All Forum Posts by: Joe Robinson

Here's a question for my fellow SEP IRA/solo 401k gurus. Assume it's a IRA LLC (a checkbook control IRA). Any opinions would be appreciated..

- Someone cannot take a management fee, for managing a rental that is owned by their IRA LLC. That's a prohibited transaction, without a doubt.

- But ... would you guys say this is a prohibited transaction? What if your IRA LLC owner finances a house to a 3rd party, and get payments every month. This not a contract for deed, or lease to own scenario, but the house is **100% in the name of the 3rd party owner** ... the IRA LLC just has a mortgage on it. AND...as a day job you the IRA LLC owner is an insurance agent, and the 3rd party who is owner financing the house from you requests that you provide them insurance. The payment will go directly from the 3rd party (owner financing person) -> to the insurance company -> and totally bypass the IRA LLC owner and/or his insurance agency. *But*, the insurance company will pay the IRA LLC owner a 15% commission on the insurance policy!!!

MORE NOTES -> The IRS is very clear - see https://www.irs.gov/irm/part4/irm_04-072-011 - a person cannot provide a service or facility to his retirement plan (the IRA LLC). But... what is stopping me from washing the windows once a month of that 3rd party, on the house I owner financed, for $100 a month? That has nothing to do with my IRA LLC, is clearly not a service for the IRA LLC, and I'm making $100 a month washing windows. I am providing a service or facility to the 3rd party owner, not the IRA LLC. But what if I provide insurance to that house ... what do you guys think??? The only catch is - the IRA LLC is named as a loss payee / mortgagee on the insurance documents - so I think that could be a red flag in an audit. But again, in the window washing scenario, I'm providing a service to the owner. Not the IRA LLC.

Any opinions??

Buddy,

We have a lot in common:
- I also am very smart / knowledgeable with taxes [you sound well educated]
- I also use (well, used) Turbotax
- I also invest in real estate
- I also was audited by the IRS
- I also bought ... the audit defense service

BUT...when I actually got the audit letter [this was the big daddy field audit, where they come to your office and/or home]...I immediately started doing tons of research on the Turbotax audit defense service I *already paid for*-- and there were so many bad reviews it's not even funny. It sounded like to me, Turbotax outsources your audit defense to the lowest paid / bottom of the barrel type of accountant or EA. It may be someone with little or no experience in dealing with the IRS.

So - I decided to find someone with TONS of experience. I hired someone, who was able to handle all the communications with the IRS agent, who kept me in the loop on a regular basis, and was able to package up my crazy complicated tax documents into a professional looking arrangement that "blew the socks off" the IRS agent. I kept a good audit trail, and was honest, so that was the most important factor! But - the way my representative packaged everything up, presented it & communicated it to the IRS agent made a huge huge difference. In the end, I owed $0. Nada. Nothing. And 85% of all people who have all field audits owe something, and usually it's 8x as much as via a mail or in person [office] audit.

So --- my point --- if it ever happens again, hire someone local to represent you. Avoid the Turbotax audit defense service.

PS --- here's my audit IRS story.

https://www.biggerpockets.com/forums/51/topics/463...

Hi Austin, to answer your questions:

Did you not issue some 1099 with some payments. As a Real Estate Professional this is required. Did you not get fined for this? As a small landlord 1099s are not required.

- You are asking several questions in one here. I'll sum it up - whether you own 1 rental property OR 100 - if you are super duper part-time OR doing it full-time --- issue 1099s to every single person you pay more than $600 to. Do it. Period. End of story. Small landlords ARE REQUIRED TO DO THIS though a few resources online say otherwise --- trust me, the IRS will agree differently if/when you get audited. It's better to be safe than sorry, and its so easy to do. So just do it.

Did you have auto mileage logs?

- I have auto mileage logs

Did you have to log your hours to meet the Real Estate Professional minimum hour requirement?

- No. If you have a job, this would probably be a GREAT idea. But in my case, *ALL I DO* is real estate investing. I do wholesaling, rentals, notes & retail rehabs. I live & breathe real estate, way more than 40 hours a week, and I love every minute of it. Once my accountant presented this, there was no argument from the IRS agent. As I said - most IRS agents are reasonable people.

Were there any questionable expenses that you had to prove were business related?

- Nope, because I am not dumb. I don't buy personal living room furniture and claim it as a business expense, or go on a cruise [that's not business related] and claim it as a business expense. I know what is a legit business expense, and what is not. It's not complicated. And of course --- this is 101 --- keep separate checking accounts & good records, and save all receipts. See https://www.irs.gov/businesses/small-businesses-self-employed/recordkeeping

How many months after you filed taxes was the audit notice mailed?

- I think around 18 months

Do you recommend doing your own taxes and books if you are up to date on tax law like you are? It seems more efficient to do it yourself.

- If you have the knowledge I have, yes. Especially if you have the time OR the lack of $$ to pay an accountant. But if you don't have the time or knowledge - outsource it. I have since outsourced all my bookkeeping / tax work due to time. I am Mr ElCheapo small business owner ... I like to save $$$ like any other small business man! But sometimes, its worth outsourcing stuff - like your books / accounting work.

Yes, but not always. Some auditors will deny a deduction if you do not issue a 1099 (though that's wrong, technically) So use checks, still do invoices (and receipts), and get W-9s and issue 1099s. 

One last note - I deal with a lot of handymen who in the past have not given me invoices. For many of these guys, I have done business with a handshake and I just gave them a check for the work they did. The returned check w/ a note in the memo section is acceptable evidence as a deduction, however it's much better to have an invoice from the person as well. I now make sure everybody gives me invoices --- and actually I keep a lot of generic blank invoices with me and I have the handymen fill them out and sign them as needed.

congratulations on getting through it! What in particular did the IRS focus on - you mentioned they were interested in your being a RE professional... What information did they look at closely?

- though the initial IRS letter said they were contacting me because of the fact my passive losses were greater than 25k, they literally went over everything. You name it, they looked at it. That it's what a field audit is unfortunately... they look at (or have the right to look at) everything 

Is there anything that you will do differently going forward based on this?

- No, except for what was mentioned above

about some things that you were glad that you did that may have saved you some hassle?? 

- even though I have crazy complicated taxes, and I report everything correctly, they probably would not have even said anything if I was not filing as a real estate professional and exceeded the 25k in passive losses (which were legitimate since I could claim that status)

 tips for the rest of us?

- Just keep good books, keep all receipts and be honest. Also, be sure to issue 1099s to everybody you pay more than $600 to. Some folks say you do not need to do it in the real estate business, but yes you do and it is good practice anyway. That's it

I have never heard of that before, but I imagine it happens. Most of my successful real estate investor friends use one bookkeeper/accountant, though some do have separate bookkeepers & accountants...and the bookkeeper is usually not a CPA.

I communicated to the IRS via the enrolled agent, yes, so I had no personal contact with the agent directly. 

However they had a looooooooooong list of questions for me [I gave answers in writing] & tons of requests for documents [which amounted to reams & reams of paper, maybe boxes of paper, however much of it was digital thank god], which I relayed through the enrolled agent. In one case, some answers were emailed to the IRS agent & I got BCC'd on the communication.

Hello fellow investors,

In 2016 I got audited by the IRS, and it got started due to my real estate investing activities.

This was a full-blown FIELD AUDIT, where they went through everything of mine. I have lots of business and personal checking accounts, and they went over the bank statements line by line. They asked for TONS of paperwork, and this took 6 months to complete. But I survived! And I owed $0 – in the end!

 About me:

- I invest in notes, rentals, I do flipping & wholesaling

- I invest in real estate full-time

- I have no S or C corporations / but I do have pass-through single member LLCs for liability protection, so everything goes directly to my 1040 & associated schedules

- Up until recently, I did my own taxes & books

- I am fairly educated on taxes. I am by no means an EA or CPA, but I know the fundamentals of bookkeeping and how to do rather complicated taxes.

- I take every legitimate deduction possible. I take ‘em all. And every year I read a new book on tax law for small businesses and real estate investors – just to keep up on what’s new.

What I learned:

- What really set off the IRS looking at my tax return was me filing as “real estate professional”, where my passive losses exceeded the $25,000 normally allowed. It was completely legitimate, but this IS a real IRS audit target. So be aware of that. In the end, everything was A-OK for me.

- The IRS has 3 kinds of audits – [1] a mail audit (where they ask for information on something specific, e.g. please provide proof you donated $3000 to your church in 2016), [2] an in-person audit (where you go into the local IRS office, and provide proof for up to 4 specific things on your return), or [3] a field audit (where they come to your home and/or office, and have the right to go through ALL your bank accounts, and all your records, etc, etc. This is the big scary audit everyone dreads…and the one I got!)
- If you are a successful business person making a lot of money – the odds are you WILL get sued and/or audited at least once in your lifetime. Both events have happened to me, and both times, I have “won”. Do NOT let fear of these things stop you from being successful.

- Do NOT BE NERVOUS / SCARED if you get audited. I sure the hell was! Haha. I’ll admit it. When I hired an EA to represent me…I was told “don’t worry, everything will probably be fine”. That was not that comforting, at the time. Haha. Anyway – I later learned - the IRS employees are not all monsters waiting to deny every deduction on your tax return, for no reason. No, they’re usually actually decent human beings, and if you are HONEST with your taxes, and keep a good audit trail [you keep good books], and have good records/receipts – guess what – when you are audited … they’ll review everything, say thanks, and it’ll be over with nice & quick. If you make a mistake, they won’t throw you in jail... worst case you pay what’s owed & some penalties and interest. Guess how much I owed? Nothing! Nada! And they looked at EVERYTHING!

- I learned I actually kept good books / records (whew!); I have now outsourced that work to my new accountant --- to make my life easier.

- If you do get audited, hire a CPA or even better – an EA/enrolled agent – to represent you. Why? Even though I am “smart” when it comes to finance/taxes, I do not speak the language of taxation. So I wanted someone between me & the IRS agent, who could do a lot of the talking on my behalf. Note if you hire a CPA, make sure he/she has both CPA & EA certifications. Why? A CPA may not deal with IRS audits and/or taxes on a constant basis, where that’s all or a lot of what an EA does.

- I am going to restructure a couple of my real estate businesses, into S-Corps and/or LPs by the end of this year. Why? The IRS watches people who have Schedule Cs like hawks – and that’s what I have [2 of them] – because a lot of those folks make a lot of errors on their tax returns [note I have a Schedule E & other schedules too]. I made no errors, but I’d rather be an S-Corp or LP where I’m not on the radar as much.

- In the end, if you get audited, do not lose any sleep over it. Remember … if you’re honest, keep good records, and do your best … you will be OK. If you are not great with bookkeeping & accounting, or don't have time time, outsource that work. 

If you have any questions ... please ask me ... and I'll post a response. Thanks!