Use LLC for Real Estate Investments

Be sure to check out Small Business Webcast for a full transcript of Jessica Chisholm’s webcast on Real Estate topics.

It is generally best not to have your corporation purchase real estate. If your company is a C corporation, your company will pay tax when the building is sold. In order to get those profits in your hands, you will have to pay yourself a dividend. This dividend is taxed again. So you are paying taxes twice on the gain from the building sale.

If the building generates a tax loss, which many buildings do because of depreciation, this tax loss will offset your corporate income. Corporate income, however, is sometimes taxed at lower rates than individual rates. Therefore, the tax benefit from the building would be less when held in a C corporation.

If the building generates a tax gain, this gain will be taxed as part of corporate profits and taxed again as a dividend when the cash is distributed to the owners. Often, real estate will generate more cash than taxable income. In C corporation form, getting that cash to the owners will involve extra income tax that would not be paid if held individually.

The same principals apply to contributing your rental property to your corporation. You will be taxed twice when you finally sell the property. Any tax benefit provided by the property may be less when corporate rates are less. Taxable income from the property will be taxed twice.

The analysis is different if you have an S corporation rather than a C corporation. However, it is still not a good idea to own real estate in your S corporation. If you change your mind in the future and you want to pull your real estate out of the S corporation, you will immediately subject yourself to tax based on the fair market value of the property. For example, suppose you want to contribute the property to a partnership to develop the property or for other reasons. You will not be able to get the property out of the S Corporation without paying income tax. Additionally, you may not want to subject such a large appreciating asset to potential liabilities that can arise in your corporation.

Buying the building personally is also not a good idea. Your personal assets would then be at risk to satisfy any potential liability that arises from operation of the building. For this reason, many people use a limited liability company to own real estate. You should still have liability insurance. Make sure to discuss liability issues with your attorney.

In addition to liability protection, a limited liability company (LLC) provides maximum flexibility and maximum tax savings for ownership of business or rental real estate.


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Best Rental Property Ownership (LLC, Corporation, Individual, Limited Partnership, General Partnership or Other)

This particular article of the Rental Property Tax Guide focuses on the different types of entities for rental property ownership. As outlined below, different types of entities have different advantages and disadvantages. However, the general goal in each case is to limit your liability and protect your property from unsecured creditors.

Individual Ownership

This is the most common and simplest method of ownership and occurs when you purchase the rental property in your own name. This includes owning the property with your spouse, or as joint tenants or tenants in common with someone else. The advantage is that this is simple, straightforward, and does not require the filing of any complicated paperwork or filing fees. The major disadvantage to this type of ownership is that your creditors may be able to force a sale of the rental property if they receive a court judgment against you, or compel you into involuntary bankruptcy.

Legal Entity Ownership

Legal entities include general partnerships, limited partnerships, limited liability companies, and corporations. The differences between the entities are important and outlined below. The major advantage to entity ownership is that your personal creditors cannot force a sale of the rental, since you do not own it. The only type of entity that does not require registration with the Secretary of State is the general partnership. For tax purposes, the type of entity chosen does not matter a whole lot because in most cases, rental income “passes through” from the entity and is taxed on your personal tax return (but see the cautionary note under corporations). See the article titled “Documents which Are Mandatory for Reporting Leasing Activity,” included in this Guide, for more on how rental income is taxed.

General partnership. A partnership is an association of two or more people to carry on as co-owners a business for profit. In a general partnership, each partner has equal management rights, but is personally liable for the debts of the partnership. Thus, a general partnership is generally not recommended.

Limited partnership. A limited partnership is tricky because it requires at least one general partner and one limited partner. The limited partner is not personally liable for the debts of the partnership, but also has no management rights. The general partner has sole management rights, and personal liability for the debts of the partnership. This arrangement is also generally not recommended.

Limited liability partnership/company. A limited liability partnership and a limited liability company are very similar entities, both providing for limited liability to the partners/members. This means that you are not personally liable for the entity’s debts, unless the debt stems from your own wrongdoing. This type of ownership is preferable because of limited liability and there are fewer formalities to observe than with corporations.

Corporations. Corporations allow for perpetual existence and limited liability. However, they also require the observance of certain formalities in order to keep the limited liability shield. In the absence of these formalities, a court may “pierce the corporate veil” and hold you personally liable. For this reason, LLPs and LLCs are generally more desirable for your purposes. Furthermore, for tax purposes, corporations are split into “S” corporations and “C” corporations. If the corporation is taxed as a “C” corporation, it will pay tax on the rental income, and then you will pay tax again when the corporation pays you dividends. You should avoid this “double taxation” trap.

  • To form any of the entities discussed below, the applicable registration form and fee must be filed with the Washington Secretary of State’s office. The forms can be found on the WA Secretary of State’s website.
  • Always consult an attorney or CPA before establishing an entity and transferring ownership of your rental property to it. This Guide is not meant to be comprehensive and requires the care of a qualified professional.

CPA in Shoreline+John Huddleston has written extensively on tax related subjects of interest to small business owners. He is a graduate of Washington State University and the University of Washington School of Law.

Deductible Rental Property Costs: Insurance, Cleaning/Maintenance, and Repairs

Since you now are leasing your property to obtain income, it’s very important that you make sure specific fees and expert services are adequately arranged and reported for IRS uses. We will take a look at some of these expenses.

Insurance

Similar to most premiums, it’s usually prepaid upfront for a certain period of time. An illustration here might be: you obtained insurance coverage with this particular rental property on March 2012 for $1200. The coverage duration is from April 2012 to March 31, 2013. Since the policy time period will exceed the present tax year, you should allocate the insurance premiums pertinent to this current tax year only and then bring forward the balance for the upcoming reporting period. This means that $900 (9 months April to Dec 2012) or $100 per month of eligible rental utilization would be your tax deductible premium.

Take note that some insurance companies routinely bundle premium plans among business and personal clients for a discount charge. Just the business rental property pertinent part will be deductible. The personal and non-business related utilization could be allowable with your individual income tax return. You should include Title Insurance within the Cost Basis of the property, because it is not an applicable expenditure.

Cleaning and Maintenance

The daily maintenance of the rental property is an allowed expense granted it is for commonly used places and day to day cleaning. These types of expenditures are also confined to the days that are allowable rental property days and not personal use days. Many property owners have contracts with local professional services to keep up the rental property on an ongoing basis to be sure it is in working and functional order. This could include such services as cleaning windows, dusting, cleaning home appliances and upkeep. Structural repairs and alterations are not allowed, so will have to be listed in the rental property’s Cost Basis.

Repairs

From time to time, there will probably be some sort of necessity to fix a home appliance, touch up a little repainting, or some endeavor which doesn’t demand serious reconstruction of the rental property structure. Depending on the leasing duration, you are able to deduct such necessary and ordinary expenses.

You should observe that these kinds of expenditures which are commonly allowable against the earnings of the property, and you mustn’t include the periods of time that are deemed personal times of use. Only those costs which are directly related to the approved leasing time period are permitted.

  • On the IRS’s website, you will find the various documents that you need. If you’d like additional information, view IRS Publication 527.

Huddleston CPA+John Huddleston has written extensively on tax related subjects of interest to small business owners. He is a graduate of Washington State University and the University of Washington School of Law.

Allowable Automobile and Travel Expenses from Leased Premises

The specific use of your own private vehicle and other vehicles might be allowed as an expense depending on some specific criteria if typical and needed. If you are using your own personal cars to maintain and coordinate any rental residence, and even secure money from residents, you could be allowed to deduct these kinds of expenses. Because commuting to work is really a private cost, it isn’t permitted for deduction. Aside from that, you will not write off costs of commuting away from home to make improvements to residences. This is generally reclaimed with a cost recovery process, for example, depreciation. You will find 2 methods used to report these expenses:

Actual Expenses

The different expenditures resulting from having to travel out of the home in association with the leased residences will be documented with this solution. These kinds of costs need to be recorded and supported by invoices in line with IRS Publication 463, Chapter 5. A number of software applications are available through iPod, Quick Books, Mint, and others; however, you must still keep a concrete record to back up the write offs. It is important that this info be reported, together with important documents attached, on your Schedule C or Schedule E. For those who have multiple rental properties, your expenses should be allotted to the individual residence where expenses were incurred. Do not include things like any type of non-business use or any other sort of vehicle use aside from that specifically involving the rental property.

Mileage Method

According to this method, you’ll want to only write off your actual distance driven. You’d utilize the existing standard mileage taxation rate of $0.55.5 per mile if you drove twelve hundred miles in 2012.

Using local transport such as Zip Cars, metro bus services, and automobile rentals should have a direct connection to the real-estate and has to have paperwork to back this. If working with public transportation, it is encouraged that you carry a separate ticket card along with an individual business account for rental cars and Zip Cars showing how the utilization is exclusively business related.

Quick Note: You can obtain the different documents outlined in this information on the IRS’s webpage. For additional information, please consult IRS Publication 527.

Seattle CPA+John Huddleston has written extensively on tax related subjects of interest to small business owners. He is a graduate of Washington State University and the University of Washington School of Law.

Resource for Business Valuations

The valuation of a business, business ownership interests or intangible assets may be performed for a wide variety of purposes including:

1)   Transactions such as acquisitions, mergers, buyouts, employee stock ownership plans, partner or shareholder buy-ins or buyouts, and stock redemptions.

2)   Litigation relating to matters such as marital dissolution, bankruptcy, contractual disputes, owner disputes, dissenting shareholder cases, employment disputes, and intellectual property disputes.

3)   Tax compliance such as corporate reorganizations, S corporation conversions, estate and gift tax, purchase price allocations, and charitable contributions.

4)   Tax planning for income estate and gift tax, and personal financial planning.

The Assumptions and Limiting Conditions Included in the Report Define the Business Valuation

The business valuation report will include a number of assumptions and limiting conditions under which the valuation was prepared. These assumptions and limiting conditions define the business valuation.

Conclusion of Value Limited to the Stated Purpose

1)   The conclusion of value is valid only for the stated purpose as of the date of the valuation.

2)   Stated purpose is very specific:

  1. A particular transaction:
    1. Acquisitions and mergers.
    2. Buyouts.
    3. Buy-ins.
  2. Litigation:
    1. Marital dissolution.
    2. Bankruptcy.
    3. Contractual disputes.
  3. Tax compliance:
    1. S corporation conversions.
    2. Estate and gift tax returns.
    3. Purchase price allocations
    4. Charitable contributions.
  4. Tax planning:
    1. Income tax.
    2. Estate and gift tax.
  5. Personal financial planning.

Reliance on Financial Statements and Other Information

1)   Financial statements and other related information are provided by the business or its representatives to the firm performing the valuation.

2)   These financial statements and other related information are accepted without any verification as fully and correctly reflecting the subject company’s business conditions and operating results.

3)   The firm performing the valuation will not have audited, reviewed, or compiled the financial information provided to them.

Public Information and Industry and Statistical Information

1)   The firm performing the valuation obtains public information and industry and statistical information from sources that it believes to be reliable.

2)   No representations as to the completeness or accuracy of the public information and industry and statistical information are made by the firm performing the valuation.

3)   No procedures have been performed by the firm performing the valuation to corroborate the public information and industry and statistical information.

Achievability of Forecasted Results

1)   Forecasts are frequently used in the calculation of value.

2)   A forecast is a prediction or estimate of some future event or trend.

3)   The firm performing the valuation provides no assurance as to the achievability of any forecasted results.

4)   Events and circumstances frequently do not occur as expected and differences between actual and expected results may be significant.

5)   Achievement of forecasted results depends on the actions, plans, and assumptions of management.

Management Expertise and Effectiveness

1)   The conclusion of value is based on the assumption that the current level of management expertise and effectiveness would continue to be maintained.

2)   The conclusion of value also assumes that the character and integrity of the subject business would not be significantly changed by any sale, reorganization, or exchange of the business, or by the diminution of the owners’ participation.

Use of the Valuation Report

1)   The valuation report and conclusion of value are for the exclusive use of the subject business or its representatives for the sole and specific purposes as noted in the report.

2)   The valuation report is not authorized to be used for any other purpose other than as noted in the report.

3)   The valuation report is not authorized to not be used by any other party, other than the subject business or its representatives, for any purpose.

4)   The report and conclusion of value are not intended to be investment advice in any manner. The conclusion of value represents the considered opinion for the firm performing the valuation, based on information provided by the subject company and other sources.

Dissemination to the Public

1)   No part of the valuation report it intended to be disseminated to the public by any means of communication. Any exception to this limitation would require the prior written consent and approval of the firm performing the valuation.

2)   Dissemination to the public would include such communications as advertising media, public relations, news media, sales media, mail, and direct transmittal.

Testimony or Attendance in Court

1)   Future services with respect to the subject matter of the valuation report, such as providing testimony or attendance in court, are not required of the firm performing the valuation.

2)   Additional services from the firm performing the valuation, such as providing testimony or attendance in court, would be available upon request and by separate arrangement.

Environmental Issues

1)   The firm performing the valuation is not an environmental consultant or auditor, and bears no responsibility for any actual or potential environmental liabilities.

2)   Those persons who need to know whether any actual or potential environmental liabilities exist, or the scope and effect of such liabilities on the value of the subject company, should obtain a professional environmental assessment.

Reliance on Environmental Reports

1)   In the case of reports provided by the subject company, or by an environmental consultant working for the subject company, of any present or future liability relating to environmental matters, for inclusion in the valuation report and conclusion of value, the firm performing the valuation may rely on those environmental reports without verification.

2)   The firm performing the valuation offers no warranty or representation as to the accuracy or completeness of any such environmental reports.

Americans With Disabilities Act

1)   The firm performing the valuation does not provide a compliance survey or analysis to determine compliance with the Americans with Disabilities Act of 1990.

2)   The valuation will not consider the effect, if any, of noncompliance with the Americans with Disabilities Act of 1990.

Future Legislation

1)   The firm performing the valuation makes no determination as to the possible effect on the subject business due to future Federal, state, or local legislation.

2)   The valuation would not consider the effect, if any, of any future Federal, state, or local legislation.

Prospective Financial Information

1)   Any prospective financial information provided by the subject company has not been examined or compiled by the firm performing the valuation.

2)   The firm performing the valuation does not express an opinion or other form of assurance on the prospective financial information or the related assumptions.

3)   Usually there will be differences between prospective financial information and actual results because events and circumstances frequently do not occur as expected. These differences may be significant.

The Valuation Engagement

Summary


This is an engagement to estimate value in which a valuation analyst determines an estimate of the value of a subject interest by performing appropriate valuation procedures, and is free to apply the valuation approaches and methods they deem appropriate in the circumstances. The valuation analyst expresses the results of the valuation engagement as a conclusion of value, which may be either a single amount or a range of amounts.

Standard of Value

The standard of value used is “fair market value”. Fair market value is the price, in terms of cash or equivalent, that a buyer could reasonably be expected to pay, and a seller could reasonably be expected to accept, if the business were exposed for sale on the open market for a reasonable period of time, with both buyer and seller being in possession of the pertinent facts and neither being under any compulsion to act.

Asset Approach

1)   The asset approach is generally considered to yield the minimum benchmark of value for an operating enterprise. The most common methods within this approach are net asset value and liquidation value.

2)   Net asset value represents net equity of the business after assets and liabilities have been adjusted to their fair market values, assuming a hypothetical sale of its net assets as part of a going concern.

3)   The liquidation value of the business represents the present value of the estimated net proceeds from liquidating the company’s assets in a quick and orderly piecemeal sale and paying off its liabilities.

Income Approach

1)   The income approach serves to estimate value by considering the income (benefits) generated by an asset over a period of time. This approach is based on the fundamental valuation principle that the value of a business is equal to the present worth of the future benefits of ownership. The term income does not necessarily refer to income in the accounting sense but to future benefits accruing to the owner. The most common methods under this approach are capitalization of earnings and discounted future earnings.

2)   Under the capitalization of earnings method, normalized historic earnings are capitalized at a rate that reflects the risk inherent in the expected future growth in those earnings.

3)   The discounted future earnings method discounts projected future earnings back to present value at a rate that reflects the risk inherent in the projected earnings.

Market Approach

1)   The market approach compares the subject company to the prices of similar companies operating in the same industry that are either publicly traded or, if privately-owned, have been sold recently.

2)   A common problem for privately owned businesses is a lack of publicly available comparable data.


  • Visit our Seattle or Bellevue business valuation sites for more information on Business Valuations from our experienced team of business professionals.

Personal Financial 433-A Form

Preparing Form 433-A

When you initially submit your Offer in Compromise request, you will also submit form 433-A. This form is actually what the Internal Revenue Service will use in ascertaining whether or not you do qualify for an Offer in compromise. The 433-A form accounts for disposable income and equity. If it is discovered that you will likely not be capable to honor your tax debt in its entirety, you may be able to go forward with the OIC appeal.

Sections 1 & 2: Personal Information and Employment Information

In Section 1, you need to provide personal details about your family and yourself. If you are married, details about your partener should also need to be written.

Section 2: In this section, supply company details for yourself along with your wife or husband. If you are self-employed, put down “Self” in this section 2, line 4a and also write the amount of time you have been self-employed. Then you’ll provide the rest of your self-employment information on another a part of Form 433-A.

Section 3: Other Financial Information

This portion will address any kind of intel about lawsuit and any would-be changes in cash flow.

In line number 6, you’ll disclose legal information when you are involved in a court proceeding, whether as the accuser or as a accused, record docket facts here on this section. Solely include facts of courtroom proceedings that have been officially submitted to a court of law. Intention to file a legal suit is definitely not reason for you to include the details surrounding this “unfiled” suit.

In line number 8, you are to provide information telling of any expected decrease or growth in your income. Best leave unspecified list any adjustments that are still only at the point of hypothetics. For instance, if you indicate that you’ll be gaining an increase in income, the irs might consider this in weighing your eligibility for an Oic, and if the increase never stops by, then you’ve been weighed inappropriately. Examples of appropriate anticipated increases to disclose are: written notice of a salary increase, new income contracts, hard copy proof of court awards.

Personal Asset Information: Section 4

In section 4, you’ll be asked to recount information about any equity property for which you have ownership, account for personal cash–including bank account, credit cards, and real estate specifics, and life insurance policy specifics.

Line 11 asks for the cash amount that you’ve on your person. Provide an average of what you will ordinarily have on person, as the amount for most will fluctuate from one day to the next.

Lines 12a and 12b: Make use of these lines to note any checking/savings accounts for which you are the owner. If you own more accounts than two accounts, provide all accounts in addition on an attached piece of paper and attach it to your 433-A. You must provide bank statements to the Internal Revenue Service for every one of the accounts Line 12a, 12b: here you’ll give any checking or savings account information. If you have more than two banking accounts, you will list the accounts in addition on a separate sheet of paper attached toyour 433-A. You must provide the supporting statments to the Irs for each account that you have under your name. It is best to give the balance amount shown on the most recent bank statement you provide.You’ll want it so that the Irs can see the entries you’ve provided fit with the details in the supporting documents.

Lines 13a through 13d: Use these lines to report investments, such as stocks, bonds and retirement accounts. Include 401k accounts even if you are not fully vested in the plan.

Lines 14a and 14b: List any credit cards that you own with existant credit balance on these lines.

Lines 15a through 15g: Life insurance policies with dollar value are reported on Line 15. However, you shouldn’t record any term life policy details. The Internal Revenue Service is solely interested in whole life insurance policies you could have. Whole life coverages have cash value and you may be able to borrow against the value, while term life insurance policies have zero cash value or borrowing possibilites.

Line 16: Document any assets which you transferred, gave or sold to an individual or business for less than absolute valuation within the recent 10 years. In order to find out if you’ve just dropped assets to avoid repaying your debt, the IRS asks these questions.

In line 17 through 17c: divulge real estate which you own. If you do not possess real estate, produce your address along with your landlord’s name and street address. Lines 18a through 18: Provide any transportation assets you have got on these lines. List motor cars, motorbikes, watercrafts, trailers and campers in this part. If any of these items is held as a result of a loan, report the note details in this section, which includes your monthly payment and balance information. You have to also note the honest market value for each item. You can easily obtain fair market values by checking webpages for instance Kelley Blue Book (kbb.com) or NADA Guides (nada.com)

Line 19a and 19b: List the type and value of your personal assets you possess. Personal effects include home furniture, home goods, collectors items and jewelry. When you mark the value of your effects, report the expected liquidation value. A reasonable strategy to consider of the liquidation value of these items is to estimate just what the items would likely move for in a quick-sell platform, just like a yard sale or auction. Don’t list the original purchase selling price as a value. The IRS will not normally ask that you sell your personal objects unless you have a lot of luxury effects. The IRS additionally allows a personal exemption amount of $7,900 for the worth of items in this specific grouping.

Monthly Income and Expense Statement

This statement is found on page 4 of the form. Within this section, you will have to provide your regular monthly revenue and expenses from all sources. If you’re self-employed as a sole proprietor, you have to complete pages 5 and 6 prior to finishing this statement found on page 4.

In the Income section: If you are self employed or receive rental income, provide your net profitsOtherwise, report gross earnings (your wages as they were before deductions and taxes are taken off.) There is a guide in the footnotes to help calculate this figure.

In the Expenses Section, you’ll go over monthly, regular expenditures, including taxes and deductions.

Self-Employment: Pages 5 & 6

If you’re self-employed, you’re going to have to give similar info for all of your work activities that you record for yourself personally. That includes business asset facts, this includes equipment, revenue streams and accounts receivable information. You have to similarly submit just how many staff you have and the payroll frequency. Submitting Form 433-A

Once you conclude preparing the 433-A, you need to compile any docs in existence to add verification to your entries. Usual documents consist of recent bank statements and paystubs, current invoicing statements for expenses, and monthly statements and payoff balance information for loan accounts.

View the Offer in compromise guide at:Seattle Offer in Compromise IRS Taxes

New Site for Free Business Education

Smallbusinesswebcast.com will have a limited number of instructors that provide free continuing education (mostly webcast) to businesses. We will promote the webcast through a direct mail campaign and other gorilla marketing. The instructors will share in the cost of promoting the Webcasts. The instructors will pay 15 cents per piece for the postcard. I’ll probably mail 5000 pieces. The mailing would be a 6 X 11 postcard that would advertise free Webcasts taught by us that would be helpful to new small businesses.

I’m putting together a flyer right now that will include me, and five other professionals that have something to offer new small businesses. I will direct mail this to new small businesses advertising the free webcast that the six of us will present. In addition, each instructor will be expected to promote the project individually (link from their website, email to their email list, twitter etc). Although the main source of clients will be the mailing, we will all benefit from the cross selling of this idea.
Establish a free profile at http://smallbusinesswebcast.com regardless of your interest in the project. It’s just a draft but it will give you an idea of what I’m thinking about. I haven’t optimized the site yet but let me know if you have suggestions. If you are interested in this idea, I’ll send you a copy of the draft postcard. You would need to draft a description of your webcast for the flyer and the website. The topic should be fairly narrow. You should come up with two topics. We will include just one topic on the flyer but I hope to get people that go to the website to attend additional webcast. We will not have dates on the postcard so you could hold the same webcast multiple times.
Right now, the classes are:

  1. S Corps & LLCs, Using them to reduce taxes. Instructor John Huddleston, J.D., LL.M., CPA
  2. Quickbooks Basics. Instructor Jessica Chisholm, Quickbooks ProAdvisor & CPA
  3. Small Business Law, Starting Your Business Right. Instructor Valarie Farris, Attorney
  4. Business Coaching (title not complete). Instructor Dusting Walling, M.S.
  5. Protecting and Growing Your Small Business with Virtualization. Instructor Eric Taneda.
  6. Business Insurance 101, What am I Paying for. Instructor Michelle Ihlan, CIC
  7. VOIP Versus Traditional Telephones. Instructor Barrett Adams.

If you are interested in participating, contact John Huddleston at (206) 310-8363.