The DST 1031 Exchange: What Smart Real Estate Investors Know

The Delaware Statutory Trust (DST) is a bona fide legal workhorse.  For the right investors and circumstances, it’s often an excellent tool that preserves passive investment income, prevents lawsuits, and has special tax benefits for Californians. It can pull double duty for asset protection and estate planning, but that’s hardly all. 

The DST can bring even greater rewards to DST 1031 exchange real estate investors.

Real estate investors in California use the Delaware Statutory Trust  to dodge franchise taxes, escaping the state’s harsh regulations and Draconian tax enforcement agency.

But all investors (regardless of where they live) can exploit the DST for its 1031 Exchange compatibility, flexible asset protection and estate planning benefits. The DST 1031 Exchange also gives you a high degree of control over the structure’s protected assets and beneficiaries.

Consider this your quick guide to understanding how DSTs work with 1031s and your crash course into the wild, flexible, world of the Delaware Statutory Trust.

2021 UPDATE: The Biden administration has proposed the 1031 Exchange for real estate investors with incomes above $400,000. The policy proposal, entitled “The Biden Plan for Mobilizing American Talent and Heart to Create a 21st Century Caregiving and Education Workforce,” states that it will roll back "unproductive and unequal tax breaks for real estate investors with incomes over $400,000.” Experts believe the 1031 exchange program is on the chopping block for high-income earners because Biden campaign officials stated that they will take aim at “so-called like kind exchanges.”

Understanding the Essentials of the DST 1031 Exchange

So, while you can still take advantage, if you want to brush up on the basics of this structure fast, you should check out our Delaware Statutory Trust FAQs to learn about the basics of the structure. It’s the quickest way to get a comprehensive understanding, but we’ll touch on why asset protection attorneys even use these darn things in the first place.

For the moment, we’re confining this conversation to DSTs in the context of 1031 exchanges (but we’ll get to other benefits, we promise!).

All you need to know that these revocable trusts can designate many beneficiaries, a feature we'll illustrate with a whimsical example shortly. Theoretically, since you’re a beneficiary, you can hide among them for extra anonymity around your asset protection measures. But that’s far from the only perk of the DST for 1031 investors.

Delaware Statutory Trusts Go With 1031 Exchange Like Peas and Carrots

Despite their many uses, most online info about the Delaware Statutory Trust relates to estate planning or 1031 features, often vaguely. These are great structures for managing and defending 1031 investments. Why these basic concepts have become intertwined in the real estate world:

No tool is perfect though. We’ve written about the DST’s drawbacks too. It’s up to you to decide what’s best after gathering the vital information.

Can I Have More Than One Beneficiary for My Delaware Statutory Trust?

The beneficiary is anyone receiving funds from the trust structure. Not only can you have more than one, you can have dozens, even hundreds, if you so desire. So if you’re using your DST to secure the 101 homes you’ve selected for your 101 pet dachshunds, each dachshund could have its own share.

[Note: Your dachshunds would need HUMAN legal reps/guardians to express their interests--sadly they’re property under current law. But if dachshunds gain full legal rights of humans, and they may just be cunning enough to pull such a feat off, each one could own his/her DST shares independently. But you could do this same move with 101 children if you had the time, funds, and inclination to set them all up for life. Parents frequently leverage land trust appreciation to pay for expenses including college tuition for children, and you can too.]

We use this ridiculous example because you can easily imagine pulling in many JV partners, family members, and others who care about your business into your DST network as beneficiaries.

But we’re guessing you aren’t making customized estate plans by the dozen, so yes, you can have up to several hundred human beneficiaries according to the state who designed the trust. You will be one of them. So can any partners, children, or people in life you wish to do business with or support using your DST’s earnings.

Perks of Managing Beneficiaries with a Delaware Statutory Trust

Both you and your beneficiaries can benefit from the DST easily. You stay in control, pick who gets what with precision, and can modify your plans at any time.

#1 Easy to Change Your Beneficiaries

Adding a new beneficiary is easy when you’ve got a DST. Removing one is a separate process, but no harder. Let’s go over some of the best benefits of using a DST to pay out certain people as beneficiaries. 

#2 Divide DST Property Easily with Beneficial Interests

DSTs offer both a high degree of control over and tremendous flexibility for handling beneficiaries., thank the concept of beneficial interest. You can think of it as a way of issuing “shares” from your DST to reflect a person’s interest in a property, or even the whole trust, is.

The concept is known as beneficial interest in the trust. You can even have them issued for minors (though regrettably, not dachshunds as of July 2019). Parents often do to offset college or living expenses of the child beyond age 18, and you can sell/give fractions of a property to others under the same reasoning.

See? Even silly examples are important. The accuracy and control you’ll have over how your beneficial interests are distributed is unique to the DST. It’s a form of co-owing that doesn’t put you at risk and is strictly, clearly defined. Whether Johnny gets 1/16th of a single DST property or the entire trust, you’re the decider.

#3 Asset Protection Benefits of DSTs

The Delaware Statutory Trust’s compartmentalization ability makes it a fantastic choice for investors with many assets, anyone with multiple investments, or those hoping to grow rapidly. This isn’t a beginner’s tool, Californians excluded. This privately filed legally-binding agreement can theoretically protect assets in a way identical to the Delaware Series LLC.  DSTs do this by simply holding title to property for you, getting it out your name.

In fact, many of our Californian clients demand series LLCs until we convince them how much better the DST is. If you’re considering asset protection, this is by far one of the strongest individual structures available. It need not be excessively complicated, but the DST will require effective legal counsel to pull off if you want its protections guaranteed. This is particularly true for REIS or anyone wanting to try out the 1031/DST combo. Not every attorney is equally skilled, but a real estate lawyer with corporate chops or asset protection pro can handle this job easily. Pick yours wisely, because you’ll come to rely on their advice.

Estate Planning with DSTs: Create a Dynasty Trust That is Truly Immortal 

If you love the idea of your business outliving you, you can make it happen with the DST. While other tools and trusts can help estate planning for REIs, the DST comes with everything you need for a business that can outlive you. And not only that, you get to stage-direct exactly how the whole affair goes down.

When you grab that handy attorney, they can explain the full estate planning potentials in your particular situation. But most investors love the DST’s ability to become a legacy business that doesn’t rely on any one person. Your real estate empire could exist in its own right, simply passing through the hands of different “managers” as generations click by. If this idea appeals to you, take a good look at your estate plan, your options, and use our checklist to know if it’s time to update the plan.

If you proceed with buying new entities or assets, these should always be included in your estate plan. Real estate investors can use tools to account for everything, but with good asset protection, you’ll want to plan ahead for business succession or liquidation. You get to call the shots with your DST 1031, no matter how you use it.

Using a Power of Attorney With a Land Trust

Using a power of attorney with a land trust is a good idea.

A power of attorney, or a POA, allows someone to act on your behalf. This is a good thing to have in case you are out of town or you are unable to act when the need arises.

You may think of a power of attorney as something for your elderly family member who cannot do anything for themselves. However, a POA is also good for those who are running a business and who might be out of town when an action is required.

If you have a land trust with someone close to you, you may need a power of attorney in case you are out of town and need someone to sign documents for you or act on your behalf. Generally, a power of attorney is not designated for a trust. However, there could be cases where you want to name the same person as your trustee and as your attorney-in-fact.

Are Land Trusts Still Effective?

Land trusts are often the unsung heroes of the real estate investing world. You can use them to control assets rather than own them yourself. The land trust is also called a “title holding trust” because that’s it’s main job: hold title to the property in your place. You still get to stay in control of any property associated with your trust, and of course, any earnings generated.

Land trusts can form a critical part of your asset protection strategy; in fact, we prefer creating them anonymously. This type of revocable trust takes the critical first step in asset protection: stripping the title out of your name.

If your attorney tells you that land trusts are not as effective as they once were, they are not educated enough on land trusts. Most attorneys don't know enough about land trusts for them to give you advice on using one. They most likely didn't get this education in law school. Land trusts are just as effective as they once were, if not more effective these days.

roth ira vs 401kWhat States Are Land Trusts Used In?

Land trusts are only used in six states as of now. These states include Illinois, Florida, Virginia, Indiana, Hawaii, and North Dakota. These are the only states that have statutes for land trusts right now. This may be why many attorneys don't know enough or, if anything, about them currently.

Who Should Have Power of Attorney for the Land Trust?

When choosing the best person to use as your power of attorney, trust is what matters. It might be your closest friend or family member. However, if you don't want to use an individual for your land trust, you also have the option to use an institution (which will usually charge you a fee).

So, in short, it is a great idea to use a power of attorney for your land trust in case you need documents signed and you are either unable to do this because you are in the hospital or out of town on a business trip.

Hopefully, these questions and answers helped you learn a little more about land trusts and you are more educated on this effective tool for real estate investors.

 

Interested in learning more? Check out our articles Do I Need a Durable Power of Attorney? and Do I Need a Medical Power of Attorney?

Maintain Your LLC Corporate Structure to Avoid Lawsuits

Why file an LLC and manage a company if it's going to get invalidated? Can't a good litigation attorney just "pierce the corporate veil" of an LLC?

That advice is just wrong. LLCs are incredibly hard to pierce—if they are maintained correctly. The problem is that most business owners fail to do the things that are necessary to maintain the adequate corporate structure.

So what are the things that you need to keep in mind about how to structure real estate investment company?

First, you must maintain records and accounting of your company. How much money is coming in? What is the money that's being spent? You need to run everything through a bank account for your company to maintain the appearance of being a legitimate, separate entity from yourself.

You can not treat the money of the company as it were your own piggy bank. This means if you ever need to take money out, you must keep an accounting of it as a dividend from the company.

If you fail to follow these steps, a corporation can get pierced. If the corporation is pierced it provides no protection.

However, if you are diligent in maintaining adequate records of the company you will be protected.

Strategies to Lower Capital Gains Taxes

Capital gains taxes are the bane of investors everywhere.

There's no wonder they stoke a little resentment among real estate investors: Uncle Sam likely had little to do with the profitability of your property. And with upcoming changes to the way capital gains are taxed, there's more uncertainty than ever. But you’ve still got to pay up.

And of course you should, but not without knowing a few of the ways you can lower your capital gains taxes or make their payments more manageable. Here are some of our top practical tips you can really use to handle cap gains taxes.

Can You Get Rid of Capital Gains Taxes?

Not entirely, at least not usually. But that doesn’t mean that they cannot be managed. What we can absolutely do is look at creative ways to lower our tax rates, ways to pay our taxes that will work out to our advantage, and any circumstance that could cut us a break. So that’s exactly what we intend to do.

The following are a selection of the tactics investors like you can use to make capital gains taxes more manageable. You may find one, several, or even a completely alternative method works best for you. Think of these techniques like tools in an arsenal that you can get out at will. In some cases you may find you’re able to get your costs so low as to be almost negligible. At the very least, you should be able to cushion the blow. Let’s talk about deferment first, then move on to some methods for reducing your overall costs.

REN 8 | Solo 401(k)

How To Defer Your Capital Gains Taxes

Since we can’t simply abandon our capital gains tax obligations, we have to approach the problem with a bit more nuance and creativity. While we can’t make the taxes disappear, we can absolutely put off paying them by employing various tactics. Let’s talk about some fan favorite techniques for deferring these payments.

The Clever 1031 Tax Maneuver: Drop and Swap

You can also use a 1031 Exchange to delay the problem of capital gains taxes. Now, if you go about using this method, you’ll want to bone up on the requirements for 1031 exchanges. Essentially, the idea is that as long as you’re willing to sell your property and use the proceeds to purchase a similar one, you can defer paying the taxes for as long as you have the second property.

Where you go from there is totally up to you. In theory, you can drop, swap, and swap again until the end of time if you can meet the basic 1031 rules. You usually have 180 days from closing to reinvest, for instance. Properties must also meet certain legal requirements. Learn more about using the 1031 exchange for real estate success now.

Pour Your Capital Gains into Opportunity Zone Investments

The U.S. designated certain economically depressed areas ‘Opportunity Zones’ in 2017. To attract investors like us, capital gains reinvested into opportunity zones get a few preferential perks:

Some creative and hands-off investors take advantage of funds known as Opportunity Zone Funds, which are usually collections of properties pre-selected by a firm, fund, or financial institution. This method may appeal to someone wishing to take advantage of these tax opportunities but lacking the time or ability to do thorough due diligence alone. It’s also a way to test the waters on this strategy if you’re considering incorporating it into your long term plan.

Strategies to Lower Capital Gains Taxes

While we can defer capital gains with many tools, there are ways to also simply lower the number. But you’re definitely not going to like all of them. Yet you may find lower capital gains taxes to be a silver lining in a less-than-desirable financial situation or as an unexpected result of your circumstances.

Here are some ways to reduce the overall tax burden easily.

Sell When Your Income is Relatively Low

If you’ve had a “low income year,” that’s actually a good thing for your capital gains tax rate. After all, it’s directly linked to your tax bracket and therefore your income. If you’ve had a year where you’ve only earned passively or simply not earned for any reason, this can be an ideal time to sell your property. You’ll pay less in taxes than if you sell when you’re in a better position overall.

Know What Expenses to Track For Primary Residences

If you’re planning to sell your home, you may be able to deduct certain expenses from your cap gains taxable income. Chief among these are any costs you pay to improve or renovate the property and any expenses associated with the sale of the property. Such expenses might include fees paid for professionals, appraisals, inspections, and of course, any upgrade--no matter how small--is worth documenting. As long as you document the expense, you can later use it to your advantage.

Let Your Asset Protection Entity Ride to the Rescue

We’ve talked before about the critical role your business entity plays in your asset protection plan And while asset protection is a completely valid reason to set up these types of business structures, you can also enjoy tax benefits on top of your peace of mind.

Which tax benefits, of course, will depend on the type of entity, whether you’ve made certain choices regarding how the entity is taxed during formation, and of course, the rules we all have to play by to keep our friends at the IRS nice and happy. But let’s take a look at an example, shall we?

Edmund Green is a Texas-based investor who uses a Traditional LLC shell company and asset holding company to defend his real estate assets and other valuables. He’d heard through the grapevine that asset protection entities could be used for equity stripping. Never one to just take anyone’s word for matters affecting his finances, Edmund decided to bounce the idea off of his CPA and was able to save himself far more than if he’d continued operating as a sole proprietor. With the help of his attorney, he has established his asset protection plan and it essentially hums along in the background while he lives his life and runs his business. The last time we talked to Edmund, he didn’t have any complaints. And his strategies can work for others, too. That said, it’s crucial that you ensure your asset protection plan is tailored to your personal needs and goals.

If you’d like to follow Edmund’s example, you easily can. Take a look at the structures you’re considering using for asset protection and do a bit of very basic research. More importantly, make notes of any questions you come up with as you read and learn for your own experts.

Bottom Line: Capital Gains Can Be Managed, and Often With the Same Tools Protecting Your Assets

When you establish entities, trusts, and other asset protection structures, you almost always have a tax opportunity. Do all investors take advantage of all of their opportunities? Certainly not. But some will go further for you than others. However you choose to handle your capital gains taxes, simply being aware of the opportunities at your disposal puts you a cut ahead of the clueless investor waiting to be blindsided by the problem. As usual, proactivity will place you in a better position than procrastination.

Is a 1031 Exchange Investment Strategy Right For Me?

1031 Exchanges offer real estate investors tax benefits and access to unique deals. Making the decision about whether using this strategy is the right move for you can be difficult. It’s important to understand the 1031 exchange process and consider the value of its benefits in your own situation. We’ve broken down some of the points we think are most important for investors to know below.

Are 1031 Exchange Solutions Tax-Free?

Not exactly. 1031 exchanges are tax-deferred. Suppose you swap out your current duplex for another. When you sell the second duplex, you will pay taxes on it. Of course, there may be ways to minimize your tax burden, and you should absolutely run questions on the subject by your CPA. But the point is, yes, if you keep within the rules, you can accomplish a tax-free transition of property. But the piper will eventually be paid.

Types of 1031 Exchange

All 1031 exchanges must conform to some basic rules we’ve covered before. Properties must be investment or business-owned (not personal residences), and the property acquired must be of greater or equal net market value than the one sold. Finding deals that will fit these terms can be challenging, but in many cases, worth it.

Traditionally exchanges must be executed inside of 24 hours. These are known as simultaneous exchanges. The logistical difficulties of finding and coordinating such deals mean that many investors opt for deferred exchanges, which offer more leeway on the timeline.

When Should I Do a 1031 Exchange?

If you're new to real estate, you may not yet know about the capital gains tax. This tax kicks in any time you sell a property at a profit, and avoiding it is one of the primary benefits of the 1031 exchange strategy.

If you’re in the position of having a valuable property for sale, congratulations. But the downside to this good fortune is the tax burden. A 1031 will offer relief here, at least for the time the new property is owned. But just know that if you use this strategy, it isn’t a permanent way around the capital gains tax. What the 1031 Exchange will offer investors selling at a high profit level is time. The use of the exchange means your gains will be deferred until the acquired property is sold

At that point, you may use other perfectly legal tactics to diminish capital gains taxes or even exchange the property again. For the creative investor, especially with an equally innovative attorney by their side, 1031 exchanges may play a role in solving a broad range of real estate “problems.” But to really get the most out of them, you’ll need some appropriate professional guidance.

Get an Expert’s Opinion Before Jumping Into a 1031 Exchange Deal

Are you considering making your first, or even yet another routine 1031 exchange deal? It’s never a bad idea to have a lawyer take a look. The time to do that is before signing anything. Never fear. Our skilled real estate legal team can assist you with any kind of real estate deal. If you’re considering a 1031 exchange and need to protect the asset--or any other type of real property investment--don’t hesitate to schedule a consultation with one of our experts.

What is a Partnership Return?

The LLC or Series LLC has the easiest tax returns for a single member. It's a "pass through entity," which means all of the income from the company can be reported on your personal income tax return.

You don't have to pay thousands of dollars to a CPA to file a business return. Great news!

This is also true for your spouse filing jointly. This can make tax preparation a lot easier.

Some states have specific tax rules regarding multi-member LLCs. For example, if you and a partner have an LLC, you may need to file a partnership return. This is a separate return for the business itself. You need a good CPA who knows about real estate investing to help you make sure you're doing it right.

Also note: In some cases, an LLC can be taxed as a corporation. In some cases, it makes sense to have your LLC taxed as an S Corps.

Keep more of your money with a Royal Tax Review

Find out about the tax savings strategies that you can implement as a real estate investor or entrepreneur by taking our Tax Discovery quiz. We'll use this information to prepare to have a productive conversation. At the end of the quiz, you'll have an opportunity to schedule your consultation.    TAKE THE TAX DISCOVERY QUIZ

When Was The Last Time You Updated Your Living Trust?

For those of you who already have living trusts, congratulations—you are certainly on the right track when it comes to estate planning.  But how do you know when to update your living trust?

Even if you don’t have one yet, this article is worth a read ...

What is a Living Trust For?

As a real estate investor, you may have many properties that you will pass on to your heirs. The living trust can help you ensure a seamless transition upon your passing.  A revocable living trust is an estate planning tool. It may be helpful to think of the living trust as a large lockbox that holds your assets. The trust’s “job” is to hold title for the properties. 

When a living trust is created, a trustee will be named to control the assets for you. You can think of your trustee as the person who has the key to your “lockbox.”  Your role is simply to be the beneficiary of your trust. You may direct your trustee to buy, sell, or transfer assets into or out of the trust. Estate planning attorneys use living trusts as a way to avoid probate court.

How a Living Trust Compares With a Will

The will may be the most widely recognized estate planning tool, but a living trust is far superior to a will alone. Wills would have to go through probate court, which means your grieving loved ones would be navigating a maze of red tape before receiving anything from the estate.

The living trust allows for the control of the assets to immediately pass to the designated heir, as opposed to getting caught up in probate court by passing through an ordinary will. With this method, you can breathe easy knowing that mortgage payments are made, rents are collected, insurance premiums are paid, etc. 

The living trust ensures that your property is not lost or diminished in value, which are both highly likely occurrences if the properties are caught in probate court. It has the added benefit of keeping the value of the home out of the taxable portion of your estate.

Living trusts are easier to modify than wills, but harder to challenge legally. Trusts are also private, meaning using a living trust would remove your name from the public record. You would no longer own the property but retain control as the beneficiary of the trust.

The Ideal Solution: Living Trust and Pour-Over Will

For real estate investors who may be buying and selling assets frequently, it is important to know that you would normally update your estate plan each time you make a significant purchase or sale. This could present a challenge for an active investor with many properties, but that problem can be easily addressed by simply using a pour-over will. The pour-over will passes all property you own into your living trust upon your death.

For the real estate investor, a pour-will pairs well with the living trust to ensure a smooth, private transition of your assets. Using these tools together is a smart move.

 

Why Millennials Aren't Buying Houses

Blaming millennials for everything has become a national pastime. One problem with cultural assumptions about entire demographics of people is these assumptions can water down or outright mislead our understanding of the real issues we're facing.

Like it or not, millennials’ habits will dictate real estate trends over the coming years. As real estate investors, we should be mindful of broader trends in the market and population. 

Millennials Are Record Low Home BuyersMillennials Set Record For Lowest Home Ownership

Folks born between 1981 and 1996 aren’t buying homes at the rate of generations before them, but not necessarily by choice. The real estate deck is stacked against first-time homeowners in a manner unprecedented in collective memory. America has become a much more difficult place to secure an affordable mortgage. “First homes” (single family homes, even multis under $250,000) make up less of the market than ever before.

The reasons come directly back to us investors. After the 2008 crash, we scooped up hot deals on these kinds of properties, enjoying a single-family budget property free-for-all. By now, most of us have upgraded these homes, up-sold them, or at least maintained them to be competitive. But that means the homes are worth more than appreciation alone would account for. Yet it’s the same asset we got cheap after the crash. Fast forward to the present day, and our prospective 18-35-year-old tenants? They’re the generation with the most people in crisis, struggling to transition from renters to buyers. 

Yesteryear’s Stats Don’t Apply: What REIs Need to Know About Millennials

Assuming people under 40 are still the  “home-buying age group” is foolish and inaccurate. Ask any 18-year-old how likely they are to own a home in the near future. Seriously. Any college student, even. Those who aren’t laughing uncontrollably may conservatively guess a decade. 

Millennials face a different world: student loans and debt are all but certain for those beginning 4-year college. This generation’s unique challenges include:

Millennials are also more likely to move in with their parents than any other generation. Many in their 20s move home under financial duress, while others lack that option and live with housing insecurity.

Taking these problems seriously shows how such factors are genuine barriers to home ownership. We haven’t even delved into this generation’s many cultural crises. Everything from later marriage age to the ongoing opioid crisis that continues to rage through mid-2019 can affect how this population rents and buys.

Why These Trends Matter for Real Estate Investors

Most investors count millennials among their tenants or desired demographic. Single-family investors and those starter home owners can stand to benefit in a seller’s market. Or, they can stand to lose if they command a rent that’s not practical for the area. 

If you own such an asset in an unfamiliar market, learning the employment situation can give you tons of insight into prospective tenants.  If you have a property worth under $250,000, you’re sitting on a high-demand property. Buyers are competing, and investors can play fair while profiting.

Millennials sometimes turn to REI to “escape” debt or employment barriers. All real estate investors could benefit from understanding the struggles their millennial tenants, partners, and fellow investors face. 

Land Trusts For Estate Planning Can Avoid Probate... But What Are The Disadvantages?

You worked hard. You saved money to pass on to your heirs.

The LAST thing you want is for them to pay legal fees to obtain it after your death. You also don’t want your family members to experience stress while they wait to find out who gets what from your estate.

One way to avoid the expenses and delays of these legal proceedings (called probate) is to create a type of living trust called a Land Trust.

What is a Living Trust?

A living trust— also known as an “inter vivos” trust, which translates from the Latin to mean a trust that is created “between the living”—places your assets in a fund that is managed by a trustee of your choosing for the best interests of your beneficiaries.

As an alternative to a Last Will and Testament, which distributes your assets after your death, a living trust bypasses the time and expense of probate because your assets already are dispersed in the trust. In addition, living trusts offer other advantages, including privacy in situations where the state requires the filing of an asset inventory and immediate access to income and principal by your beneficiaries.

While a living trust can hold any type of asset, a Land Trust is a type of living trust designed specifically for real estate-related assets. A Land Trust can hold physical properties, mortgages, air rights, notes, and other types of property assets.

The property owner is the beneficiary of most of these anonymous trusts, meaning the owner controls how the property is managed and retains all of the property rights, including developing, renting, and selling it. Land Trusts are generally considered to be revocable trusts, meaning that the owner can amend or even terminate them at any time.

What Are the Benefits of a Land Trust?

In addition to avoiding probate, there are other possible benefits of making a Land Trust part of your estate plan. A land trust offers:

What Are the Disadvantages of a Land Trust?

A Land Trust does not protect property owners from all potential liability, and it does not offer privacy in all cases. Also, the IRS requires that all trusts, including Land Trusts, file Form 1041.

Here are three potential pitfalls of setting up a Land Trust.

  1. Redemption rights allow homeowners to reclaim their property before and, in some cases, after foreclosure. This right is lost if the property is purchased under a land trust and you are the beneficiary.
  2. Homestead exemptions, which protect your property from taxes and creditors in 48 states, are forfeited with a land trust.
  3. A land trust disqualifies you from secondary market loans. In the secondary mortgage market, lenders and investors buy and sell home loans and servicing rights.

When is Best Time To Set Up A Land Trust?

If you have decided that the benefits of a land trust outweigh any potential disadvantages, your first step is to choose your trustee. The trustee can be a friend, family member, or institution, but make sure it is someone you trust. 

Next, setting up a land trust requires two primary documents—a deed to trustee and a land trust agreement. After you have chosen your trustee, you will need to draw up an agreement that satisfies all parties and complete and sign the documents.

You can keep your ownership private by forming a land trust with either a private trustee or an institutional trustee just before closing on the property. By keeping your name off the permanent property records, you will protect your property from creditors who might use the Uniform Fraudulent Conveyance Act to gain your assets.

A land trust trustee should be exempt from personal liabilities related to the land trust’s debts and obligations. However, not every state views land trusts in the same way. Your trustee should research their state laws so that they are clear on their liability before they sign a land trust agreement.

Royal Legal Solutions will work with you to construct a trust agreement and file the right paperwork on behalf of your land trust. If you choose us your “nominee trustee,” our name will appear on all public records to protect your anonymity. After filing the paperwork, we will then transfer the trustee title back to you.

The professionals at Royal Legal Solutions are experienced in assisting with land trusts throughout the U.S. and Canada.

Image by un-perfekt from Pixabay

Real Estate Investing Fraud: Schemes to Know About 

Investing in real estate can be both a satisfying and lucrative way of building your portfolio. However, the complexity of buying and owning property can make you vulnerable to some unscrupulous characters.

From corrupt builders to phony appraisers, the real estate market can be tricky to navigate for investors of all experience levels. Unlike the typical tax scam or trustee fraud, real estate investment schemes can lure in even the savviest investor with promises of making a lot of money quickly with low risk. Many fraudsters are so good at what they do that it takes a careful eye to see them for what they really are.

Here are 13 real estate investing scams you should know about.

Buy and Bail

In this scam, the homeowner is up-to-date on their mortgage payments, but the home’s value has dropped below the amount owed on the loan. The homeowner applies for a mortgage on a similar home with a much lower price. After falsely saying that the first home will be rented out and securing the new loan, the homeowner allows the first home to go into foreclosure.

Builder Bailout

The builder artificially boosts the purchase price of newly constructed properties by offering false down payment assistance or by using straw buyers or shell affiliates. This scheme creates the impression that the builder is able to successfully sell units while also leaving the lender with loan exposure that exceeds the actual value of the property.

Chunking

Also known as a Ponzi scheme, this scam occurs when a third party convinces an investor to buy the property or a group of properties at artificially inflated prices with the promise of high returns and low risks. The third party, who is often an owner of the property, acts as the unsuspecting investor's agent.

joker cardDouble Selling

In this scheme, an unethical loan officer copies a borrower’s loan application and sends it to several different lenders, asking that they fund the loan. All of the closings are scheduled within a few days of each other, and the various lenders have competing loans against the same property.

Fake Loan

A mortgage broker uses a real person’s identity to create a phony loan application. The loan is funded, and the “seller” receives payment for a property that does not exist.

Flipping

This fraud occurs when two parties buy and sell the same property to one another and then obtain fraudulent appraisals as a way to inflate the property value.

Phony Appraisal

There are a few ways to accomplish this scheme. One way is to offer an appraiser a bribe to artificially inflate a property’s appraised value. A related scam involves a real estate investor providing the appraiser with falsified vacancy rates, rental rates, or expenses for a property.

Skimming

Here’s the scenario for a skimming scam. An investor uses a loan that covers 80% to 90% of a home’s purchase price. Then the investor pays a 10% down payment and rents the properties but does not make mortgage payments.

Modification and Refinance Fraud

A borrower understates income or gives false primary residence information in order to persuade the lender to accept loan terms that benefit the borrower.

Mortgage Servicing Fraud

This scheme involves a mortgage servicing company diverting principal, interest, or escrow funds from the underlying lender and retaining the funds for its own use.

Phantom Sale

A scammer files a false deed on an abandoned property and then transfers the property to another scammer. That scammer applies for a mortgage loan and pockets the loan proceeds.

Reverse Mortgage Fraud

In this scheme, a fraudulent person obtains title to a property and then deeds it to a fake individual who qualifies for a reverse mortgage. Then the fraudster gets the lump sum payment option on the reverse mortgage.

Short Sale Fraud

Short sale fraud can be conducted by either the homeowner, the lending institution, or an outside party. Generally, short sale fraud involves withholding facts or using false information to defraud the lender or induce a homeowner to sell a property for less than the mortgage debt owed.

How To Fight Real Estate Investing Fraud

How can you avoid these and other real estate investment frauds? Here are some key steps to stay safe.

Solid real estate investments take time and careful consideration. Before you make an investment, do your due diligence and consult someone you trust and who you know has your best interests in mind.

Image by Alexas_Fotos from Pixabay

Is A Grantor Trust Right for Your Estate Plan?

When you’re building your estate plan, one goal is to minimize the tax burden for your heirs. One tool to accomplish this is a grantor trust. In this article, we will examine these types of trusts, including their pros and cons, for your long-term financial plan.

What is a Grantor Trust?

The term "grantor" describes the person who creates a trust and owns its property and assets for both income and estate tax purposes. Therefore, a grantor trust is a living trust in which the grantor is treated as the owner of all portions of the trust.

A grantor needs to have one of the following powers for a trust to be considered a grantor trust.

The grantor usually is a trustee and beneficiary of the trust’s income and principal. This income from a grantor trust is taxable to the grantor and should be listed on the grantor's personal tax return.

The IRS allows grantor trusts to file taxes under the grantor’s personal Social Security Number (SSN) rather than a separate Tax Identification Number (TIN). A married couple who files joint taxes and who share the grantor’s trust powers may use either spouse’s SSN to file taxes for the trust. Grantors may request a TIN for the purpose of privacy. The trust will need to apply for its own TIN upon the death of the grantor(s).

grantor trust: kid with plantWhat is a Non-Grantor Trust?

A non-grantor trust is simply any trust that is not a grantor trust. That means that in a non-grantor trust, the person who established the trust has given up all right, title, and interest in the principal.

Only the trustee has the legal right to revoke or amend a non-grantor trust. Also, the grantor cannot serve as a trustee or as a beneficiary of the trust and cannot have any remainder interest in the trust.

The IRS requires a non-grantor trust to have its own TIN. As a separate tax entity, non-grantor trust must pay taxes on all income received.

What is an Intentionally Defective Grantor Trust?

Despite its ominous-sounding name, an intentionally defective grantor trust (IDGT) refers to an irrevocable trust where the grantor pays the trust’s income tax bill during their lifetime.

The grantor does this by making an irrevocable gift of property into a trust -- typically set up for the grantor’s children -- and names someone else as the trustee. In an IDGT, the grantor retains the right to substitute other property of equal value for the initial property.

The grantor of an IDGT must obtain a TIN and file an IRS Form 1041 with trust income reported every year. However, unlike with a standard grantor trust, a typical IDGT is not subject to estate tax upon the grantor’s death. Instead, the grantor pays a gift tax on the value of the property when it is transferred into the trust.

Are Land Trusts Seen As Grantor Trusts?

A Land Trust is a private legal agreement in which the trustee agrees to hold title to a piece of real estate for the benefit of another person (the beneficiary). The individual who establishes the entity is called the grantor.

For the most part, Land Trusts are structured as grantor trusts and are considered to be disregarded entities. A disregarded entity is an LLC or trust that is “disregarded” in the sense that the IRS does not recognize it as a separate taxpayer.

In other words, disregarded entities do not pay tax and do not file a tax return. Instead, the owner of the trust must report the entity’s income and deductions directly on their tax return.

Pros and Cons of Grantor Trusts

The main advantage of having a grantor trust in your financial plan is the opportunity to preserve your hard-earned wealth while minimizing the tax burden for your heirs. Typically, you pay less income tax on trust assets at your own personal tax rate instead of at a rate set for the trust.

A grantor trust can also serve to protect your assets against creditors in a lawsuit. You can transfer assets to a grantor trust for long-term care planning, and your assets held in a trust won’t be subject to the lengthy and costly probate process after your death.

On the other hand, setting up a grantor trust assumes that you have the financial resources to pay the income tax on trust assets throughout the rest of your life. A large capital gain inside the trust could significantly increase your tax burden.

Keep in mind that grantor trusts and IDGTs become non-grantor trusts upon the grantor’s death. On December 31 of the year of the grantor’s death, the administrator must obtain a TIN for the trust must then be obtained and become responsible for filing a Form 1041 for this now non-grantor trust.

Should I Set Up A Grantor's Trust?

There is no one-size-fits-all answer to this question. It depends on your individual financial situation. Talking to an estate planning attorney can help you determine whether you would benefit from a grantor trust and which type of trust is best for you and your family.

11 Productivity Tips For Real Estate Investors

Real estate investors wear a lot of hats. The ones who do well must figure out how to manage their time. Making smarter investment decisions and seeing higher returns depend on it.

As a real estate investor, your success depends on how you use your time. You need to make every minute count. These productivity tips will help you stay focused on your goals and push your business in the right direction.

#1 Prioritize Tasks for the Next Day

Prioritizing tasks for the next day will ensure that you are prepared. Separate the next day's tasks into two categories. First category will be tasks that you will be handling on your own. The other category is tasks that you  assign to others. When you prioritize, you leave nothing to chance.

Prioritize tasks that must be done first due to a deadline or any other reason.

#2 Make a To-Do List

Each day should have more than 24 hours so you can finish everything, right? Until that happens, time management is the key to making sure that you don’t miss out on any task that needs to be completed on a given day. 

Prepare a to-do list that features all the tasks you face. This will help you stay on top of almost everything related to your projects.

#3 Learn the Art of Delegation 

If you are a hardcore DIYer, you need to change a little to be more productive. It is figuratively impossible for you to complete all the work you have on a given day all by yourself. Learning to delegate can help you get more done in less time. 

Real estate investors are all over the map. In a given day, you may have to visit a new property. Prepare a listing on your own. Or plan a kitchen renovation. There will be other routine tasks to take care of as well. You can delegate many of these tasks one you find reliable people whom you can trust to do them correctly. And of course, that's the hard part.

#4 Take a Break 

Too many real estate investors believe that taking a break is a sin. Keeping your work hours crammed could negatively impact both your physical and mental health. Taking breaks every now and then will help you stay refreshed and enthusiastic throughout the day. So take a quick walk or grab a snack. Or you can take a power nap to recharge yourself. 

#5 Stop Multitasking 

Contrary to popular opinion, multitasking doesn’t improve your productivity. When you are handling more than one task at a time, it's hard to keep your focus. By not giving an important task the attention it requires, you may complete it with substandard quality.

Real estate investors should rarely multitask. When you try to perform more tasks than your body and mind can handle, you end up creating a mess. Don’t let anything distract you while you are doing tasks that are harder for you or that you don’t find too interesting.

Multitasking will do more harm to your productivity than good. So stop multitasking and start focusing on one task at a time to improve your productivity.

#6 Ditch The Meetings 

Even self-employed real estate investors have to meet clients, financial advisors and attorneys on a regular basis.  However, if you can reduce the number of meetings, you will be rewarded with improved productivity. A lot of meetings can be handled with an email exchange or a quick phone call. Get back the time you need to focus on tasks that can actually help you get more out of your investments. 

#7 Limit Social Media Time 

Social media is a big distraction. But you don’t need to stay off it completely because it is often the best place to get industry updates (speaking of which, check out our Tax, Legal, & Asset Protection Secrets For Real Estate Investors mastermind group if you aren't already a member).

What you need to do is be smart about the time you spend on social media. You can access your social media accounts during breaks or whenever you feel stuck on something. It is a great way to get your mind off something that you cannot get through and then start afresh. 

#8 Turn Big Projects Into Small Milestones 

The biggest reason you need to break a big project into smaller milestones is not to feel overwhelmed. By doing this, you will be better positioned to manage the smaller tasks or milestones, which will help you complete the entire project on time. 

This will also allow you to delegate a few of the smaller tasks to other people in your team, which will help take some of the burdens off your shoulders.

#9 Make Time for Networking

Networking gives you the opportunity to interact and communicate with others in your industry as well as those that could be your potential clients. So when you build a network, you establish professional associations with people and set the stage for business possibilities.

So it is very important for every real estate investor to make some time for networking in their daily schedule. Real estate investors thrive on relationships. No wonder networking is given so much importance. 

#10 Leverage Technology to Boost Productivity 

You need to make the most of the time and resources available to make your real estate investing business a success. One way of doing this is to leverage technology. There are tools that can help you do a lot more with your day than you end up doing. For example, using technology can help you avoid contract drafting mistakes in your real estate transactions.

Technology can help you with tracking listings, scheduling tasks, managing expenses, organizing documents, and screening prospects amongst other things. 

#11 Review Your Week on Friday 

Measuring your performance every week can help you improve your performance. Did you achieve the targets that you set at the start of the week? If you didn’t, where did you fall short? On the other hand, if you succeeded in achieving your targets, you will have the entire weekend to celebrate your success.  

Reviewing your week will also help you maintain workplace discipline. And you can figure out how differently you need to approach different tasks so that you don’t fall short going forward.

 

4 Property Investing Tips to Remember

When most people think of investing, stocks, bonds, and mutual funds often come to mind. For most Royal Legal clients (including members of our mastermind group), the investment avenue of choice is real estate.

Investing in property such as rentals, commercial office space and multi-family housing isn't everyone’s cup of tea, though because it can be challenging and risky. It also requires dedication, knowledge, and planning.

There is no shortage of online resources if you want to get your feet wet in this highly competitive industry like this one. Before you start taking notes about the basics of real estate, check out these four property investing tips that increase your chances of success.  

Property Investing: runner at starting lineTip #1: Make a Plan

Investing in real estate is no different than any business. If you intend to be a serious investor, you need a plan. Having a roadmap allows you to see the whole picture and focus on what’s critical instead of being distracted by unavoidable setbacks.

Start with deciding your goals. Are you looking for capital appreciation or yield? The answer will depend on how you view facing challenges. If you’re a risk-taker, you’ll buy properties based solely on their potential for growth and long-term returns. Or you might look at assets that offer rental income for instant profits.

Setting a timeframe for achieving results is another determinant of which investing method you’ll adopt. Deciding what you’ll do will enable you to formulate a specific plan instead of a shoot-and-miss approach.

Be sure to regularly review your strategy so you can take immediate action when needed to stay on course. No matter how well you prepare for the future, you’ll need to be able to deal with curveballs when they come at you.

Your knowledge of the market and keeping abreast with news will help you anticipate most events and make the right decisions.

Tip #2: Location Is All-Important

You’ve heard the saying, “location, location, location." Every real estate investor will tell you that the primary factor in buying landholdings is where they’re situated. 

Don’t buy based solely because the assets are low-priced. Do your research on the area so you’ll know the reason for its current value and the potential it offers. Not every inexpensive property can be profitable.

You should identify areas where the demand for buildings exceeds its supply. This shortage will ultimately push prices upwards. 

It’ll take due diligence on your part to check the neighborhood and what it offers in terms of return on investment. As part of your assessment, be sure to study the following: 

Tip #3: Get Advice From Property Investment Specialists

Before buying your first investment property, get professional help with your financial affairs. Taxation laws are complex, and you don’t want to get on the wrong side of the IRS and lose money to penalties and fines.

It’ll be beneficial for you to work with an accountant who’s well-versed with real estate when you plan your strategy. The ability to prepare cash flow projections is vital to providing you with valuable and timely fiscal information. With expert advice from a CPA and an attorney specializing in asset protection strategies, you can use legal structures tailored for property investment to save on your tax liability. Your advisors will also counsel you on whether to invest as an individual or corporate entity for risk management reasons.

Tip #4: Have an Exit Strategy

Knowing when to sell is just as important as when to buy. It’s all about timing. 

Be vigilant and continuously watch the market. If you need to cut your losses, do it and move on. There’ll always be other opportunities. Having a plan in mind at the onset makes it less stressful when it comes to disposing of your asset.

Property Investing Can Be Profitable

Any investment is risky, but as long as you exercise due diligence and prepare for the challenges, you can attain your investment in the long run.  Remember: any people have built their real estate empire by following fundamentals. If you do the same, you can be successful too.

 

 

Using Your S Corp: Section 179 Deductions

If the title of this article is already making you yawn, I promise—this will be more exciting than you think. Why’s that? Because this article is all about SAVING YOU MONEY BY LOWERING YOUR TAXES.

Save Money? Lower Taxes? Tell Me More!

Now that I have your attention, let’s dive in. Using a Section 179 tax deduction with your S Corp allows you to deduct the full purchase amount of business equipment from your personal taxable income.

When a Section 179 deduction is personally allocated to you from an S Corp or partnership, the income and expense are “passed through” to you, and you claim it on your individual tax return. This means any income you earn from your S Corporation will be reduced by your Section 179 deductions, and you’ll only have to pay taxes on the reduced amount. 

Let’s look at an example to see how this would play out in real life:

Tom is a real estate investor who started an S Corp to hold his investments. He earned $100K in 2020 through the S Corp. Since an S Corp is a pass-through entity, Tom would typically have to pay personal income taxes on the $100K the S Corp made. However, if Tom has $20K of Section 179 deductible expenses, he’d only have to pay personal income taxes for $80K. 

Pretty spiffy, right?

s corp section 179How Section 179 Works

Section 179 gets its name because the rule is found in section 179 of the Internal Revenue Code. Essentially, this rule allows you to write off the full cost of eligible Section 179 property in the year it is purchased and put into use instead of deducting the depreciation over time.

This means you cannot take a 179 deduction on property purchased in a previous year, even if this is the first year you used the property for business purposes. For example, if you bought a vehicle for personal use in 2019, then converted it to a company car 2020, you cannot use a Section 179 deduction.

What You Can and Can’t Deduct

Property eligible for the Section 179 deduction is usually tangible personal property (usually equipment or office furniture) purchased for use in your business. 

Some common examples of Section 179 qualifying property include:

However, certain types of depreciable property are NOT eligible for a Section 179 expense deduction. Ineligible property includes:

Additionally, if you use property for both personal and business purposes, you can only use a Section 179 deduction if the asset is used at least 51 percent of the time for business. 

Section 179 Deduction Limitations

The total amount of purchases you can write off changes every time Congress updates IRC section 179 of the tax code. As of 2020, the maximum Section 179 expense deduction is $1.04M. 

In addition, this limit will be reduced by the amount by which the cost of Section 179 eligible property placed in service during the tax year exceeds $2.59M. This means if your business purchases and puts into use $2.6M, you’ll only be able to deduct $1.03M of these expenses using Section 179. The $10K overage on the $2.59M limit will reduce the $1.04M limit by $10K.

As a small business, I know you probably won’t come anywhere close to this amount of Section 179 expenses. But it’s always a good idea to know the rules, just in case.

Business Vehicle Deductions

People used to refer to Section 179 as the “Hummer Deduction” or the “SUV Tax Loophole” because many businesses took advantage of these deductions to write off the full purchase price of expensive vehicles. In response, the IRS severely reduced allowable write-offs for business vehicles. As of 2020, the maximum section 179 expense deduction for sport utility vehicles is $25,900.

Bonus Depreciation

If you can't write off an asset immediately, you have to depreciate it. You deduct a percentage of the value each year until you've written off the entire cost. 

It's also possible that you can take off extra for expenses that exceed the Section 179 limit, the first year as "bonus depreciation." Through 2022, the amount of bonus depreciation you can claim is 100%. 

Starting in 2023, bonus depreciation rates decrease to:

When you use Section 179 deductions with your S Corp, you can save a ton of money in taxes. Make sure you keep track of everything you buy for your business and GET THOSE DEDUCTIONS!

Interested in learning more? Check out our articles Using Your S Corp: Payroll Taxes and Getting The Most Out of Employee Business Deductions.

Using Your S Corp: Payroll Taxes

As we continue our series on S Corps, we’ve come to an interesting question: Does an S Corp need to pay payroll taxes? Your short answer is yes. S Corps, even single-member ones, are responsible for payroll taxes just like any other business. However, one of the fantastic benefits of an S Corp is that you can avoid payroll taxes for at least some of the money you make.

What Are Payroll Taxes?

The term “payroll taxes” refers to the Social Security and Medicare taxes that are withheld from an employee's paycheck and matched by employers. 

Here’s how it works:

s corp payroll taxesWhat Is Self-Employment Tax?

If you own your own business as a sole proprietor, you’ll have to pay self-employment tax. Since you essentially are your own employer, you have to pay both the employee and the employer’s share of payroll taxes. This means that you have to pay 15.3% of your income in self-employment taxes to ensure your share of Medicare and Social Security taxes is covered. 

A quick note: self-employment taxes and payroll taxes both refer to Medicare and Social Security taxes. They’re just called different names depending on how they are paid, because people like tax law to be unnecessarily confusing.

Payroll Taxes And Your S Corp

This is where having an S Corp comes in handy. With an S Corp, you can avoid payroll taxes on any profits you make from your business, as opposed to a sole proprietorship – where you have to pony up payroll taxes for 100% of your earnings. 

Here's the catch: you can’t just call all of your earnings profits, skip payroll taxes altogether, and call it a day. The IRS requires that, if you work as an employee of your S Corp, you have to pay yourself “reasonable” compensation for your services. 

What Is 'Reasonable' Compensation?

That’s a great question! Unfortunately, there’s no great answer. Reasonable compensation isn’t defined anywhere in the tax code. Instead, the IRS will look at the facts of your particular circumstances to determine if your salary is reasonable. If they think your compensation is too low, they can recharacterize your distributions as wages, and you’ll have to fork over payroll taxes.

In deciding whether compensation is reasonable, the IRS (and the courts, for cases that go to litigation) will look at factors such as:

In general, the more qualified you are and the more professional services you provide for your S Corp, the higher your salary should be. You definitely want to seek guidance from your attorney or account on this issue because the IRS is notorious for its thorough scrutiny of S Corp salaries and distributions.

Payroll Taxes On Your Compensation

If you’re paying yourself (salary or wages) and you’re an employee of your S Corp, payroll taxes must be withheld just like any other employer. The S Corp will pick up the employer’s share of payroll taxes, and your share will be deducted from your pay. This means you can’t benefit from the S Corp’s magic payroll-tax-avoiding powers until your business is lucrative enough to pay yourself a reasonable salary AND have some profits left over.

Another thing to keep in mind: If you have a health insurance policy through your S Corp, make sure your S Corp is footing the bill. That means the S Corp will have to add your insurance payments as income on your W-2. 

Qualified Business Income Deduction

The qualified business income (QBI) tax deduction lets you deduct up to 20% of your S Corp income on your taxes. Of course, the IRS has put plenty of limitations on who can use this deduction and what type of business income is covered.

What Is Qualified Business Income?

The IRS defines qualified business income as “the net amount of qualified items of income, gain, deduction and loss with respect to any trade or business.” In other words, it’s your S Corps net profits.

This means you can take a QBI deduction on the PROFITS of the S Corp you receive as distributions. You do not get to use the QBI deduction on the SALARY you pay yourself. 

QBI Income Limits

In 2020, your total taxable income must be under $163,300 for single filers or $326,600 if you file jointly with a spouse.  In 2021, the limits will increase a bit to $164,900 for single filers and $329,800 for joint filers.

Remember — since your S Corp is a pass-through entity, you’ll report its income as your own on your personal income taxes. So these limits apply to your TOTAL taxable personal income and not just the part that comes from your S Corp.

If you’re over the income limit, you may still qualify for a full or partial deduction. But these laws are immensely complicated and confusing, so it’s best to contact your accountant or lawyer to discuss if you qualify.

 

Interested in learning more? Check out our article How You Can Save Thousands in Taxes with an S-Corp and Using Your S Corp: Section 179 Deductions.

 

 

Self Employment Tax & The Independent Contractor

Paying taxes as an independent contractor can be a pain. The purpose of this article is to make it easier for self-employed individuals (such as real estate agents, brokers, and investors) to understand, calculate and plan for paying Uncle Sam the self-employment tax he is owed.

What Is An Independent Contractor?

An independent contractor is essentially a nonemployee, meaning a person or business entity that provides products or services to other businesses and is in business for themselves. This is in contrast to an employee, who works for an employer and is paid a certain wage or a salary.

Sounds pretty obvious, right?

According to the National Association of Realtors, there are about 2 million independent real estate agents and brokers in the United States. Each one of these individuals is a self-employed business owner, considered an independent contractor.

The Internal Revenue Service (IRS) has declared that real estate agents are "statutory nonemployees" for tax purposes. As such, they are considered self-employed and subject to self-employment tax, just like any other independent contractor.

What Is Self-Employment Tax?

Self-employment tax consists of Social Security and Medicare taxes for self-employed individuals. It is equivalent to the Social Security and Medicare taxes that employers are required to withhold from their employees’ paychecks.

Think of it this way: If you were working for an employer, you would have a certain amount of money withheld from your paychecks for Social Security and Medicare taxes. What you may not know is that your employer would also have to pay that same amount on the wages you receive.

Those required to pay self-employment tax include:

Independent contractors are responsible for paying both the employee's and the employer's portions of self-employment tax on their earnings. Also, rather than having the tax withheld from multiple paychecks throughout the year, independent contractors must pay self-employment tax as a lump sum, along with their income tax return in the spring, or by making estimated quarterly tax payments throughout the year.

Self-Employment Tax & Real Estate Investors

Investing in real estate is one of the best ways to create wealth and enhance your cash flow. For passive income investors, your rental income is not subject to self-employment tax. However, if you do several real estate transactions in a year, the IRS might consider you to be doing active business or trade rather than simply enjoying passive income from your real estate investments.

While the IRS treats everything on a case-to-case basis, if you earn more than half of your total income through real estate investments, the IRS may consider your earnings to be a source of earned income rather than passive income. Earned income is subject to self-employment tax and higher income taxes.

How you legally structure your investment activities can also affect how your investment income will be taxed. For example, investing in real estate as a C corporation, and paying yourself a management fee or salary can also trigger self-employment tax and higher income taxes.

How To Calculate Self-Employment Tax?

You calculate self-employment tax on Schedule SE (Form 1040). To do so, you must take 92.35% of your total net earnings (gross earnings minus any deductions) and multiply that figure by the current self-employment tax rate.

Currently, the self-employment tax rate is 15.3%, which is a combination of 12.4% Social Security tax plus the 2.9% Medicare tax. Therefore, the formula for self-employment tax is as follows:

SE Tax = (net earnings) x (92. 35%) x (15.3%)

For example, if you earn $10,000 in self-employment income in 2020, you will pay approximately $1,412 in self-employment tax ($10,000 x 0.9235 x 0.153 = $1,412.955). Likewise, if you earned $50,000, you would pay $7,064.775 in self-employment tax ($50,000 x 0.9235 x 0.153 = $7,064.775).

How Do I Pay Less Self-Employment Tax?

Self-employment tax can be a hefty price to pay for doing business as an independent contractor. The only way to reduce your self-employment tax is to reduce your self-employed income.

Shockingly, the IRS allows independent contractors to deduct a wide range of valid business expenses on Schedule C (Form 1040). Knowing what these deductions are and keeping good receipts and records can save you thousands of dollars.

Common expenses that can be deducted on Schedule C include:

Other expenses that individuals often forget to deduct on Schedule C are:

Your self-employed income and expenses are reported on Schedule C. The result of that form is the total self-employed income that gets transferred to the Taxable Income line on your 1040.

Why Become An S Corporation?

If you are an active real estate flipper or wholesaler, you are more than likely subject to self-employment tax. But you can save thousands in taxes by electing to be taxed as an S Corporation.

S Corporations (and LLCs that have elected S Corporation tax treatment) can be structured to minimize or avoid self-employment tax entirely. Also, as an S Corporation, you will not be obliged to pay federal income tax or corporate taxes.

For instance, you can structure your S Corp so that you only pay self-employment tax on a fair salary that you pay yourself, rather than on your corporation’s net earnings. Moreover, any distribution you pay yourself from the S Corporation will be completely exempt from self-employment tax.

Budgeting For Self-Employment Tax

As a rule, whenever you have income from sources other than a salary or wages, and you expect to owe $1000 or more when you file your tax return, you need to make estimated quarterly tax payments to the IRS to avoid penalties, interests, and a sizable tax bill at the end of the year. While it is best to consult with a tax professional to determine your quarterly tax payments, there are steps you can take to budget for your self-employment tax obligation:

Set Money Aside

After accounting for self-employment tax, set aside at least one-third or even as much as 45% of all your earnings in a dedicated savings account. This will help ensure that you have enough to make estimated tax payments each quarter.

Track Your Expenses

Remember, self-employment tax is paid on your net earnings, meaning the amount you have left over after you have accounted for all your expenses. So, be sure to keep accurate records of all your expenses to ensure that you are not paying more taxes than necessary.

Pay On-time

If you must submit estimated tax payments each quarter, make sure that you submit them on time to avoid penalties.

Consult With A Qualified Tax Professional

A qualified tax professional can help you determine what your self-employment tax liability will be and ensure that you pay your taxes on time. With the right preparation and advice, you will not be caught off guard when tax season rolls around.

Keep more of your money with a Royal Tax Review

Find out about the tax savings strategies that you can implement as a real estate investor or entrepreneur by taking our Tax Discovery quiz. We'll use this information to prepare to have a productive conversation. At the end of the quiz, you'll have an opportunity to schedule your consultation.    TAKE THE TAX DISCOVERY QUIZ

Basics of Land Investing

Are you tired of all the inconveniences that come with real estate investing, like tenants and structural repairs? The landlord life is not for everyone, and it's getting old for you, it might be time to try something new.

Land investing provides a variety of profit opportunities. Whether you choose to invest in farmland or property for development, such as vacant lots and raw land, there is money to be made in land. Whether you want to develop an unoccupied property or purchase agricultural farmland, real property investments can create long-term and dependable revenue streams. 

Basics of Land Investing: overhead shotTips For Investing In Development Property

If you're interested in taking the development route, here are a few tips and tricks to follow when investing in your first tract of raw land.

Location, Location, Location

As a savvy real estate investor, I'm sure you know that it's all about location. Whether you're buying a new rental property, a home for your family, or a vacant lot, location is one of the most substantial contributing factors to a property's investment value. 

While you can usually improve or change the property itself, you're stuck with the neighborhood where it's located. For this reason, you should never forget that you aren't just investing in real property; you are investing in the location as well. When you have found a property you may want to purchase, check with a commercial real estate broker to learn more about the site and surrounding areas.

Zoning Laws

An unavoidable aspect of land development is local zoning laws, limiting the way you can use it. For instance, if you buy a property that's zoned for residential use only, you can't build a strip mall or a factory on it. It's nearly impossible to change the zoning for a tract of land, so you should always make sure the property's zoning corresponds with your development plan before you buy it. 

Environmental Site Assessment

In addition to zoning and the surrounding area's qualities, you should always investigate the land itself by conducting an Environmental Site Assessment (ESA). An ESA consists of four evaluation phases that will confirm whether the land can actually be developed according to your plan.

Utilities And Easements

You'll also need to check with the local utilities about the process for setting up the electric, water, and sewage. If you have to cross someone else's property to access the land, you'll need to obtain an easement before you can start developing the land.

Cost Analysis

While you are probably already familiar with the costs associated with real estate investment, it can be more expensive to get started when purchasing land. First, since banks consider vacant lots to be riskier investments than real estate, you'll likely see higher interest rates than you're used to with traditional mortgages. To save some dough on interest, it helps to put down as much cash as you can. 

Here are a few other back-end expenses to consider: 

farmland agricultural landTips For Investing In Farmland

The American economic system was built on agriculture, and farmland remains an integral part of our economy and cultural heritage today. As one of the least volatile types of real estate, farmland is also a stable and relatively low-risk investment method. 

The primary reason that farmland is such a low-volatility investment is simple: humans need food. As long as we rely on farmers to grow our food, there will be money to be made investing in agricultural land. Additionally, farmland will always retain value because it is a limited resource: there is a finite amount of land suited for agriculture. For this reason, farmland is rising in popularity among real estate investors looking for long-term and steady gains.

Returns from Farmland

Strategic farmland investors can see dependable returns from both the appreciation of the land value and the income made from agricultural activities on the farmland itself. While agricultural land may appreciate more slowly than typical real estate investments, you can realize short-term returns through direct income, either by renting to a farmer or operating the farm yourself.

Tax Advantages

Agricultural properties come with a variety of tax advantages that make them an even more attractive investment. Here are a few ways the tax laws can work in your favor when purchasing farmland:

Funding Options

You don't need to have piles of cash to invest in farmland. Here are a few creative ways to finance an agricultural land purchase if you're not rolling in dough:

Do Your Research

Whether you want to check out development land or farmland, it's essential to do your due diligence before diving in. If you do your research to make smart property choices, land can be an excellent investment and an exciting diversion from standard real estate. 

 

How To Invest In Real Estate With No Money

So you've caught the real estate bug, and you're ready to start investing! But then you check your bank account and ... Oh yeahhh ... You're broke. This doesn't mean you can't get in the game—it just means you need to think a little more creatively. Here are a few tips on how to invest in real estate with no money.

Option #1: Find A Partner

Finding a partner with deep pockets to fund your ventures is one of the best ways to get started in real estate investing when your own pockets are too shallow. Of course, to find someone willing to bankroll your real estate mogul aspirations, you better bring something to the table as well. 

In addition to moolah, the recipe for a successful real estate investment includes a variety of ingredients, such as:

Take inventory of your talents and resources to figure out what you can bring to a partnership. Then find someone who has the cash for real estate investing but lacks an essential quality that you can offer. Forming a partnership can get you into the game without investing any of your own money.

Option #2: Start An LLC

An alternative to partnerships is forming a Limited Liability Company (LLC). On top of the asset protection benefits of buying an investment property with an LLC, starting a new LLC can also be a source of funding for the property: You can use the capital that equity owners invest in the new LLC to purchase real estate. 

Option #3: Borrow From Hard Money Lenders

If you're interested in flipping a house instead of making a long-term investment, hard money lenders can get you the funds you need to get started. Instead of going to a bank (or if the banks have already rejected you), you can pursue financing from hard money lenders. These lenders are typically corporations established specifically to issue hard money loans or wealthy folks looking to get wealthier.

Hard money loans have:

Sounds great, right? Yes, hard money is pricey. But, if you have found the perfect flip and you can still make a profit after paying their fees, hard money lenders are sometimes the best way to get the money you need to make the deal. 

Option #4: Buy A Seller-Financed Property

If you're struggling to secure a loan from a traditional lender, seller financing is a great option to explore. With seller financing, the property's current owner sells you the real estate, and you make payments directly to them. You'll sign a promissory note, which is basically a formal IOU, and they'll hold a mortgage on the property. 

Some real estate investors and other property owners who don't need all the money for the property upfront use seller financing to make a little extra cash off selling their properties. They benefit from the interest you pay them, and you can cut the third-party lender entirely out of the process. Seller financing can allow you to snag a property you couldn't qualify to buy through a traditional loan.

Option #5: Put Your Retirement Savings To Work

Many people don't know that real estate investing with your 401(k) or IRA is even an option. While a traditional retirement account is generally limited to common investments such as stocks, bonds, and mutual funds, a self-directed 401(k) or IRA allows you to invest directly in real estate. 

With a self-directed retirement account, you can use your savings to purchase real estate. Your account will be listed as the property's owner, and you can start making money off the investment.

Option #6: Crowdfund

Real estate crowdfunding is a relatively recent development. While the idea is just starting to catch on, crowdfunding is already attracting attention from serious investors. The popularity of real estate crowdfunding promises to grow as time goes on.

Crowdfunding can be an exceptional opportunity for people with limited resources to pool their money to invest in real estate. If you can't raise capital through a traditional method, you can crowdfund using social media, real estate crowdfunding platforms, or other online sources to purchase real estate. 

Option #7: Combine Methods

No rule says you have to pick just one of these options. If you want, you can create your own tailor-made investment funding strategy using a combination. For example, you could start an LLC to purchase a seller-financed property. Or you could flip a property with a partner but secure some of the financing from a hard money lender. Or you could invent your own strategy that isn't mentioned in this article!

If you think creatively and focus on your goals, the sky is the limit when it comes to your investment options. Knowing how to build a real estate empire means keeping your eyes open and being ready to open the door when the opportunity knocks. That said, as with all investments, make sure you do your due diligence before jumping into anything. 

What’s The Difference Between An S Corporation & A C Corporation?

If you’re trying to set up a business to hold your real estate investments, all the jargon and legal mumbo jumbo can be confusing. For instance, the internet is probably telling you to decide if you want your business to be an “S” corporation” or a “C” corporation,” but you don’t even know the difference between an S Corp and a C Corp. So how are you supposed to decide?

Don’t worry—I’ve got your back. Think of this article as your starter guide to deciding how your business should be structured and taxed.

Before you can choose between an S Corp and a C Corp, you need to understand the basics of how businesses are classified. 

There are two different levels of classification:

First, you’ll need to choose the type of legal structure you want your business to have (corporation vs. LLC), and then you’ll select how you want to be taxed (S Corp vs. C Corp).

difference between s corp and c corp girl walking down pathFirst Level of Business Classification — Legal Structure

State laws will control the process of forming a corporation or LLC. When you start a business, you’ll need to decide if you want to be a corporation or an LLC, which controls your business’s legal structure and has nothing to do with how it will be taxed.

Corporation

A corporation is a business entity that is legally considered to be entirely separate from its owners. Real estate corporations can be held liable for corporate actions and earn profits that are considered the business’s income and not the owners. 

Generally, corporations are:

Limited Liability Company

Like corporations, a Limited Liability Company (LLC) is also a separate legal entity from its owners. However, real estate LLCs provide more flexibility in management options and fewer record-keeping requirements.

LLCs are:

Side note: If you’re starting your business to hold multiple real estate investments, you may want to consider forming a series LLC, which allows you to hold your investments in separate “series” within the same LLC for maximum asset protection and convenience.

Should Your Business Be An LLC Or A Corporation? 

Whether an LLC or corporation is a better structure for your business depends on various factors, including your goals for your business and your desired management structure. You should consult with an experienced business attorney when deciding which type of entity is best suited to your ambitions.

Second Level of Business Classification — Tax Status

Once you’ve decided on a legal structure for your business, you’ll also have to choose how you want to be taxed: S corp or C Corp? Both corporations and LLCs have the opportunity to choose between the two tax statuses.

C Corporation

The IRS acknowledges C Corps as distinct taxpaying entities. This means that if you go with a C Corp, your business’ profits will be taxed like "personal income" of the corporation. You’ll have to file a tax return for the company each year. Any portion of the profits distributed to the owners will be taxed again as their personal income.

S Corporation

S Corps are what is known as “pass-through” entities. This means that S Corps themselves don’t pay taxes. Instead, the company’s profits (or losses) are passed through to its owners for tax purposes. 

Each owner will include their portion of the company's profits and losses on their personal tax returns and pay taxes based on their individual tax bracket. Additionally, S Corp distributions are not subject to Social Security taxes as long as you’re paying yourself a reasonable salary. Because of the advantages offered by S Corp taxes, many real estate investors elect this tax status for their businesses.

Default Tax Statuses

The IRS will assign a default tax status to your corporation or LLC if you don’t tell them that you want them to do something different. What your default tax status is depends on the type of entity you formed and how many owners there are. 

Default Tax Status For Corporations

When you form a corporation, the IRS will automatically consider you to be a C Corp.

Default Tax Status For LLCs 

When it comes to taxes, there’s no such thing as an LLC. By default, single-member LLCs will be treated as sole proprietorships, and LLCs with two members or more will be treated as partnerships. The LLC will be viewed as a "disregarded entity" and will not be taxed.

How To Change Your Default Tax Status

If you form a corporation and decide you’d prefer to be taxed as an S Corp than a C Corp, you can file Form 2553 with the IRS to change your corporation’s tax status. Similarly, LLCs can file Form 8832 and choose to be taxed like an S Corp or C Corp.

S Corp Versus C Corp

So, you can elect to be taxed as either an S or C corporation. Why would you choose one over the other? 

In short: If you are going to bleed your company dry, an S Corp may be better. If you are building a business and need to leave funds with the company to grow the business, a C Corp may be better. However, you should always talk to your tax advisor and your attorney to figure out which is best for your particular circumstances and goals..

When An S Corporation Is Better

An S corporation works really well when you’re taking all the money out because there’s only one tax level—at the shareholder level. That means the owner is the only one that’s taxed—the company is not taxed. This is the best option if you’re going to take all the money out of the business. 

When A C Corporation Is Better

There are also many advantages to going the C corp route, including a 21% corporate tax rate. In a state like Texas or Wyoming or Nevada (where there aren’t corporate taxes), you’re getting a 21% flat rate on all the money you leave in the company. The more you can keep in a C corp, the better off you will be because of the 21% tax rate.

In a C Corp, the corporation is taxed, and then, when money is distributed, it’s taxed again at the shareholder level. If you’re taking money out of the company, it probably should be as salary, because otherwise, you’re going to be double taxed.

What’s Next?

After you decide how to tax your business (S Corporation or a C Corporation), you need to pay yourself a reasonable salary. You’re going to want a bookkeeper. 

You’re an independent contractor employed by your business now, but you’ll have to correctly handle the withholdings. This includes filing the payroll tax reports. An experienced lawyer can help you get through this process and make sure you set everything up properly. 

 

Interested in learning more? Check out our articles Using Your S Corp: Payroll Taxes and Using Your C Corporation’s Tax Brackets To Reduce Your Tax Burden.

How You Can Bypass The 20% Withholding Tax On 401(K) Distributions Using Your IRA

You have to think of the IRS like they’re pirates out to steal your money. They want to get into your home. They want to carry off your daughter. They are the barbarians at the gate.

Our clients are wealthy investors who will pay their fair share when and where they are obligated.

But there are ethical and legal means to keeping more of their money, and it's our job to help them find those means.

Here’s one way to keep the government’s greasy fingers off of your retirement savings by bypassing the withholding tax on 401(k) distributions. 

Tax Advantage of Retirement Tax Savings

Your 401k is subject to a 20% withholding tax when you cash in. IRA distributions, however, aren’t subject to taxation at the time of distribution.

That means you have a head start against the pirates.

This is the easiest switch in the world. Dump your 401(k) into an IRA. To get started, check out our article, IRA Rollovers: Yes, Rolling Over Your 401(k) Into An IRA Is Smart!

Everything in your 401(k) is going to take this hit. But your IRA is all yours.

Now, this isn’t a complete get-out-of-jail free card. The real world isn’t Monopoly and you’re going to look like an idiot if you start wearing a monocle.

The tax owed on the distribution of an IRA or 401(k) is identical. You will still receive a 1099-R.

The difference is when you have to pay the piper. If you keep your 401(k), you pay the Man up front. 

The Difference 20 Percent Can Make

You may not think 20 percent is a big deal, but with a little creativity, 20 percent is going to add up. There’s nothing wrong with retiring on the beach. My buddy (we'll call him John) took $500,000 from his 401(k) and he went got himself a fine little spot with plenty of sun and plenty of surf.

My buddy Sam, on the other hand, talked to me first. So, when he pulled his half a million bucks out of his IRA, we figured out how to get him a beach house like John. We also figured out how to put a little boat at the end of the pier for him. Sam loves to fish, so we invested a little in a fishing business too. Sam doesn’t care if the fishing business makes any money, but he got to keep enough money to buy a boat and make it a business expense. He also got to retire with a nice expensive Dunhill cigar in his hand.

John only gets a nice smoke when Sam is feeling generous.

It’s no contest folks. IRA or give your money away.

Keep more of your money with a Royal Tax Review

Find out about the tax savings strategies that you can implement as a real estate investor or entrepreneur by taking our Tax Discovery quiz. We'll use this information to prepare to have a productive conversation. At the end of the quiz, you'll have an opportunity to schedule your consultation.    TAKE THE TAX DISCOVERY QUIZ

Investing In Promissory Notes With Your Self-Directed IRA

IRAs allow you to make tax-deferred investments while working, so you'll reap the rewards when you retire. A custodian typically puts your money in mutual funds, stocks and bonds. 

The self-directed IRA allows you to bypass the custodian, take charge of your retirement savings, and put your money into a wide range of investments, including real estate and cryptocurrency. You can also use your self-directed IRA to invest in promissory notes, including mortgage notes and trust deeds.

Financial advisors will usually steer you away from alternative assets and towards Wall Street investments, but if you're a smart real estate investor, don't you want control over how your IRA is invested?

If you invest in promissory notes and other alternative assets using IRA funds, all income is tax-deferred until you choose to take a distribution. This keeps more money in the account and increases the effect of compounding. And with a Roth IRA, there will never be an income tax since contributions are taxed on their way into the account.

The self-directed IRA lets you put promissory notes to work for you. Let's take a closer look.

What Are Promissory Notes?

Good question! Promissory notes are legally-binding IOUs that borrowers sign when they take out loans. Essentially, it's a promise to pay back the lender. 

Most promissory notes will list the terms of the loan, such as:

After a borrower issues a promissory note, the lender will keep it until the last payment is made. When the loan is entirely paid, the lender will mark the note "paid in full" and return it to the issuer. 

What Are Real Estate Notes?

Real estate or mortgage notes are promissory notes associated with real estate purchase loans and secured by the property. When a borrower takes out a home loan, the lending institution will typically require them to sign a promissory note and a mortgage agreement. It will be a deed of trust in some states rather than a mortgage, but they're pretty much the same thing (for our purposes, at least). 

While promissory notes outline the terms of the loan, a mortgage or deed of trust secures the loan with the purchased real estate. After the loan is executed, the lender will record their lien on the property by filing the mortgage. Promissory notes don't get filed, so the lender will hold onto it until the loan's paid in full.

Performing Versus Non-Performing Notes

There are two categories of real estate notes you should know about: performing and non-performing. The distinction between the two types of promissory notes is relatively simple. If the borrower makes their payments on time, and the loan has never been in default, the note is "performing." When the loan is in default or the borrower is late on payments, the note is called "non-performing." 

Both performing and non-performing promissory notes can be purchased, traded, sold, or transferred at any time before they are paid off. If you buy real estate notes, you will acquire the right to receive all future payments on the loan. In other words, you're investing in debt, not property.

Why Should I Invest In Promissory Notes?

The appeal of promissory notes varies with your investment strategy. People looking for a truly passive investment should consider performing real estate notes. Being a performing noteholder is basically just an upgrade from being a landlord. Since you own the debt, not the real estate, you don't have to handle tenants or repairs. Your only responsibility is to collect mortgage payments each month.

Investing in non-performing notes, on the other hand, can be a much wilder ride. While this route is not all that passive, you can make a lot of moolah through non-performing notes. Since the borrowers aren't paying, you can usually acquire these types of notes at a hefty discount, leaving plenty of room for profits.

While there are various strategies for investing in non-performing notes, the most common are:

No matter what strategy you choose, investing in real estate notes is an excellent way to diversify your retirement portfolio.

How Do I Invest In Promissory Notes With My Self-Directed IRA?

While investing in notes with your self-directed IRA may sound complicated, it's actually pretty straightforward. 

Step One — Open A Self-Directed IRA

I'm sure I don't have to tell you this, but, just in case, if you don't currently own a self-directed IRA, the first thing you need to do is get one.

Step Two — Purchase Or Create A Promissory Note

Once you find a note you want to invest in, you'll use your IRA to purchase it. You can also create your own promissory notes by lending out funds from your IRA and collecting interest.

Step Three — Do Paperwork

You'll need to fill out some paperwork and provide an original copy of the note to your bank. Take note — your IRA must be listed as the lender instead of you personally.

Step Four — Make Money

That's pretty much the entire investment process. Once you've secured the note and the bank has processed your paperwork, you're officially a promissory note investor!

Important Considerations

As always, when investing with your self-directed IRA, some due diligence is required. You should always thoroughly review the existing legal documents, information on the property, and the borrower's financial background before investing in a note. 

Once you have added notes to your IRA, you should also engage a third-party loan servicing company. Having a servicer deal with your loans eliminates the possibility of engaging in prohibited transactions by providing services to your retirement plan. While there may not be any issues with you handling certain aspects of servicing the loan yourself, hiring a third-party to manage your notes is your safest bet.

 

Everything You Need To Know About IRA & 401k Distributions

Are you ready for the next phase of life? One that leaves the daily grind behind? If you're nearing retirement age, you've been saving for a long time, and now you're getting close to the point where you can start taking distributions (finally).

Let's review everything you need to know about taking a distribution from an IRA or 401(k).

Options For IRA or 401(k) Distributions

When you receive a distribution from a 401(k) or IRA you should weigh the following tax options:

What Happens When You Take Money Out of Your IRA or 401(k)?

You'd think this would be a no brainer, wouldn't you? You saved up for retirement, now it's time to start receiving it. But it's never simple when the IRS is involved. When you take money out of your IRA or 401(k), the following income tax rules apply.

How Are Distributions From a Traditional IRA Taxed?

Distributions from a traditional IRA are taxed as ordinary income, but if you made non-deductible contributions, not all of the distributions will be taxable.

Internal Revenue Code Section 72(t) imposes a tax equal to 10 percent of certain early distributions from IRAs (exclusive of portions considered a return of non-deductible contributions).

The 10% tax, which must be paid in addition to the regular income tax on the distribution, applies to all IRA distributions except the following:

 

Options For Receiving Distributions Before Retiring

The current retirement plan rules discourage taking distributions before retirement. The following are the options you have when receiving a distribution prior to retirement:

As I mentioned above, you can also choose to do forward averaging. But your best bet is to just wait until you reach retirement age.

How Landlords Protect Themselves From Lawsuits

If you are a landlord, you have likely put in a lot of blood, sweat, and tears to get where you are. Still, you have to put in a little bit of extra work to avoid the risk of losing it all in a lawsuit. 

Let's look at how landlords protect themselves from lawsuits and limit their liability exposure.

Asset Protection Is A Little Different for Landlords

While it would be improper to cast the landlord/tenant relationship in an adversarial light, the best way to protect yourself and your assets from lawsuits is to be a good landlord.

Don't get defensive; hear me out. This is easier said than done!

After all, no one sets out wanting to be a terrible landlord who will inevitably get sued by an angry tenant. For this reason, getting competent legal advice on how to effectively meet all your obligations as a landlord will be a huge step forward in making sure there is no grounds for any tenant to sue.

You can start by checking out these asset protection articles. As our backlog of articles will show, we're big fans of corporate structures that protect assets—structures like the LLC. As its name implies, a limited liability company (LLC) limits your liability exposure. Furthermore, if you set up an LLCs for each property you own, you can ensure that each property is isolated from the others in the event of legal action.

Beyond creating an anonymous structure to hide away your assets, you might also establish a shell company through which you manage everything. This keeps your assets from being taken from a lawsuit by making your shell company the entity that interacts in legal issues.

But let's not get ahead of ourselves. Let's look at ...

A Landlord’s Legal Duties

One of the most fundamental contractual agreements is that between a landlord and tenant. As such, there is a wealth of legislation and case law establishing the exact nature of that legal relationship. For landlords, it is vital to effectively discharge all legal duties in order to avoid a lawsuit.

These primary duties are:

Unless you have a particularly belligerent tenant, lawsuits will be the last resort for most. This means that there will be chances to remedy the situation long before you're facing legal escalation.

That said, it is worth noting the most common reasons a tenant will try to sue. In no particular order, they are:

1. Wrongful Eviction

Although landlords win 90% of all lawful evictions, a wrongful eviction is not good for anybody.

If you need to evict a tenant, seek legal advice so make sure it's done lawfully. You must obtain a court order before simply changing the locks, moving the tenant’s belongings out of the property, or cutting off utilities.

Additionally, a tenant has what is called a right to “quiet enjoyment”, this protects a tenant from harassment and privacy violations. If the tenant is compelled to leave the premises due to a breach of quiet enjoyment then this can be deemed a “constructive eviction” and is subject to be treated as a wrongful eviction.

As the penalties can include everything from legal fees to jail time, a savvy landlord looking to protect themselves will be best to only proceed to evict in a lawful manner.

2. Livability Issues

Another potential opening for a lawsuit is if the property has issues that make the property unlivable. A well-maintained property should not have livability issues. After all, you do want to take care of your investment, right?

Generally, a property will be considered to have livability issues if one of the following is present:

As mentioned, regular maintenance means protecting your investment and rarely having to worry about these potential legal issues. Let's hope you never need it, but be sure to check out our article, When Should a Landlord Hire a Lawyer?

3. Misusing Consumer Reports

It is common for landlords to screen potential tenants by looking at their credit reports or by running criminal background checks. While a wise policy, the Federal Fair Credit Reporting Act has strict compliance rules for how you use the information obtained. If in doubt, seek qualified legal advice.

4. Misusing Security Deposits

If not handled properly, issues around the security deposit can be the most volatile for lawsuits. However, there are key things that can be done to protect against lawsuits:

Above all, know the requirements imposed by the law regarding security deposits as the risks are severe if these requirements are not fulfilled.

Additional Ways Landlords Can Limit Liability

At the risk of sounding like a broken record, getting a great lawyer to advise on this issue is essential. Every great player needs a coach, and every great landlord needs a competent lawyer to advise on winning strategies to limit liability exposure.

You should also limit your exposure as a landlord by ensuring that you have these forms completed. Here, attention to detail matters; every detail of the lease needs to be spelled out. 

Being a landlord is an achievement, and it is well worthwhile putting in the effort to ensure that your asset is protected from lawsuits. Along with being a good landlord, having a great lawyer is key to avoiding those pitfalls of legal exposure.