All Forum Posts by: Nick Am

Hi All, 

I have 2 multifamily rental units that I entirely self-manage. For 2025 I will be taking a leave from my fulltime W2 work start 1st July for rest of the year. I want to take this opportunity by qualifying for REP status.

I have also been meaning to build 2 units in my backyard and put them on rent. The area where i live, land is very expensive. So building ADU some what makes financial sense.

I have following questions:

1. Does the time and effort behind designing, permitting, and building the ADU count towards the REP status?

2. I will be renting ADU fulltime and will not use for personal usage. Can IRS still see it as a part of primary dwelling unit and thus, consider it not eligible towards achieving REP status?

3. Will the renting of ADU rise to the level of trade or business?

Kindly share your thoughts and suggestions. 

Regards, 

Nick

@Sean O'Keefe: 
Can I get a copy of the real estate professional log sample, please?

@Ashish Acharya: You hit the nail on its head !!

Yes business purpose of LLC-B is my underlying question here. My confusion is why a property management NOT a valid business purpose? Can you please help me understand better what potential concerns in your experience can potentially arise here?

Thank you Brett, mainly for properly reading my inquiry and genuinely trying to help me. I am grateful to you for the same. 
I have booked an appointment with a tax advisor for now. But will also DM you to get your referrals.

To answer your questions:
1) I agree with your suggest of Sole Prop and I am open to that. 
2) REPS is hard for me. Both me and my wife have full time jobs. 
3) That $5875 is the 25% of contribution that S-corp can make towards employee retirement. 
4) Thank you so much for improving my understanding on how 401K limits are calculated. You are spot on. As I max out my 401K with my 9-5 job, I CANNOT contribute to solo 401K as an employee. This is significant. I am grateful to you for sending me back to the white board. 

 Thank you, Katie. I will keep that in mind too. 

@Aristotle Kumpis

1) The depreciation is a real advantage. That i agree. But how much? You might do cost seg. in the first year or down the line. Also depreciation is a type of "loan". When the property is sold, it needs to be paid back unless step-up in basis happens at death. I think its useful income tool, but not significant. Besides, for depreciation land value is taken out. In CA, land is ridiculously expensive. So huge portion of investment is not even depreciable. 

2) All the repairs and property management fees etc are real expenses. One has to make payments.

3) I agree on your REP comment. That is nearly impossible with a fulltime W2 income unless spouse doesnt work. Do you know a scenario (except STR) where REP status can be gained while having a full time job?

@Michael Plaks: Really sorry if I offended you. That wasnt my intention. I am trying to bounce of ideas from you and learn from you. 

Going back to my assumptions, what part did I miss? Why would I owe ordinary federal and state income tax on the S-corp income? Wouldnt the retirement contribution, home office deduction, and health care premium absorb the income? I am not able to see the point you are making. 

@Brett Synicky

Thanks for your response. Let me try and answer your comments. Might help others to help me better. 

--> I am trying to setup a management company (LLC-B) and charge LLC-A management fees. This active income can help me fund my retirement as well as help me get reimbursement for home office and health care premium while lower my tax liability.

--> This is my plan. I have two properties which at 10% fee will be around $35K. If I leave this amount in Sch-E, I get taxed at ordinary income tax rate at Federal and State level, which along with my regular W2 income can be substantial. Assume for a moment its close to max tax bracket ie. nearly 49% (Federal  + State), roughly $17K. 

Now if I pass that income as management fees to S-corp, I pay $3.5K (SE tax) + $800 (LLC fee) + $1700 (CPA + bookkeeping) = $6K in total.

Against $35K income:

1) I take $23,500 W2 which 100% goes into Solo 401K --> No income tax

2) LLC-B contributes $5875 towards retirement --> tax deduction

3) Remaining $5625 is reimbursed to me as home office expense. 

Where is the income tax of 49% here? How is this juice not worth the squeeze? $6K in taxes and expense vs $17K in Federal and State taxes. 

What am I missing?

@Michael Plaks

"Self-employment tax that you will pay on your property management income is not instead of ordinary income tax on rental income. It's in addition to this tax. So, by transferring income from a rental schedule E to a business schedule C you're creating a significant extra tax. You will owe more, not less, taxes."

--> The SE taxes are STRICTLY NOT in addition. The ordinary income tax on income passing through LLC-B applies on the income AFTER retirement contribution, home office deduction etc, which will make the income nearly zero and hence leaving only the SE taxes and NO income tax. The reason I would end up paying ordinary income tax on Sch-E is that I get NO other deduction whatsoever like I would get for LLC-B (S-corp).

--> I agree on the $800 LLC tax to CA. And agree on the extra paper work too.

Benefits of long-term rental are literally ZERO unless one of the following is true for you:

1. Your spouse does not work and can be classified as a REP

2. Instead of LTR you opt for STR using AirBnB.

3. You have a freelance job and you can qualify as REP 

I sharing this from my personal experience. Before purchasing a rental property carefully evaluate the appreciation potential. It is a huge myth that real estate appreciate greatly. This is true in absolute terms only. If you compare it with growth from Stock investment you will be disappointed. There is no housing market in US where real estate can out perform stocks. Besides, like you hint in your questions, tax benefits from LTR are nearly zero. Sure you can argue 1031 exchange and such, but again apples-to-apples, you will end up making more money with stocks and with much little headaches.