to be pretty good to support a 15 year term, but if the property is paying for itself (even if you are not pulling money out) that is a pretty good result.

Of course, if you are interested more in immediate cash flow from your rentals then you should go with a 30 year loan.

Hi Evan,

As to your first question, no one can answer that but you.  I think as a 22 year old you can get away with it without too much of a hit to your social life.  It seems to be becoming more and more common.  If you were in your late 20s/ early 30s, it might be different (but that is just my opinion, and everyone's situation is different).

For the second question, I think you should consider multi family (duplex, triplex, quad) so that you can house hack. You can get into a house fairly cheap, and if you find the right deal you might be able to still live for free but without the hit to your social life. Of course you can house hack with a SFR by, essentially, having a roommate, but personally I would want my own space especially if I owned the place.