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?

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.

 

Using A Land Trust In Estate Planning: How To Avoid Probate

When you work hard and save money to pass on to your heirs, you don’t want them to have 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

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.

Can A Land Trust Borrow Money to Buy Property? Finance Your Next Investment

There are many advantages to setting up an anonymous Land Trust for your real estate investments. Did you know that you also can use these trusts to borrow money to buy additional property?

In this article, we will examine the advantages of a Land Trust mortgage and how to obtain one.

What is a Land Trust?

Over in our Tax, Legal, & Asset Protection Secrets For Real Estate Investors mastermind group, you'll hear me recommend this type of asset protection pretty often, but before we go much further, let’s make sure we are clear on some definitions.

A Land Trust is a legal entity that has control over a physical property and other real estate-related assets at the instruction of the property’s owner. As a living trust—one that is created during your lifetime—a Land Trust is typically revocable, meaning it can be amended or terminated at any time.

A Land Trust can protect both your assets and your privacy and prove to be a valuable part of your estate plan. Let’s say you own an investment property. If you deed the property to the trust, your name comes off the property deed as the owner, and the trust becomes the owner.

The terms of a Land Trust can be unique to the type of real estate it owns. You, as the grantor, then choose someone, called a trustee, to make sure your instructions in the trust agreement are carried out to benefit your heirs (beneficiaries). The trustee can be a friend or a relative, your attorney, or a professional appointed from a financial institution.

Unlike a will, which is a public document, a living trust is private. No one can know the details of your Land Trust other than the trustee.

REN 12 | Real Estate Investment And Tax

What Is A Land Trust Mortgage?

Now, let’s say you want to borrow money to make improvements or preserve assets that are held in a Land Trust. Or maybe you need to refinance a property held in the trust. As long as the trust is revocable, you can apply for a mortgage.

Not all lenders extend loans on trusts, so your first step is to notify the lender that the property is included in a trust and provide them with a copy of the trust agreement. If the lender is on board, you’ll next need to check the trust deed to determine if the trust allows the trustee to take out a mortgage on the property. (It is not always the case.) You’ll also need to confirm that the trust allows the property to be used as collateral or security for a loan.

How to Obtain Financing Through Your Land Trust

If the trust does allow the loan, the trustee will need to sign the mortgage or a promissory note. The note stipulates that the trust will be responsible for paying back the loan and that the refinanced property will be used as collateral for the loan. If the trustee won’t be signing personally, you will have to apply for the loan and sign the guarantee or the note.

If the trust doesn’t allow for the loan, the trustee cannot sign the mortgage. If the property can still be used as collateral, however, the lender may require you to re-title the property. This requirement means you will have to take the property out of the trust and return it to your personal ownership before you can take out a new loan.

This process requires the preparation and recording of two deeds with your county recorder or registrar. One deed takes your property out of the Land Trust, and the other one puts it back.

Some lenders will accomplish this deed paperwork for you, or you can ask your attorney to handle it. Your attorney should then draw up a document that states the property can be used as collateral on the new loan.

Suppose your property is already in a Land Trust and you want to borrow against the beneficial interest. In that case, the lender must serve a Notice of Collateral Assignment on the trustee. Then the trustee will write an acknowledgment of the assignment. When this situation occurs, the trustee cannot transfer the property’s title in the trust or encumber or mortgage it without the lender’s written consent.

Now, here are the five steps the lender will take before granting the loan.

  1. The lender will review the trust instrument, also called a deed of trust.
  2. The lender will confirm the identities of both the grantor and trustee.
  3. The lender will establish whether the trust grants the trustee power to borrow money and pledge or encumber trust assets.
  4. The lender will determine if the trustee needs to sign a trustee certificate to stipulate the trust’s terms and confirm the trustee’s authority to apply for a loan.
  5. The lender will require the deed on record as legal evidence that the trust actually owns the property. (You’ll need to provide the deed on record for this step.)

Advantages of Land Trust Mortgages

Borrowing money on property held in a Land Trust gives you more options than a conventional loan can provide. In addition, selling property held in a Land Trust to current tenants is often more secure and less risky than conventional sales.

In addition to maintaining your privacy as an investor, you also can avoid transfer taxes because the sale of a beneficial interest in a Land Trust does not involve the property itself. Another advantage is that tax assessments are lower because the sale price of the property is not publicly available for real estate assessors to view. You also can skip lengthy and costly probate procedures after the death of an owner.

What About The Due On Sale Clause?

Many investors worry that they will sacrifice their anonymity by triggering the due on sale clause if they finance a property purchase through a Land Trust. This clause in a loan or note states that the full balance of a loan may be called due upon sale or transfer of ownership of the property used to secure the note.

It's important to understand that banks rarely invoke the due on sale clause if mortgage payments are being made regularly on a property. After all, banks profit from your mortgage payments.

You are able to transfer your property or obtain better financing for an investment property without the worry of triggering this clause. Here are the basic—and perfectly legal—steps to take.

I like to encourage my clients with this advice–a Land Trust is simply a tool for an investor. You can use this tool to protect your anonymity, prevent frivolous lawsuits, or manage certain pieces of property. Yes, an unethical person can use a Land Trust in a dishonest way, but that reveals more about that individual’s integrity (or lack thereof) than it does about the Land Trust as an investment entity.

Finally, if you’re seeking to obtain a loan against your Land Trust assets, you’ll need the advice of an expert trust administration attorney. Our dedicated professional team at Royal Legal will prevent you from taking any action that might harm the assets of the trust.

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.

 

 

Without An Anonymous Trust, Your LLC (And Investments) May Be At Risk

When it comes to protecting your property, you should build a castle, not a fence. This is where an asset protection plan comes into play. Think of an LLC's protection as being on par with a fence. It offers you decent protection, but you could do better.

How? By getting an Anonymous Trust. When you compare a trust to an LLC, it's like comparing a castle to a fence. A trust offers superior asset protection you can't get from an LLC alone.

Protecting your assets is about building legal walls. When you get a trust, you're putting up high walls to defend against an attacking litigation attorney. A trust isolates your assets so even if an attorney files and wins a lawsuit against you or your LLC, they can’t get at the prize assets. Poor guys, all that work for nothing!

Why An LLC Doesn't Completely Protect You

Are you a real estate investor with one or more properties held in an LLC? If so, listen up: There are many tricky ways litigators are able to break into an LLC and get access to all your assets—even when the lawsuit pertains to a single property. The LLC will protect the properties from suits against you individually, but a lawsuit relating to the sale or lease of property will go against the owner (the LLC).

In a landlord/tenant dispute or a dispute relating to the sale of a property, the LLC is liable as the owner. If the opposing party is successful in the lawsuit, they will be able to collect on their judgment against the assets of the LLC (as in ALL of your properties). They will be able to foreclose and auction off your properties at a discount until they have collected enough money to satisfy their judgment.

Poof. There went your years of hard work, into the pocket of an attorney.

Anonymous Trusts Stop Lawsuits Dead

The more walls you have, the harder it is for the other side to recover your hard-earned assets and the more likely it is that they will not even bother filing suit. Lawsuits are a three legged stool, and a trust destroys one of the legs, which causes the lawsuit to crumble. The three stool legs which support a successful lawsuit are:

In layman's terms it translates respectively to:

  1. The law recognizes liability either by common law or statute,
  2. The facts show that the party suffered money damages because of the defendant's conduct, and
  3. Assuming that previous two are true, there are assets which we can take from the defendant to satisfy the judgement.

A Trust Makes Attorneys Think Twice Before Suing You

An attorney won’t file a lawsuit without all three legs being in place. Using an Anonymous Trust/LLC combination cripples litigation because it makes the pool of assets for recovery, the third leg of our stool, unattractive. Ten properties held in an LLC makes an attorney drool like a hungry dog. That’s a lot of assets, and likely some equity an attorney can get a hold of.

A single property held in trust doesn’t even get an attorney to the keyboard to type out a petition to file suit. There just isn’t enough equity to recover against.

A Trust Is The Castle Protecting Your LLC's Assets

Let's say you have all your property held in an LLC and want to transfer each of those properties into individual trusts.

The first step toward developing your asset protection plan is to establish an irrevocable trust. You can hold property in the name of this trust instead of your LLC or personal name. Now that the trust owns the property, you or your LLC are merely beneficiaries. This entitles you to the income from the property without exposing you to liability.

In a dispute regarding the property, the opposing party will only be able to collect against the asset of the trust, the trust property, which hopefully has limited equity. Why do I hope that the trust property has limited equity? The lawsuit that is filed against the trust is limited to recovery against the trust property.

If the mortgage on the property is close to the value of the property, then there isn’t enough equity in the property to justify a lawsuit. Remember, the litigation attorney only gets paid after he auctions off the property and pays off all the liens including the mortgage. And it just so happens that there are several ways to hide the equity in your property.

An Auction Can Work In Your Favor

The fees for the auction and the costs in litigation to get it to auction are also subtracted from the equity. In the end, there is hopefully little hope that an attorney and his or her client will make any profit.  Same goes for the client, who also pays large litigation fees. If neither the attorney nor the client can make money, they won’t file suit.

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

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 To Take Money Out Of Your S Corp

If you’ve formed an S Corp to manage your real estate investments, you probably already know about the benefits that come with S Corp taxes. In fact, the primary difference between S and C corporations is the way the businesses are taxed:

That’s the beauty of an S Corp compared to a C Corp. C Corp income is taxed twice: once at the corporate level, and once at the individual level (as a dividend). S Corps avoid this double taxation by passing all of their income through to their owners. The business doesn’t pay taxes; only the owners do.

Whether you’ve started a corporation, an LLC, or a series LLC, you can elect to be taxed as an S Corp. If you’ve gone this route, congratulations! You’ve made a great economic decision that can save you some serious dough that would otherwise go to Uncle Sam. Now the question is: how do you take the money you earn out of your S Corp?  

Take Money Out Of Your S Corp: Cash RegisterHow To Get Your Money

In addition to tax benefits, a major advantage to forming a corporation is the protection it offers your personal assets in case the business gets sued. You should never use business money to pay for personal expenses; you could lose the protection of the corporation in the event of a lawsuit because you have commingled assets.

So how do you access the money that your S Corp makes? I’m assuming you didn’t start a business for your health: you’re doing it to make money to cover personal expenses.

If you want to take money out of your S Corp, you have three options:

Take A Distribution

Distributions are the best way to get money from your S Corp. Because you’ll report it as “passive income” on your income tax return, it won’t be subject to employment taxes. This saves you money! 

Because S Corps are pass-through entities, you have to report your business’s income on your personal return whether you actually receive it as a distribution or not. The upside of this is that you won’t have to pay additional taxes on a distribution unless it constitutes a capital gain. A lawyer or tax accountant can help you determine the most advantageous way to take your distributions.

Pay Yourself A Salary

Unfortunately, Uncle Sam won’t let you take all of the money out of your S Corp as distributions, because the government wants your tax money. For this reason, the IRS requires that you pay yourself a “reasonable” salary for your contributions to the company. You should try to minimize the amount of salary you take while still meeting the “reasonable” standard.

True to form, the IRS doesn’t give any specific guidance as to what “reasonable” means. Some factors that courts have considered when deciding whether a salary is reasonable include:

Another way to look at it is to pay yourself what you would pay somebody else to do your job.

Give Yourself A Loan

When you’re taking money out of an S Corp other than your salary, you can set up a line of credit between you and your business. Then, you’ll take cash out as a loan against that line of credit. At the end of the year, you and your accountant can decide if you should convert some of that loan to a distribution or leave it as a loan (you’ll need to pay interest on the loan). If you borrow money from the corporation (via a loan), you’re never going to have capital gains. 

However, even if you list your withdrawal of funds as a loan on your financial statements, the IRS can recharacterize it as a distribution. If Uncle Sam recharacterizes your loan, you’ll have to pay income taxes on it just as you would a distribution.

If you take out a loan from your S Corp, you need to dot your i’s and cross your t’s to make sure it stays characterized as a loan. For example, creating a legally enforceable promissory note helps prove that the transaction was actually meant to be a loan. Before you take a loan from your S Corp, you should seek advice from your lawyer and your accountant.

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.

Community Property: What Investors Need To Know

You can't be a great real estate investor if you don't have an understanding of marital property laws and how they affect your investments. Most U.S. states use common law, also known as or equitable distribution, as their matrimonial regime, but in Texas and eight other states, community property is the rule.

What is Community Property?

The principle of community property is that each spouse owns half the couple’s assets.  It assumes that every contribution each spouse makes to the "marriage community" should be shared.

This means property, income, and other assets acquired by either spouse during the marriage belongs equally to each of them. It also means that in the event of death or divorce, each spouse gets an equal share of the property.

And before you ask me, yes, it also means that both spouses are accountable for the other’s debts.

Some exceptions apply to allow sole ownership of a property or certain assets:

Property one spouse acquired before the marriage remains that person’s sole property, unless it transmutes, or changes, to community property by:

It is important to note that in Texas and Idaho, income earned from separate properties is considered community property. In the other community property states, such income is considered separate. That bring me to our next section ...

What Are The Community Property States?

Community property is the law in the following states:

Out of the nine states that use community property instead of common law, Texas is the only community property state that recognizes common-law marriages (not to be confused with common law property). In the other states, only legal marriages pertain to community property. 

Property rights in some states, including Texas, may come into play in partnerships that resemble traditional marriages, e.g. by length of cohabitation or the raising of children together. Where separate ownership cannot be ascertained, the court m

ay rule on an equitable split, which is partly depending on how much each spouse contributed financial assets to the marriage (e.g. 40/60 or 30/70 instead of 50/50.) In California, the split must be 50/50.

Which State Has Jurisdiction Over Your Investments?

community property family law

For most people, it's an easy-to-answer question. Where do you live? Is it in a community property state or not?

But for may of us who invest in assets all over the country or all over the world, we have to look at other factors.

Yes, domicile, a person’s legal permanent address, is used to define where a couple lives, and therefore which state’s jurisdiction their property law comes under. This becomes important for couples that end up in the divorce courts if they have homes in more than one state, or are on the move regularly, e.g. from being in the military, or temporary work placements. 

Some factors used to determine domicile include: 

The Tax Benefits of Community Property

Community property has several tax benefits. In the event of the death of one spouse, both partners’ interest in the property get a "step-up" in basis. The property gets an updated tax basis on the market valuation at the date of their death. The deceased spouse legally has a half interest in the entire community property, so both halves of the property receive the step-up in basis, instead of just the deceased’s half.

Say a couple own a house with a basis of $50,000, the amount they initially paid. The house now has a value of $500,000, making each spouse's’ share of the house worth $250,000 with a basis of $25,000.  The deceased spouse’s share now has a basis of $250,000. If the property were not community-owned, the living spouse’s share’s basis would remain at $25,000, and the total basis $275,000. In a community property state, each half would get the new basis of $250,000, giving a total basis of $500,000.

Marital Agreements Mean Fewer Headaches

While community property has some tax benefits, it is easy to see the downsides to the system. But there are ways to protect your assets. When it comes to the potential for divorce, one way to avoid complications from community property laws is to draft a marital agreement, a.k.a. a "prenup."

A prenuptial, post-marital, or divorce agreement can convert community property into separate property in the event of death or divorce. Some states allow you to opt-out of the system without a pre-signed agreement, but others, such as California, are stricter, and there is the chance other states may follow suit. So it is best to sign a formal agreement under any jurisdictions.

When Might There Be A Dispute? 

Disputes can arise upon the death of a spouse, particularly if children are involved. Typically, if somebody dies without leaving a will, their half of the estate goes to the remaining spouse unless they had children from a previous relationship. In which case, the remaining spouse retains their half, but the deceased spouse’s half goes to his or her children. 

Estate planning and making a will can help you or your family avoid extra stress in times of loss. 

What Happens In Cases of Bankruptcy?

In community property states, if one spouse needs to file for bankruptcy, it must include all community-owned property. In many cases, judges will require the other spouse to declare bankruptcy too. Creditors can make claims against community property, and even against the other spouse’s individually owned properties.

Trusts and Dower Rights

Placing your property into a trust has several benefits. 

Three states still have Dower Rights for spouses not on the title to a property. In Ohio, Kentucky, and Arkansas, a widow or widower is entitled to the interest or income from one-third of their deceased spouse’s property.

California land trusts aren’t subject to community property or dower rights, so are a great way to invest without the risk associated with the usual marital property laws in California. 

 

What's The Difference Between A Roth IRA And A 401(k)?

Sometimes saving for retirement seems more complicated than it should be, and even more so when you work for yourself. There are a seemingly endless number of retirement accounts to choose from, and you want to make the best decision for your future (and for your family's security).

As a self-employed real estate investor, we know you like to make smart money moves, and we're committed to helping you make that happen. So let's talk about two of the most common types of retirement savings plans: what’s the difference between Roth IRA and 401k?

What You Need To Know About Roth IRAs

Roth IRAs are a type of Individual Retirement Account (IRA), a retirement savings account you can use to invest in common securities such as stocks, bonds, certificates of deposit, and mutual funds. A traditional IRA allows you to contribute to your account with pre-tax moolah, but you'll have to take required minimum distributions (RMDs) once you turn 72, and pay taxes on the money you receive.

With a Roth IRA, you pay your taxes up-front and then invest. Because Uncle Sam already got his cut, you won't be required to take RMDs. You also don't have to pay taxes when you choose to take distributions, as long as you're older than age 59½, and you've had the Roth IRA for more than five years.

Roth IRAs are an exceptional choice if you're self-employed or if your employer doesn't offer a 401(k) plan. Even if you have a 401(k), you can use a Roth IRA to increase your retirement savings once you hit your 401(k) contribution limit.

Income and Contribution Limits

Unfortunately, the government puts income limits on who can invest in a Roth IRA and contribution limits on how much you can invest. 

If you're married and file taxes jointly, you can't use a Roth IRA if your combined modified adjusted gross income (MAGI) is $206,000 or higher. Roth IRAs are also unavailable if you're single and your MAGI is $139,000 or more.

If you meet the income requirements, you can open a Roth IRA, but you can't contribute more than $6,000 each year, or $7,000 if you are 50 or older.

Self-Directed Roth IRAs

A self-directed IRA (SDIRA) is a type of IRA that enables you to make investments that a regular IRA won't allow. While IRAs can only accommodate common types of securities, an SDIRA can hold a much broader array of investment options.

Investments types available for SDIRAs but not regular IRAs include:

An SDIRA is administered by a custodian or trustee, but you'll manage the account directly. (That's why they call it a "self-directed" account.) An SDIRA is available as either a traditional IRA or a Roth IRA and is an attractive choice for savvy real estate investors who want to use a tax-advantaged account.

What You Need To Know About 401(k)s

A 401(k) is a retirement savings plan that employers can offer, but there's also a variation for you self-employed folks out there. As with a traditional IRA, a 401(k) allows you to invest pre-tax money in mutual funds, and then you'll pay taxes on your distributions. 

401(k)s are usually funded through paycheck deductions from your gross pay. Many employers will also match contributions you make to your 401(k), which allows you to invest even more. You should always take advantage of an employer match if one's available: it's free money!

Contribution Limits

Like the Roth IRA, 401(k)s also have contribution restrictions. There are personal contribution limits and a total contribution limit for combined individual and employer contributions.

The annual 401(k) personal contribution limits for 2020 and 2021 are:

The annual 401(k) total contribution limits for 2020 and 2021 are:

Solo 401(k)s

A Solo 401(k) is a 401(k) plan for self-employed people and their spouses. Solo 401(k)s follow the same rules as an ordinary 401(k) plan, but are only available to business owners with no employees. A significant advantage of the Solo 401(k) is that you can contribute to the account as both an "employee" and an "employer." 

What Is The Difference Between Roth IRA And 401(k)?

When comparing Roth IRA vs. 401k, the main difference is the tax benefits offered. With a Roth account, you pay taxes now and then take tax-free distributions later in life. A 401(k)s allows you to contribute pre-tax money, reducing your taxable income and giving you a tax break now, but you'll have to pay taxes when you take distributions.

The differences between Roth SDIRAs and Solo 401(k)s are even more apparent.

Roth SDIRAs allow you to invest in diverse types of assets, including real estate. Unfortunately, income and contribution limits can limit a Roth SDIRA's effectiveness as an investment tool.

Solo 401(k)s are much more limited in the type of investments you can make, with your choices usually restricted to various mutual funds. However, you can invest much more money each year since you can contribute as both the employee AND the employer. 

Given the advantages and disadvantages of these retirement plans, your best course of action may just be to invest in both. There's no rule that you can only pick one! You can even convert your IRA or 401(k) into a Roth account if you change your mind later. Creating a diverse retirement savings plan can help you maximize your investment opportunities and better prepare for your future.

Can A Trustee Sell Trust Property To Himself or Herself?

A land trust can be a simple and effective tool for real estate investors who want to maintain privacy in their investments. With a land trust, you appoint a trustee to hold legal title and manage the property for your benefit or the benefit of a third party.

But what happens when trustees take advantage of their positions of power and start using trust property to benefit themselves? Can a trustee sell trust property to himself or herself?

What Is A Land Trust?

To answer whether trustees can sell trust properties to themselves, we need to start at the beginning.

A trust is a type of agreement where someone holds the legal title to someone else's property and manages it to benefit another person.

Here are a few standard terms that will help you understand how trusts work:

If you place real estate investments into a land trust, you will sign a trust deed that transfers your property’s legal ownership to the trust. When you establish a land trust, you can specify in the trust document how the trustee should manage the property and how to distribute any income generated by the property to the beneficiaries.

Real estate investors use land trusts for various reasons, but the primary advantage is the ability to protect your privacy. When you purchase real estate through a land trust, your name and the price you paid for the property do not become public records like they do when you buy real estate in your own name. You can also use the anonymity that a land trust can offer to keep your identity confidential when making strategic real estate investments.

sealing cards: Can A Trustee Sell Trust Property To Himself or Herself?What Are The Legal Duties Of A Trustee?

The trustee is responsible for holding property title and managing it for the beneficiaries' benefit. (We've also written about the roles of the trustee and beneficiary in case you want to know more). When the trust document includes specific instructions for managing the property or distributing income, the trustee is obligated to follow them. Trustees should ensure that they understand all of the trust instructions and obey them to a "T."

Because of the dependent nature of the relationship between trustees and beneficiaries, trustees have a fiduciary duty to the beneficiaries of any trust they manage. A fiduciary duty is an ethical and legal obligation to act solely for the beneficiary's interests when controlling the trust. The trustee cannot use trust property to primarily benefit themselves or third parties who are not beneficiaries. This responsibility is sometimes called a duty of loyalty.

Self-Dealing

Because of their fiduciary duties to protect the beneficiaries' interests, trustees cannot self-deal. Self-dealing is when a fiduciary acts in their own best interests in transactions instead of in the beneficiaries' best interests. This means that trustees cannot use trust assets in transactions that serve their own interests more than the trust's interests. The trustee should make decisions to benefit the trust—not to benefit himself or herself.

Some of the most common ways that a trustee can self-deal include:

Can A Trustee Sell Trust Property to Himself or Herself?

If a trustee were to sell trust property to himself or herself, there would be a conflict of interest, as the trustee would be both the buyer and the seller of the property. The trustee cannot act in the beneficiaries' best interest by getting the maximum price for the property while also pursuing his or her own interests, which is paying less than fair market value for the property.

Unless the trust document expressly authorizes it, a trustee generally cannot:

When the trustee is also a trust beneficiary, that does not change the trustee's obligations to the other beneficiaries.

So the answer to our original question is an emphatic "NO." A trustee cannot legally sell trust property to himself or herself unless the terms of the trust specifically allow it.

What Is The Difference Between A Will And A Trust?

While you probably know that wills and trusts are both used in estate planning, many people don’t truly understand the difference between the two.

So, what what IS the difference between a will and a trust, anyway?

Both wills and trusts are used to pass your property on to your loved ones after your death. However, trusts allow you to transfer property before your death, while wills do not take effect until after you die.

What Is The Difference Between A Will And A Trust?

What Is A Will?

When most people envision a will, they are thinking about a simple will. A simple will is a legal document that leaves instructions for how your assets should be distributed after your death. If you have any minor children, you can also designate who you would like to be their guardians upon the death of both parents. 

The laws about what makes a will valid vary between states. However, all states require five fundamental elements.  In order for your simple will to be valid, it must meet the following requirements:

Let’s talk about each one of these requirements individually.

Legal Age

In most states, you need to be at least 18 years old to be able to make a legally binding will. However, some states allow people to create wills at a younger ages, and the majority of states allow some minors to create wills, such as underage members of the military or emancipated minors. 

Testamentary Capacity

For a will to be valid, you must be of “sound mind” at the time it was created. This means you must understand three essential concepts:

Testamentary Intent

While the first two requirements relate to who can create a will, the final three requirements dictate what the will must contain to be valid. Testamentary intent means that the will must clearly state your desire for that document to be your will. This can be accomplished through a simple statement such as “I declare this to be my last will and testament.”

Signed

For your will to be legally valid, you have to voluntarily sign it. Your signature is considered evidence that the will is yours and you have agreed to what it says.

Witnessed

The final requirement is that at least two witnesses sign the will. By signing the will, the witnesses are confirming that you seemed to be of sound mind when you signed the will and that you intended for the document to be your will.

What Is A Trust?

A trust is a legal agreement where one party agrees to hold the legal title to certain property and manage it for the benefit of another. Here are a few terms that will be helpful in understanding how trusts work:

There can be multiple grantors, trustees, and beneficiaries for a trust. Two common types of trusts used in estate planning are living trusts and testamentary trusts.

Living Trust

A living trust is created while the grantor is still alive by transferring property to a trustee. While the grantor is alive, the trust remains revocable, meaning that the grantor is free to alter the trust or revoke it completely. However, once the grantor dies, the trust becomes irrevocable and cannot be changed. Many people use living trusts in their estate planning in order to avoid probate.

Testamentary Trust

A testamentary trust is created by the grantor’s will, which creates the trust and includes instructions for what property should be included, who the trustee should be and who the beneficiaries will be. Testamentary trusts allow grantors to have greater control over how their assets are used after their death.

Primary Differences Between Wills And Trusts

Let’s get back to the original question. Will versus trust: what are the differences? 

When They Take Effect

Wills always distribute property after your death; living trusts take effect during your lifetime. This means that you can use the trust to distribute property while you are still alive.

When Property Is Distributed

While you can leave detailed instructions on how you want to your property to be used in your will, it will be distributed at the time of your death with no real enforcement mechanism in place. In other words, you generally will have to rely on your heirs following your instructions for how to use their inheritance. 

A trust, on the other hand, puts a third party of your choosing in control of the property. The trustee can then ensure that the property is being used according to your wishes before it is distributed.

What Property Is Distributed

A will distributes all property that is solely in your name at the time of your death. This means that any property you own jointly or that is in a trust will not be disposed of through your will. A trust, on the other hand, only distributes that property that you transferred to it.

How Property Is Distributed

After you pass away, a will must go through the probate, which means a court will oversee the process to ensure the will is valid and that the property is distributed according to the will. Conversely, a trust does not go through the probate process, which generally makes the process quicker and cheaper.

How Private They Are

Because a will goes through probate in a court, your will and the proceedings will become public record.  As a trust passes outside the court system, all of this information will remain private.

If you found this article useful, please check out our asset checklist for estate planning.

Top 10 Things You Need To Know About Distributions From Your Retirement Account

Congratulations! You've lived long enough to retire or you're almost there.

But before you "cash out" and get your money via distributions from your retirement account, you may want to know what some people learn the hard way.

Let's start with distributions from traditional IRAs and 401(k)s. The first five questions will relate to these traditional accounts. If you have either a Roth account (IRA or 401k), you can skip to number 6 on the list below.

And whether you're getting ready to retire or you have a long way to go, the information below can benefit everyone.

Traditional IRA and 401k Accounts

1. Early Withdrawal Penalty.

A distribution from your traditional IRA or 401k before you reach the age of 59 1/2 will cause a 10% early withdrawal penalty on the money distributed. And yes, you're paying taxes too, so you're losing a big chunk of money if you withdrawal early.

Let's say you take a $5,000 distribution from your traditional IRA at age 50. You will be subject to a $500 penalty and you will also receive a 1099-R from your IRA custodian. You will then need to report $5000 of income on your tax returns.

Long story short: Don't withdraw early unless you really need the money.

2. Required Minimum Distributions (RMD).

But whether you need the money or not, at age 70 1/2, your friends at the IRS will force you to begin taking distributions from your retirement account. Unless you're still employed.

Your distributions will be subject to tax and you will also receive a 1099-R of the amount of money distributed which will be included on your tax return. The amount of your distribution is based on your age and your account’s value.

For example, if you have a $150k IRA & you've just hit the age of 70 1/2, your first RMD would be $5,685 (3.79% of $150k).

3. Don't Take Large Distributions In One Year.

Unfortunately, money from your traditional retirement account is subject to tax at the time of distribution. With this in mind, it would be wise of you to be careful about how much money you take out in one year. Why? Because a large distribution can push your distribution income and your other income into a higher tax bracket.

Let's say you have  employment or rental/investment income of $100,000 yearly. That would mean you're in a joint income tax bracket of 15% on additional income.

However, if you take $100,000 as a lump sum that year this will push your annual income to $150K and you will be in a 28% income tax bracket.

If you chose to instead break up that $100K over two years, then you could stay in the 15% to 25% tax bracket. This way, you reduce your overall tax liability.

Long story short: When it comes time for you to start enjoying retirement, don't take out too much money or the IRS will be enjoying it instead.

4. Distribution Withholding.

Most distributions from an employer 401k or pension plan will be subject to a 20% withholding, unless you're at the age of 59 1/2. This withholding will be sent to your friends at the IRS in anticipation of tax and penalty that will be owed.

In the case of an early distribution from your IRA, a 10% withholding for the penalty amount can be made.

5. If You Ever Have Tax Losses Consider Converting to a Roth IRA.

Roth IRAs are popular for a reason. When you have tax losses on your tax return, you may want to consider using those losses to offset income that would arise when you convert a traditional IRA or 401k to a Roth account.

When you convert a traditional account to a Roth account, you pay tax on the amount of the conversion. This is usually worth it, because you’ll have a Roth account that grows entirely tax free which you won't pay taxes on when you distribute the money.

Interesting fact: Some tax savvy people use tax losses so that they end up paying less in taxes later on.

Tips For Roth IRAs and Roth 401(k)s

6. Roth IRAs Are Exempt from RMD.

It's amazing right? While traditional IRA owners must take required minimum distributions (RMD) when they reach the age of 70 1/2, Roth IRAs are exempt from RMD rules. This allows you to keep your money invested for as long as you wish.

7. "Designated" Roth 401ks Must Take RMD.

Yea, tax code can be confusing. "Designated" Roth 401k accounts are subject to RMD. These kinds of Roth accounts are part of a 401k/employer plan, which is where the word "designated" comes from.

Anyway, so how do you avoid this you may ask? By rolling your Roth 401k funds over to a Roth IRA when you reach the age of 70 1/2.

8. Distributions of Contributions Are Always Tax Free (Unless The Government Changes That)

Unless the government makes major changes, distributions of contributions to a Roth IRA are always tax-free. No matter your age, you can always take a distribution of your Roth IRA contributions without penalty or tax.

9. Tax-Free Distributions of Roth IRA Earnings.

However, in order to take a tax free distribution from your Roth IRA, you must be age 59 1/2 or older and you must have had your Roth IRA for five years or longer.
As long as those two criteria are met, all amounts (contributions and earnings) may be distributed from your Roth IRA tax free.

Note: If your funds in the Roth IRA are from a conversion, then you must have converted the funds at least 5 years ago and must be 59 1/2 or older in order to take a tax-free distribution.

10. Delay Your Roth Distributions.

Don't be so quick to use the funds in your Roth account. It's usually better to distribute and use other funds and assets that are at your disposal. Why? Because those funds aren’t as tax efficient while invested.

Long story short: Roth retirement accounts are the most tax efficient way to earn income in the U.S if you use them right. Learn even more from our other article on the lesser-known benefits of Roth accounts.

That's all folks. As always, if you have any questions, please don't hesitate to ask in the comments below.

A Guide to Estate Planning for Blended Families

Marriages don’t always work out. Whether it’s divorce or death, people deserve a second chance to find their soulmate. However, your second marriage can have important implications for the children you had during the first one. More specifically, you may need to use a different approach when planning your estate to make sure that your children receive what you mean for them to receive after you’re gone.

That’s why we’ve created this guide to estate planning for blended families. Continue reading to learn everything you need to know about how to prepare your estate in a way that will ensure every member of your blended family is taken care of.

Understanding the Modern Blended Family

The definition of a blended family is very straightforward: it is a family that consists of the two spouses and all of the children they’ve had from previous marriages. This can take a few different shapes, which are worth exploring to solidify our understanding of what a blended family may look like.

As you can imagine, each of these situations presents unique challenges during the estate planning process. For example, you will likely want to leave something to your children from a previous marriage and your child’s children from a previous marriage. However, you may not want to leave anything to children that your child’s spouse had in a previous marriage.

Navigating these challenges is a complex process that requires a professional’s expertise. Below, you’ll find some of the most important factors that you need to keep in mind while planning your estate.

A Simple Will Won’t Be Enough

What works for traditional families during the estate planning process doesn’t always work for blended families. There’s no better example of this than the will. Experts recommend that blended families use a trust during the estate planning process instead of a will.

When you create a trust, that entity becomes the legal owner of your assets when you pass away. The trustee (the person who manages the trust) is then responsible for divvying up your assets in the ways that you’ve specified. This ensures that your children from a previous marriage actually receive the assets that you want them to receive.

Wills, on the other hand, leave open the possibility that your children get cut out of your estate after you die. Even if you believe that your spouse will do the right thing and take care of your children from another marriage, there’s no real guarantee of that in a will. It’s better to be safe than sorry and only a trust can provide you with that kind of certainty.

Choose a Trustee You Can Count On

The person that you put in charge of your trust will make the final decisions about how your assets are invested and distributed once you’re gone. That’s why it’s so important that you pick someone who both has experience with managing trusts and who you can count on to carry out your wishes. Asset protection is an incredibly important part of estate planning. Creating a power of attorney trust is the best way to ensure your wealth is protected.

Plan For the Possibility That Your Spouse Remarries

It can be difficult to imagine your spouse remarrying after you're gone. However, it’s absolutely essential that you embrace remarriage estate planning -- even if you seriously doubt that your spouse would actually get married again.

Ultimately, you can never say with certainty what will happen after you're gone. Successful estate planning is about eliminating as many sources of uncertainty as possible. That’s why your trust should have specific directions for what happens in the event that your spouse does decide to get remarried. Including this clause is another important part of both keeping your assets protected and ensuring that they go where you want them to go.

Consider Leaving Assets Directly to Your Biological Children

This is especially important for people with spouses who are much younger than them. When you go, you probably want your children to be able to use what you’ve left for them as soon as possible. 

You don’t want to create an awkward situation where your children are essential waiting around for their step-parent to die. Of course, this has to be balanced against the interest you have in ensuring that your spouse has what they need while they’re still living.

If you do decide to leave assets directly to your biological children, make sure that you use specific language itemizing what you’re leaving to each of them. The more specificity you can provide, the lower the chance that someone is able to successfully contest your will.

Choose Your Legal Guardian Carefully

Legal guardianship is defined at the state level and can vary based on where you live. It’s important that you take the time to understand what legal guardianship looks like in your state. Doing so will help you make a better decision about who you’ll select for this position.

Generally speaking, legal guardians are responsible for making your health care decisions when you’re not able to do so. Most states only allow you to pick one person for this role, so it’s important that you choose carefully.

The last thing you want is for in-fighting to occur between your spouse and children while you’re in the hospital and incapacitated. That’s why you should consider selecting as your legal guardian the person in your life who you feel is the fairest and most responsible. That could be your spouse, one of your children or someone else in your life who can act as a neutral third-party between them.

Rely on the Help of Trained Professionals

Estate planning for blended families is much more complex than it is for traditional families. As you’ve seen throughout this article, there are many different considerations you need to make throughout this process. Attorneys who specialize in estate planning are the best-equipped to make these complicated decisions and translate your wishes into actionable legal documents. Make sure that you consult with one before you finalize your estate.

Calculating RMD For An Inherited IRA

If a loved one passes away and you are the beneficiary of their IRA, you might not know what you need to do next. The IRS has a lot of complicated rules about inherited IRAs, and you can be subject to large penalties if you don’t follow them.

While it’s always a good idea to get tax advice from an attorney or accountant, we’ve put together a handy guide to help you figure out what you need to do to stay on the IRS’s good side when calculating RMD an inherited IRA. That's the "required minimum distribution," and it can get confusing!

Note: The information here pertains to Charles Schwab, eTrade and Ameritrade IRAs .... or even an inherited self-directed IRA (SDIRA) ... But, as always, you should check with someone on our team for the solution that will apply to you and your situation.  

What Is An IRA?

Let’s start from the beginning. An IRA, which is short for Individual Retirement Account, is a retirement savings account that is not provided by your employer. You open the account yourself and can contribute up to $6,000 a year of pre-tax income, or $7,000 a year if you're 50 or older. Yes, that means you don't get taxed on the money you invest in your IRA.

But since Uncle Sam is involved, of course you know there must be a catch. A traditional IRA allows you to make pre-tax contributions, but you will be subject to required minimum distributions after you turn 72, and any withdrawals you take will be taxed as ordinary income after age 59½. Since you're skipping taxes now and paying them later, traditional IRAs are called "tax-deferred retirement accounts".

Another type of popular retirement account, the Roth IRA, is NOT a tax-deferred account. With Roth IRAs, you pay your taxes up-front by investing post-tax dollars, so you aren't subject to required minimum distributions later in life.

How Do Required Minimum Distributions Work?

While you can invest pre-tax funds in an IRA, you'll eventually have to pay taxes on that income. For this reason, the IRS is going to start making you take money out of your account once you turn 72, so that they can tax you on your distributions. However, if you're still working, you can get out of taking distributions until you retire.

These mandatory annual withdrawals are fittingly called required minimum distributions, or RMDs for short. Your RMD requirement is calculated based on your age and the amount of money in your account.

Before 2020, the RMD age for IRAs was 70½, but when the SECURE Act passed in 2019, they raised the age to 72. If you turned 70½ before January 1, 2020, you may be subject to RMDs. A tax advisor can tell you if you are required to take RMDs now or when you turn 72.

If you try to skip an RMD, you can receive a whopping 50% tax penalty from the IRS. However, you may be able to receive an RMD Penalty Waiver to avoid IRS penalties under certain circumstances.

Inheriting IRAs

Upon an IRA owner's death, the remaining balance of the account will be inherited by their designated account beneficiary. The rules are different for spouse beneficiaries and non-spouse beneficiaries, so we'll talk about them separately.

A quick note before we get into the nitty-gritty of calculating these things. These rules apply to BOTH traditional IRAs and Roth IRAs. While the original account owner was not required to take RMDs from their Roth IRAs, if you inherit a Roth IRA and transfer the assets into an Inherited Roth IRA, you will be required to take RMDs. However, as long as the funds have been invested in the Roth IRA for at least five years, your RMDs will not be taxed.

Spouse Beneficiaries

If you inherit an IRA from your spouse, you have three options:

If you decide to treat the IRA as your own or roll over the balance into your own IRA, you would simply follow the regular RMD rules for your IRA. If you choose to transfer the balance into an inherited IRA, your RMD amount will be based on your age and be recalculated each year.

Non-Spouse Beneficiaries

If you inherit an IRA from someone who is not a spouse, you cannot roll the inherited balance into your own IRA and must transfer the balance to an Inherited IRA. 

If The Original Account Owner Died Before January 1, 2020

If the original account owner died before January 1, 2020 and was younger than 70½, you have two options:

However, if the original account owner was 70½ or older at the time of death, then you must receive RMDs over your lifetime.

If The Original Account Owner Died On January 1, 2020 Or Later

If the original account owner died on January 1, 2020, or later and you are not an eligible designated beneficiary, under the 10-year rule instituted by the SECURE Act, you must deplete the account within 10 years.

Eligible designated beneficiaries include:

Under the SECURE Act, eligible designated beneficiaries still have the option to take RMDs based on their life expectancy.

How To Calculate RMD For Inherited IRAs

RMDs for Inherited IRAs are calculated based on two factors:

Your life expectancy factor will be recalculated each year based on the IRS Single Life Expectancy Table. This table provides a life expectancy factor based on your current age. The older you are, the lower your life expectancy factor will be.

Once you determine the life expectancy factor for your age, you can do the following calculation:

Account Balance ÷ Life Expectancy Factor = RMD

You can also use an online RMD calculator to determine annual RMDs for you. We've linked a few good ones below:

Does A Revocable Trust File A Tax Return?

Where legal issues are concerned, the answers to most questions are  rarely simple. This blog post provides the full answer (the yes/no, the why, the exceptions and other related issues) to the question: Does a revocable trust file a tax return?

In transferring properties to beneficiaries, avoiding probate is one benefit that makes a revocable trust, also known as the grantor's trust, a better option than a simple will. Therefore, the property owner (the grantor) is saved the hassles of an expensive legal process of distributing the assets of a will (probate).

What Is A Revocable Trust?

A revocable trust a kind of living/land trust where the grantor can alter, amend, or cancel its provisions as they deem fit. The grantor has this power throughout his/her lifetime, after which it will be transferred to the beneficiary or beneficiaries, as stated in the trust. However, before this transfer, all income earned by the trust is owned by the grantor alone. The characteristic of the revocable trust to be solely alterable by the grantor is what makes it a grantor's trust.

What Is A Living Trust?

Another classification of trust instrumental to the question "Does a revocable trust file a tax return" is that of a living trust.

A living trust is a trust that is created while an individual (the grantor) is alive. Like with every other form of trust, a person is chosen to be responsible for managing the grantor's assets for the beneficiary's benefit. Living trusts are either revocable or irrevocable. Living revocable trusts are the point of focus in this post.

Why Use A Revocable Trust?

A revocable trust is an excellent alternative to a will. With a revocable trust, taxpayers can manage their assets and distribute them to whomever they choose as beneficiaries.

A revocable trust is great for estate planning because the grantor does not have to take his/her assets through the expensive and sometimes public probate process in the event of the grantor's death.

Revocable Trust Taxes

The effect of a revocable trust on tax liability is rather interesting. In a revocable trust, the grantor retains the right to receive the trust's income and principal (because of his power to manage his assets).

Consequently, the Internal Revenue Service views a revocable trust as a grantor's trust and, therefore, not a separate entity. The income from a revocable trust is not reported separately; instead, it must be reported on the grantor's personal tax return.

Does A Revocable Trust Need To File A Tax Return?

Having understood the characteristics of the revocable trust, people want to know the tax implications and the question that pops up in the mind of many, more often than not, is "Does a trust need to file a tax return?" A revocable trust or grantor's trust is a land trust, an agreement between two individuals: the property owner and the beneficiary. Before the grantor's death, taxes paid over the assets and their capital gains are made by the grantor. As seen on the Internal Revenue Service website, the grantor has to correctly input the taxes in the Form 1040 if he is the trustee:

The effect of this is that the trust will not exist for tax purposes as long as it remains a Grantor trust.

Taxes After Death

Upon the death of the owner, the trust changes entirely and becomes an irrevocable trust. The closest explanation that can be given for this is the testamentary trust, a type of irrevocable land trust. Once the grantor is dead, his rights over the trust properties are automatically transferred to the beneficiaries.

However, for proper distribution, a  trustee specified in the trust documents gets all the powers and rights the grantor used to possess. This trustee might be one of the beneficiaries. The revocable trust taxes will then be known as irrevocable trust taxes, and these are the kinds of taxes that require the filing of a tax return. The process to be carried out by the specified trustee is as follows.

Land Trusts, Living Trusts & Standard Trusts

A living trust is a trust that is helpful in avoiding probate. The name of the trust, living trust, comes from the fact that decisions about how a person's properties will be distributed are made while they are alive. Land trust means the same thing, except the properties involved are real estate or related assets. 

Both the land trust and living trust have revocable and irrevocable types and similar benefits, distinguishing land trust when you have a land trust vs. standard trust comparison.

Conclusion

 

What Is The Difference Between A Single Member LLC And A Sole Proprietorship?

If you are looking to start a real estate investing business, you should be familiar with two popular business structures at your disposal. 

These are Single Member Limited Liability Companies (SMLLC) and Sole Proprietorships.

Both options can help you get your business off the ground, but it is worth considering the protections and future commercial growth you can achieve with each. Sole Proprietorships offer simplicity and ease of creation, and an SMLLC is advantageous if you are looking for a legal limitation of liability and the flexibility to change tax status as you grow.

Starting a Business: Giving Structure To Your Idea

Though it may begin with an idea, the successful establishment of a profitable business requires a suitable legal framework for hiring employees, purchasing capital, and saving money all while keeping the taxman happy. In this regard, many legal entities (including both a Sole Proprietorship and an SMLLC) are able to perform these basic functions and the difference comes in the advantages each provides.

What Is a Sole Proprietorship?

Put in the simplest of terms, a Sole Proprietorship is when you yourself take on the responsibilities and benefits of running a business. While you can use your own name, it is better to take on a trade name. Forming an LLC can be done by filing the name with the clerk in your county for a nominal fee.

Depending on the type of business you intend to run, you will need to acquire the necessary licenses and permits. If you wish to hire employees you will need an Employer Identification Number as well. All of these may come with certain fees but nevertheless the whole process is easily the cheapest method of setting up a business.

In addition to its low cost, there are certain tax advantages afforded to a Sole Proprietorship, (this will be expanded on later) and this, combined with its simple set up process, makes it an attractive option.

What Is a Single Member Limited Liability Company (SMLLC)?

In Texas, it is permitted to establish a Limited Liability Company (LLC) with a single owner (referred to as a ‘member’). Although there are many types of LLCs, they all have the benefit of limiting liability for their members. Of course, this is a huge advantage as you will not be at risk for the LLC’s debts and conversely, the LLC will also not be liable for your personal liabilities.

Since it is a sort of hybrid between partnerships and corporations, LLCs have a certain relaxed level of formality when compared with traditional corporations. This is ideal for smaller business operations who want a streamlined process while also getting the perception of credibility that comes with being a company.

Setting up your SMLLC will be a bit more of an involved process than a Sole Proprietorship. You will need to file Articles of Organization for your new LLC with the state and then draft an Operating Agreement to ensure the maximum possible benefits are made available.

Shared Benefits Between Between A Single Member LLC And A Sole Proprietorship

While both a Sole Proprietorship and a single member LLC are subject to a self-employment tax, overall the tax burden can be reduced by taking advantage of pass-through taxation. In short, pass-through taxation is when the profits pass through the business, in this case, either a Sole Proprietorship or a SMLLC, and is taxed as part of your personal income tax return. Since you can deduct expenses including up to half of the self employment tax, you can greatly reduce the amount of tax you need to pay.

Additional Advantages of The Single-Member LLC

As expected given its popularity, the SMLLC does afford some additional benefits over the Sole Proprietorship model. For many, the limited liability provided by an SMLLC is the most attractive feature as it allows for separation between personal affairs and those of the LLC. For this reason, although not required, having an Operations Agreement for your SMLLC will effectively separate your affairs from those of the LLC.

Furthermore, an LLC has further tax flexibility as it can opt to be taxed as a Sole Proprietorship (as explained above), as a partnership or as a corporation. As your business grows, having these options is of great benefit to make your tax burden as efficient as possible.

For enterprising individuals, trading as a Sole Proprietorship or using an SMLLC are attractive options due to the pass through tax feature. While they differ in the legal protections offered, the creation process, and the level of tax flexibility, it is worthwhile to consider seeking competent advice to determine which one is right for you.