All Forum Posts by: David Beard

Also, the Nolo article is extremely simplistic and not worth much.  The author may have a J.D., but he's a professional writer and this article picked up none of the nuances of this topic.  The CPA I spoke to said he did a return just yesterday with the installment sale of rental real estate, and the software handled it just as expected, deferring the depreciation.

I reviewed the TurboTax output to Forms 4797 and 6252 for one of the assets I sold, and it's doing the deferral perfectly.  In fact, if you manually follow the logic on the forms, you can see that the software is doing it correct.  I'm satisfied at this point. And the CPA on the other thread that was mentioned somewhere above concurred with this deferral as well.

@Brandon Hall  Brandon, sorry for sounding rude and/or brusque.  I'm in a hurry and frustrated.  I sold 10 properties last year with seller financing in gain position.  I've got two CPAs and two software packages telling me that I can defer taxes on most of the unrecaptured 1250 depr. gain (defer on all but the down payment and small principal received last year) , and I'm anxious to resolve before Monday, needless to say ...  very much appreciate your taking a moment during an incredibly busy seasonal time...

@Brandon Hall, the CPA is not confused about rental real estate vs business real estate.  He made no distinction.  I actually used the example of the business sale in which one of the underlying assets is Sec 1250 real estate.  The treatment of the real estate (even though owned by a business) is no different than rental real estate owned by an individual or an partnership.  If you think so, please cite your support.

I've reviewed his research straight from the IRC and it all hangs together.  Your citations of IRS publications seem to me to be not fully in context.  Your research refers only to "depreciation recapture income" being treated in such-and-such a way, and the point is that Sec 1250 straight-line depreciation IS NOT "depreciation recapture income" at all, so any references to "depreciation recapture income" do not apply.  It is in fact capital gains, albeit a special type of gain subject to a special rate.  Thus your citations do not apply.  Both the CPA's professional software, as well as Turbotax, agree.

You reference Section 453(i)(1), which is fine, but then 453(i)(2) has the definition for "recapture income", basically saying that it's only the portion of depreciation treated as ordinary income, and Section 1250 straight-line depreciation is NOT ordinary income, it's capital gains (technically called "unrecaptured section 1250 gain").  Please refer to the next section for support of what depreciation is treated as ordinary income (in short, straight line depreciation on Sec 1250 real estate is not ordinary income).

Quoting from IRS Pub 544:

Section 1250 Property

Gain on the disposition of section 1250 property is treated as ordinary income to the extent of additional depreciation allowed or allowable on the property. To determine the additional depreciation on section 1250 property, see Additional Depreciation, below.

Section 1250 property defined. This includes all real property that is subject to an allowance for depreciation and that is not and never has been section 1245 property. It includes a leasehold of land or section 1250 property subject to an allowance for depreciation. 

If you hold section 1250 property longer than 1 year, the additional depreciation is the actual depreciation adjustments that are more than the depreciation figured using the straight line method.  For the treatment of unrecaptured section 1250 gain, see Capital Gains Tax Rate, later.

As a final test, I ran an example through TurboTax Business 2015, and the program did in fact defer the ENTIRE gain, including accumulated depreciation...  @Steven Hamilton II, @Kim B., @Robert McEachern, wanted you to see this information, thanks.

I received a second confirming opinion from another CPA that the accumulated depreciation is eligible for deferral under an installment sale.  As a minor additional point, I was told that as gains are recognized in current and future periods, the total amount will be taxed at the 25% rate until all prior depreciation has been recognized/exhausted... and then the remaining gains will be taxed at the normal 15% cap gains tax rate.

The CPA/tax attorney also demonstrated that his tax software does the full deferral of the accumulated depreciation in the manner in which he described.

There is much confusion and misinformation on-line (including here on BP), which is surprising give how common it is to sell rental real estate property with seller financing.  One would think It would be unambiguous.

Interested to hear further comments from CPA's, EA's, or other tax pros.  Seems like an area where real estate investors need to have a clear understanding.

@Brandon Hall, I just had a CPA/tax attorney tell me that for Section 1250 property (real estate) that was amortized straight line (as essentially all investment real estate has been for many years), the accumulated depreciation is not characterized as "recapture income" at time of sale, but as "capital gains" with a special rate (up to 25% vs 15% cap gains rate).  Since it's capital gains, he says that it CAN be deferred in an installment sale.  Refer to IRC section 453 for definition and use of term "recapture income".  Please refer to Pub. 537, section titled "Example -- Sale of a Business" and look how the sale of the Building (Sec 1250 property) is being handled in an installment sale, for confirmation in an IRS example.

It can be very area-specific, but in many areas there are HMLs that will loan 85-90% of cost (subject to a max of 60-70% of ARV). So perhaps you can call around and find better terms. Check out REIA meetings and make an effort to network with moneyed folks in your circle of friends and acquaintances. Not to generalize too much, but high-earners in their late 40's to early 60's often have surplus funds.

You have done some successful flips, so summarize your track record in a couple of pages for sharing with these potential investors, emphasizing the relative safety of the investment via the low LTV, your successful track record, and the short holding period.

Offer them 10% interest, bring 10% of your own money.

As long as you stick with an experienced and reputable provider (that have ERISA, corporate, and tax attorneys on staff, such as the four I listed previously), and follow their clearly delineated guidelines for avoiding prohibited transactions and running the 401k in a nondiscriminatory manner, then I don't view this as a risky technique whatsoever.

Again, I tallked to all four providers that I cited, and all indicate that in those instances where their client plans have been audited (talking about actual audits, not generic letter of determination), that the IRS has taken no adverse actions against their clients, insofar as those clients followed the clear rules. There are also various rules in administering your self-directed checkbook IRAs and 401k's, this is only a bit more complicated and well within the pay grade of most smart folks on here!

I've been impressed by the knowledge base and credentials of attorneys and representatives of these ROBS providers. They've come a long way in the decade since these plans came on the scene, and pretty much have it down pat at this point. Some general rules that they all agree on, that I can think of at the moment:

• Take a salary only as the company earns revenue.
• Invest some personal funds in the C-Corp alongside the 401k's funds (can be as little as 1 or 2% of the total investment)
• Contribute to the 401k from your salary, at least 1%
• If you have employees in this C-Corp or any other entity that you control (i.e. a so-called control group), don't be discriminatory in running your 401k. There are short cuts and "safe harbor" techniques that you can follow. It's not a minefield, and each of the four providers that I mentioned have ERISA attorneys that provide ongoing support and guidance.
• Avoid prohibited transactions between the C-Corp and yourself (or a party that is disqualified relative to yourself), as well as between the 401k and yourself
• Have the business appraised annually, and whenever C-Corp shares are issued or redeemed.

ROBS is not a fringe technique. It has been used to start tens of thousands of small businesses, often franchises. In fact, a sizable percentage of all franchises are financed in this manner (particularly after the crash when banks would simply not lend on such enterprises). The IRS has essentially blessed this structure, as long as the rules are followed. The larger/reputable providers state that they have never lost in an IRS audit (Guidant, Benetrends, SDCooper, IRAFinancialGroup) . Here are the advantages from my perspective, as I just went this route.

• Use your 401k to invest in "active" real estate businesses (rehabbing, home building, property management, wholesaling) without incurring trust tax on your 401k (a 40% rate after active income hits about $12k)
• Avoid taxes and penalties that would be incurred if the funds were withdrawn from the 401k.
• The C-Corp can borrow from a bank on highly favorable terms, and the business owner is free to provide a personal guaranty (in this case, the guaranty is not a prohibited transaction)
• The C-Corp pays you a salary
• If successful, you can eventually buy out the 401k and convert to an S-Corp, which would be more tax efficient.
• This may be the only viable way to start a sizable real estate operating business!

There are no tax benefits to slicing and dicing LLC's, where did you get that idea?

There is still a benefit to deeding over to land trusts, in that it makes it much more difficult to ascertain your total holdings from the public records. A trial lawyer may conclude that you have little net worth.

Someone might use a holding LLC domiciled in a strong asset-protection state like Nevada, which would own their local LLC's. This has the effect of ensuring that any legal actions against your local LLC's are governed by the holding LLC states's laws, which may be far better as pertains to charging order protection, for example.

It is worthwhile to carve up into multiple LLCs at whatever point you feel that your net worth in LLC assets is great enough to warrant the additional protection. Only you can determine this number, though many use $250k as a maximum amount of equity per LLC.